\[4830-01-p\]

DEPARTMENT OF TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

\[TD 9075\]

RIN 1545-AX52

Compensation Deferred Under Eligible Deferred Compensation Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations that provide guidance
on deferred compensation plans of state and local governments and
tax-exempt entities. The regulations reflect the changes made to section
457 by the Tax Reform Act of 1986, the Small Business Job Protection Act
of 1996, the Taxpayer Relief Act of 1997, the Economic Growth and Tax
Relief Reconciliation Act of 2001, the Job Creation and Worker
Assistance Act of 2002, and other legislation. The regulations also make
various technical changes and clarifications to the existing final
regulations on many discrete issues. These regulations provide the
public with guidance necessary to comply with the law and will affect
plan sponsors, administrators, participants, and beneficiaries.

DATES: Effective Date: July 11, 2003.

[Applicability Date]{.underline}: These regulations apply to taxable
years beginning after December 31, 2001. See "Effective date of the
regulations" for additional information concerning the applicability of
these regulations.

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

SUPPLEMENTARY INFORMATION:

**Paperwork Reduction Act**

The collection of information contained in these final regulations has
been reviewed and approved by the Office of Management and Budget in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545‑1580. Responses to this collection of information
are mandatory.

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

The estimated burden per respondent varies from .033 hour to 2 hours per
trust established depending upon individual respondents' circumstances,
with an estimated average of one hour for each trust established, and
from 20 hours to 50 hours per application for approval as a custodian
with an estimated average of 35 hours for each application submitted to
qualify as a custodian.

Comments concerning the accuracy of this burden estimate and suggestions
for reducing this burden should be sent to the **Internal Revenue
Service**, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP
Washington, DC 20224, and to the **Office of Management and Budget**,
Attn: Desk Officer for the Department of the Treasury, Office of
Information and Regulatory Affairs, Washington, DC 20503.

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

**Background**

Section 131 of the Revenue Act of 1978 (92 Stat. 2779) added section 457
to the Internal Revenue Code of 1954. On September 27, 1982, final
regulations (TD 7836, 1982-2 C.B. 91) under section 457 (the 1982
regulations) were published in the **Federal Register** (47 FR 42335).
The 1982 regulations provided guidance for complying with the changes to
the applicable tax law made by the Revenue Act of 1978 relating to
deferred compensation plans maintained by state and local governments
and rural electric cooperatives.

Section 1107 of the Tax Reform Act of 1986 (100 Stat. 2494) extended
section 457 to tax-exempt organizations. Section 6064 of the Technical
and Miscellaneous Act of 1988 (102 Stat. 3700) codified certain
exceptions for certain plans. Notice 88-68, 1988-1 C.B. 556, addressed
the treatment of nonelective deferred compensation of nonemployees, and
provided an exception under which section 457 does not to apply to
certain church plans.

Section 1404 of the Small Business Job Protection Act of 1996 (110 Stat.
1755) added section 457(g) which requires that section 457(b) plans
maintained by state and local government employers hold all plan assets
and income in trust, or in custodial accounts or annuity contracts
(described in section 401(f) of the Internal Revenue Code), for the
exclusive benefit of participants and beneficiaries.

Section 1071 of the Taxpayer Relief Act of 1997 (111 Stat. 788) permits
certain accrued benefits to be cashed out.

Sections 615, 631, 632, 634, 635, 641, 647, and 649 of the Economic
Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) (115 Stat. 38)
included increases in elective deferral limits, repeal of the rules
coordinating the section 457 plan limit with contributions to certain
other types of plans, catch-up contributions for individuals age 50 or
over, extension of qualified domestic relation order rules to section
457 plans, rollovers among various qualified plans, section 403(b)
contracts and individual retirement arrangements (IRAs), and transfers
to purchase service credits under governmental pension plans.

Section 411(o)(8) and (p)(5) of the Job Creation and Worker Assistance
Act of 2002 (116 Stat. 21) clarified certain provisions in EGTRRA
concerning section 457 plans, including the use of certain compensation
reduction elections to be taken into account in determining includible
compensation.

On May 8, 2002, a notice of proposed rulemaking (REG-105885-99) was
published in the **Federal Register** (67 FR 30826) to issue new
regulations under section 457, including amending the 1982 regulations
to conform them to the legislative changes that had been made to section
457 since 1982.

Following publication of the proposed regulations, comments were
received and a public hearing was held on August 28, 2002. After
consideration of the comments received, the proposed regulations are
adopted by this Treasury decision, subject to a number of changes that
are generally summarized below.

**Summary of Comments Received and Changes Made**

1\. [Excess Deferrals]{.underline}

The proposed regulations addressed the income tax treatment of excess
deferrals and the effect of excess deferrals on plan eligibility under
section 457(b). The proposed regulations provided that an eligible
governmental plan may self-correct and distribute excess deferrals and
continue to satisfy the eligibility requirements of section 457(b)
(including the distribution rules and the funding rules) by reason of a
distribution of excess deferrals. However, the proposed regulations
provided that if an excess deferral arose under an eligible plan of a
tax-exempt employer, the plan was no longer an eligible plan.

Commentators objected to the less favorable treatment for eligible plans
of tax-exempt employers.

After consideration of the comments received, the regulations extend
self-correction for excess deferrals to eligible plans of tax-exempt
employers. If there is an excess deferral under such plan, the plan may
distribute to a participant any excess deferrals (and any income
allocable to such amount) not later than the first April 15 following
the close of the taxable year of the excess deferrals, comparable to the
rules for qualified plans under section 402(g). In such a case, the plan
will continue to be treated as an eligible plan. However, in accordance
with section 457(c), any excess deferral is included in the gross income
of a participant for the taxable year of the excess deferral. If an
excess deferral is not corrected by distribution, the plan is an
ineligible plan under which benefits are taxable in accordance with
ineligible plan rules.

The income tax treatment and payroll tax reporting of distributions of
excess deferrals from eligible section 457(b) governmental plans are
similar to the treatment and reporting of distribution of excess
deferrals from tax-qualified plans. Such amounts should be reported on
Form 1099 and taxed in the year of distribution to the extent of
distributed earnings on the excess deferrals. For eligible section
457(b) tax-exempt plans, the excess deferrals are subject to income tax
in the year of distribution to the extent of distributed earnings on the
excess deferrals and such earnings should be reported on Form W-2 for
the year of distribution. See also Notice 2003-20, 2003-19 I.R.B. 894,
for information regarding the withholding and reporting requirements
applicable to eligible plans generally.

2\. [Aggregation Rules in the Proposed Regulations]{.underline}

The proposed regulations included several rules that aggregate multiple
plans for purposes of meeting the eligibility requirements of section
457(b). These regulations retain all of these rules. For example, the
regulations provide that in any case in which multiple plans are used to
avoid or evade the eligibility requirements under the regulations, the
Commissioner may apply the eligibility requirements as if the plans were
a single plan. Also, an eligible employer is required to have no more
than one normal retirement age for each participant under all of the
eligible plans it sponsors. In addition, all deferrals under all
eligible plans under which an individual participates by virtue of his
or her relationship with a single employer are treated as though
deferred under a single plan for purposes of determining excess
deferrals. Finally, annual deferrals under all eligible plans are
combined for purposes of determining the maximum deferral limits.

Few comments were received with respect to the aggregation rules under
the proposed regulations. However, one commentator requested that, where
it is determined that multiple eligible plans maintained by a single
employer, which have been aggregated pursuant to the proposed
regulations, contain excess deferrals, the employer have the ability to
disaggregate those plans solely for the purpose of either (1)
distributing the excess deferrals under the self-correcting mechanism or
(2) limiting the characterization of such plans as \"ineligible\" to the
one(s) that actually contain the excess deferrals. Taking into account
the ability for all eligible plans to self-correct by distribution,
these regulations retain without material revision the aggregation rules
that were in the proposed regulations.

3\. [Deferral of Sick, Vacation, and Back Pay]{.underline}

The proposed regulations would have allowed an eligible plan to permit
participants to elect to defer compensation, including accumulated sick
and vacation pay and back pay, only if an agreement providing for the
deferral is entered into before the beginning of the month in which the
amounts would otherwise be paid or made available and the participant is
an employee in that month. Comments requested that terminating
participants be allowed to elect deferral for accumulated sick and
vacation pay and back pay even if the participant is not employed at the
time of the deferral.

The final regulations retain the rule under which the deferral election
must be made during employment and before the beginning of the month
when the compensation would have been payable. However, the regulations
include a special rule that allows an election for sick pay, vacation
pay, or back pay that is not yet payable (subject of course to the
maximum deferral limitations of section 457 in the year of deferral).
Under the special rule, an employee who is retiring or otherwise having
a severance from employment during a month may nevertheless elect to
defer, for example, his or her unused vacation pay after the beginning
of the month, provided that the vacation pay would otherwise have been
payable before the employee has a severance from employment and the
election is made before the date on which the vacation pay would
otherwise have been payable.

4\. [Unforeseeable Emergency Distributions]{.underline}

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

5\. [Plan Terminations, Plan-to-Plan Transfers, and
Rollovers]{.underline}

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

a\. [Plan terminations]{.underline}

The regulations allow a plan to have provisions permitting plan
termination whereupon amounts can be distributed without violating the
distribution requirements of section 457. Under the regulations, an
eligible plan is terminated only if all amounts deferred under the plan
are paid to participants as soon as administratively practicable. If the
amounts deferred under the plan are not distributed, the plan is treated
as a frozen plan and must continue to comply with all of the applicable
statutory requirements necessary for plan eligibility.

b\. [Plan-to-plan transfers among eligible governmental plans and
purchase of permissive service credit by plan-to-plan
transfer]{.underline}

The proposed regulations would have allowed plan-to-plan transfers
between eligible governmental plans under new circumstances, as well as
the purchase of permissive service credits by transfer from an eligible
governmental plan to a governmental defined benefit plan, but only if
the transfers were made by plans within the same State. Commentators
objected to the requirement under the new transfer rules that the
transfers be to plans within the same State.

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

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

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

-   No severance from employment is required for a transfer from one
    eligible governmental plan of an employer to another eligible
    governmental plan of the same employer.

The final regulations also allow a plan-to-plan transfer from an
eligible governmental plan to a governmental defined benefit plan for
permissive service credit, without regard to whether the defined benefit
plan is maintained by a governmental entity that is in the same State.
In addition, language that was in an example which implied that section
415(n) (which addresses the application of maximum benefit limitations
with respect to certain contributions) might apply to such a transfer
has been eliminated because Treasury and the IRS have concluded that
section 415(n) does not apply to such a transfer in any case in which
the actuarial value of the benefit increase that results from the
transfer does not exceed the amount transferred.

c\. [Plan-to-plan transfers among eligible plans of tax-exempt
entities]{.underline}

The regulations retain the rule from the 1982 regulations allowing a
plan-to-plan transfer after a participant has had a severance from
employment.

d\. [Rollovers]{.underline}

The proposed regulations specified the treatment of amounts rolled into
or out of an eligible governmental plan and stated that amounts rolled
into the plan are treated as amounts deferred under the plan for
purposes of the regulations. Some commentators requested that
consideration be given to allowing eligible governmental plans to have
the same flexibility that they claimed was permitted for qualified plans
with respect to the timing of distributions of rolled-in assets.
Specifically, these commentators requested the ability for an eligible
governmental plan to allow a participant to receive a distribution of
rolled-in assets even though the participant may not yet be eligible for
a distribution of other assets held under the plan. Commentators pointed
out that, since section 402(c)(10) allows an eligible governmental plan
to accept a rollover contribution only if the rolled-in assets from
other plan types are separately accounted for (in order to apply the
section 72(t) early withdrawal income tax for distributions from these
assets), this ability should not cause administrative problems for plan
sponsors. Commentators also asserted that the flexibility to design an
eligible governmental plan to permit such distributions would be
beneficial to its participants.

These regulations do not permit an eligible governmental plan to
distribute rolled-in assets to a participant who is not yet eligible for
a distribution until future guidance of general applicability is
published that addresses this issue. Treasury and the IRS intend to
issue, in the near future, guidance of general applicability resolving
this issue in coordination with the applicable rules for qualified plans
and section 403(b) contracts.

Commentators also requested clarification on the order of accounts for
partial distributions to participants who have rolled-in assets that are
subject to the early withdrawal income tax. They requested that
consideration be given in final regulations to clarifying that the
participant may be treated as receiving a partial distribution first
from other plan assets to minimize the early withdrawal income tax that
would otherwise apply. These regulations clarify that, if a rollover is
received by an eligible governmental plan from an IRA, qualified plan,
or section 403(b) contract, then distributions from the eligible
governmental plan are subject to the early withdrawal income tax in
accordance with the plan's method of accounting, i.e., for purposes of
applying the section 72(t) early withdrawal income tax, a distribution
is treated as made from an eligible governmental plan's separate account
for rollovers from an IRA, qualified plan, or section 403(b) contract
only if the plan accounts for the distribution as a distribution from
that account. Thus, for example, an eligible governmental plan may
provide that any unforeseeable emergency withdrawal is made from other
accounts to the extent possible, in which event the early withdrawal tax
will not apply assuming that the plan only debits such other accounts to
reflect the distribution.

The proposed regulations had requested comments on the issue of separate
accounting for rolled-in amounts and asked if there are any special
characteristics that would be lost if multiple types of separate
accounts were not maintained. Commentators asked for the regulations to
permit maintenance of a single rollover account for all amounts that are
rolled into the eligible governmental plan. These regulations require
separate accounting only to the extent mandated by section 402(c)(10),
i.e., only for rollovers from IRAs, qualified plans and section 403(b)
contracts. Section 72(t)(9) provides that the early withdrawal income
tax applies to distributions from rollovers attributable to IRAs,
qualified plans, and section 403(b) contracts. Thus, if an eligible
governmental plan accepts a rollover [from another eligible governmental
plan]{.underline} of an amount that was originally deferred under an
eligible governmental plan and commingles that rollover in the same
separate account that includes a rollover amount from an IRA, qualified
plan, or section 403(b) contract, then distributions from that account
will be subject to the early withdrawal income tax. Accordingly, in
order to avoid this result, eligible governmental plans may choose to
establish [three separate accounts]{.underline} for a participant even
though these regulations only require that a single separate rollover
account be maintained for all amounts that are rolled into an eligible
governmental plan: first, an account for all amounts deferred under that
plan; second, an account for any rollover from another eligible
governmental plan (disregarding any amounts that originated from an IRA,
qualified plan, or section 403(b) contract); and third, an account for
any rollover amount from an IRA, qualified plan, or section 403(b)
contract (including any amounts rolled over from another eligible
governmental plan that originated from an IRA, qualified plan, or
section 403(b) contract). These regulations include an example
illustrating that the early withdrawal income tax would not apply to a
partial distribution from a plan with such accounts assuming that the
plan debits either of the first two such other accounts to reflect the
distribution.

6\. [Ineligible Plans]{.underline}

The proposed regulations included guidance regarding ineligible plans
under section 457(f). Section 457(f) generally provides that, in the
case of an agreement or arrangement for the deferral of compensation,
the deferred compensation is included in gross income when deferred or,
if later, when the rights to payment of the deferred compensation cease
to be subject to a substantial risk of forfeiture. Section 457(f) was in
section 457 when it was added to the Code in 1978 for governmental
employees, and extended to employees of tax-exempt organizations (other
than churches or certain church-controlled organizations) in 1986,
because unfunded amounts held by a tax-exempt entity compound tax free
like an eligible plan, a qualified plan, or a section 403(b) contract.
Section 457(f) was viewed as essential in order to provide an incentive
for employers that are not subject to income taxes to adopt an eligible
plan, a qualified plan, or a section 403(b) contract.[^1]

Section 457(f) does not apply to an eligible plan, a qualified plan, a
section 403(b) contract, a section 403(c) contract, a transfer of
property described in section 83, a trust to which section 402(b)
applies, or a qualified governmental excess benefit arrangement
described in section 415(m). The proposed regulations stated that
section 457(f) applies if the date on which there is no substantial risk
of forfeiture with respect to the compensation deferred precedes the
date on which there is a transfer of property to which section 83
applies. The proposed regulations included several examples, including
an example illustrating that section 457(f) does not fail to apply
merely because benefits are subsequently paid by a transfer of property.
Comments were requested on the coordination of sections 457(f) and 83
under the proposed regulations.

In response, a number of commentators objected to the proposed
coordination of sections 457(f) and 83, including arguing that the
proposed regulation would place tax-exempt organizations at a
competitive disadvantage when it comes to attracting and retaining
executive talent because it would effectively eliminate the use of
discounted mutual fund options as a tax effective component of total
compensation. Some commentators also asserted that the proposed
regulations were ambiguous as to their applicability to steeply
discounted mutual fund options, and recommended that, if the provision
is not removed, at a minimum future guidance should be more specific.

The final regulations retain the interpretation of the coordination of
sections 457(f) and 83 that was in the proposed regulations, and also
clarify the application of the rule by adding an example involving an
option grant. The regulations also include a clarification that, when
benefits are paid or made available under an ineligible plan, the amount
included in gross income is equal to the amount paid or made available,
but only to the extent that the amount exceeds the amount the
participant included in gross income when he or she obtained a vested
right to the benefit.

7\. [Severance Pay and Other Exceptions]{.underline}

In 2000, the IRS issued Announcement 2000-1 (2000-1 C.B. 294), which
provided interim guidance on certain broad-based, nonelective plans of a
state or local government that were in existence before 1999. Comments
were requested on arrangements, such as those maintained by certain
state or local governmental educational institutions, under which
supplemental compensation is payable as an incentive to terminate
employment, or as an incentive to retain retirement-eligible employees,
to ensure an appropriate workforce during periods in which a temporary
surplus or deficit in workforce is anticipated. Treasury and the IRS
continue to be interested in receiving comments on this issue, which
should be sent to the following address: Internal Revenue Service, Attn:
CC:DOM:CORP:R (Section 457 Plans), Room 5201, P. O. Box 7604, Ben
Franklin Station, Washington, D.C. 20044. Written comments may be hand
delivered Monday through Friday between 8 a.m. and 4 p.m. to: Internal
Revenue Service, Courier's Desk, Attn: CC:PA:RU (Section 457 Plans),
1111 Constitution Avenue, NW., Washington, DC 20224. Alternatively,
written comments may be submitted electronically via the Internet by
selecting the "Tax Regs" option on the IRS Home Page, or by submitting
them directly to the IRS Internet site at:
<http://www.irs.gov/tax_regs/reglist.html>[.]{.underline} Comments
should be received by October 9, 2003.

8\. [Effective Date of the Regulations]{.underline}

The proposed regulations included a general effective date under which
the regulations would have applied to taxable years beginning after
December 31, 2001. This is the general effective date for the changes
made in section 457 by EGTRRA. Commentators did not express concern
about this effective date and some commentators also stated that
eligible governmental plans have adopted plan amendments to address the
changes that have been allowed by EGTRRA, so that it would be
appropriate to have the final regulations effective date coincide with
the effective date for EGTRRA.

These regulations are generally applicable to taxable years beginning
after December 31, 2001, subject to certain specific transition rules.
Under one of these transition rules, for taxable years beginning after
December 31, 2001, and before January 1, 2004, a plan will not fail to
be an eligible plan if it is operated in accordance with a reasonable,
good faith interpretation of section 457(b). Whether a plan is operated
in accordance with a reasonable, good faith interpretation of section
457(b) will generally be determined based on all of the relevant facts
and circumstances, including the extent to which the employer has
resolved unclear issues in its favor. The regulations state that a plan
will be deemed to be operated in accordance with a reasonable, good
faith interpretation of section 457(b) if it is operated in accordance
with the terms of these regulations. The IRS will also deem a plan to be
operated in accordance with a reasonable, good faith interpretation of
section 457(b) if it is operated in accordance with the terms of the
1982 regulations as in effect for taxable years beginning before January
1, 2002 (to the extent those 1982 regulations are consistent with
subsequent changes in law, including EGTRRA) or in accordance with the
terms of the 2001 proposed regulations. However, a plan will be deemed
not to be operated in accordance with a reasonable, good faith
interpretation of section 457(b) if it is operated in a manner that is
inconsistent with the terms of the 1982 regulations as in effect for
taxable years beginning before January 1, 2002 (to the extent those 1982
regulations are consistent with subsequent changes in law, including
EGTRRA) except to the extent permitted under either these final
regulations or the 2001 proposed regulations.

Further, there is a special delayed effective date for the rule under
which an eligible governmental plan cannot distribute rollover account
benefits to a participant who is not yet eligible for a distribution.
Thus, this rule is not applicable until years beginning after December
31, 2003, since this issue is expected to be resolved before that date.

The regulations also retain the rule in the proposed regulations under
which the regulations do not apply with respect to an option that lacked
a readily ascertainable fair market value (within the meaning of section
83(e)(3)) at grant that was granted on or before May 8, 2002. Thus, the
status of such an option under section 457(f) would be determined
without regard to these regulations.

**Special Analyses**

It has been determined that this Treasury decision is not a significant
regulatory action as defined in Executive Order 12866. Therefore, a
regulatory assessment is not required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations. It is hereby certified that the
collection of information in these regulations will not have a
significant economic impact on a substantial number of small entities.
The collection of information in the regulations is in section
1.457-8(a)(3)(ii)(B) and consists of the requirement that a custodian of
a custodial account may be a person other than a bank only if the person
demonstrates to the satisfaction of the Commissioner that the manner in
which the person will administer the custodial account will be
consistent with the requirement of section 457(g)(1) and (3) of the
Code. This certification is based on the fact that the cost of
submitting this information is small, even for small entities.
Therefore, a Regulatory Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to
section 7805(f) of the Code, the notice of proposed rulemaking preceding
these regulations was submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.

**List of Subjects**

[26 CFR Part 1]{.underline}

Income taxes; Reporting and recordkeeping requirements.

[26 CFR Part 602]{.underline}

Reporting and recordkeeping requirements.

**Amendments to the Regulations**

Accordingly, 26 CFR part 1 is amended as follows:

PART 1\--INCOME TAXES

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

Authority: 26 U.S.C. 7805 \*

Par. 2. Sections 1.457-1, 1.457-2, 1.457-3 and 1.457-4 are revised to
read as follows:

[§1.457-1 General overviews of section 457]{.underline}.

Section 457 provides rules for nonqualified deferred compensation plans
established by eligible employers as defined under §1.457-2(d). Eligible
employers can establish either deferred compensation plans that are
eligible plans and that meet the requirements of section 457(b) and
§§1.457-3 through 1.457-10, or deferred compensation plans or
arrangements that do not meet the requirements of section 457(b) and
§§1.457-3 through 1.457-10 and that are subject to tax treatment under
section 457(f) and §1.457-11.

[§1.457-2 Definitions]{.underline}.

This section sets forth the definitions that are used under §§1.457-1
through 1.457-11.

\(a\) [Amount(s) deferred]{.underline}. [Amount(s) deferred]{.underline}
means the total annual deferrals under an eligible plan in the current
and prior years, adjusted for gain or loss. Except as provided at
§§1.457-4(c)(1)(iii) and 1.457-6(a), amount(s) deferred includes any
rollover amount held by an eligible plan as provided under §1.457-10(e).

\(b\) [Annual deferral(s)]{.underline}\--(1) [Annual
deferral(s)]{.underline} means, with respect to a taxable year, the
amount of compensation deferred under an eligible plan, whether by
salary reduction or by nonelective employer contribution. The amount of
compensation deferred under an eligible plan is taken into account as an
annual deferral in the taxable year of the participant in which
deferred, or, if later, the year in which the amount of compensation
deferred is no longer subject to a substantial risk of forfeiture.

\(2\) If the amount of compensation deferred under the plan during a
taxable year is not subject to a substantial risk of forfeiture, the
amount taken into account as an annual deferral is not adjusted to
reflect gain or loss allocable to the compensation deferred. If,
however, the amount of compensation deferred under the plan during the
taxable year is subject to a substantial risk of forfeiture, the amount
of compensation deferred that is taken into account as an annual
deferral in the taxable year in which the substantial risk of forfeiture
lapses must be adjusted to reflect gain or loss allocable to the
compensation deferred until the substantial risk of forfeiture lapses.

\(3\) If the eligible plan is a defined benefit plan within the meaning
of section 414(j), the annual deferral for a taxable year is the present
value of the increase during the taxable year of the participant's
accrued benefit that is not subject to a substantial risk of forfeiture
(disregarding any such increase attributable to prior annual deferrals).
For this purpose, present value must be determined using actuarial
assumptions and methods that are reasonable (both individually and in
the aggregate), as determined by the Commissioner.

\(4\) For purposes solely of applying § 1.457-4 to determine the maximum
amount of the annual deferral for a participant for a taxable year under
an eligible plan, the maximum amount is reduced by the amount of any
deferral for the participant under a plan described at paragraph
(k)(4)(i) of this section (relating to certain plans in existence before
January 1, 1987) as if that deferral were an annual deferral under
another eligible plan of the employer.

\(c\) [Beneficiary]{.underline}. [Beneficiary]{.underline} means a
person who is entitled to benefits in respect of a participant following
the participant's death or an alternate payee as described in
§1.457-10(c). (d) [Catch-up]{.underline}. [Catch-up]{.underline} amount
or [catch-up]{.underline} limitation for a participant for a taxable
year means the annual deferral permitted under section 414(v) (as
described in §1.457-4(c)(2)) or section 457(b)(3) (as described in
§1.457-4(c)(3)) to the extent the amount of the annual deferral for the
participant for the taxable year is permitted to exceed the plan ceiling
applicable under section 457(b)(2) (as described in §1.457-4(c)(1)).

\(e\) [Eligible employer]{.underline}. [Eligible employer]{.underline}
means an entity that is a State that establishes a plan or a tax-exempt
entity that establishes a plan. The performance of services as an
independent contractor for a State or local government or a tax-exempt
entity is treated as the performance of services for an eligible
employer. The term [eligible employer]{.underline} does not include a
church as defined in section 3121(w)(3)(A), a qualified
church-controlled organization as defined in section 3121(w)(3)(B), or
the Federal government or any agency or instrumentality thereof. Thus,
for example, a nursing home which is associated with a church, but which
is not itself a church (as defined in section 3121(w)(3)(A)) or a
qualified church-controlled organization as defined in section
3121(w)(3)(B)), would be an eligible employer if it is a tax-exempt
entity as defined in paragraph (m) of this section.

\(f\) [Eligible plan]{.underline}. An [eligible plan]{.underline} is a
plan that meets the requirements of §§1.457-3 through 1.457-10 that is
established and maintained by an eligible employer. An [eligible
governmental plan]{.underline} is an eligible plan that is established
and maintained by an eligible employer as defined in paragraph (l) of
this section. An arrangement does not fail to constitute a single
eligible governmental plan merely because the arrangement is funded
through more than one trustee, custodian, or insurance carrier. An
[eligible plan of a tax-exempt entity]{.underline} is an eligible plan
that is established and maintained by an eligible employer as defined in
paragraph (m) of this section.

\(g\) [Includible compensation]{.underline}. [Includible
compensation]{.underline} of a participant means, with respect to a
taxable year, the participant's compensation, as defined in section
415(c)(3), for services performed for the eligible employer. The amount
of includible compensation is determined without regard to any community
property laws.

\(h\) [Ineligible plan]{.underline}. [Ineligible plan]{.underline} means
a plan established and maintained by an eligible employer that is not
maintained in accordance with §§1.457-3 through 1.457-10. A plan that is
not established by an eligible employer as defined in paragraph (e) of
this section is neither an eligible nor an ineligible plan.

\(i\) [Nonelective employer contribution]{.underline}. A [nonelective
employer contribution]{.underline} is a contribution made by an eligible
employer for the participant with respect to which the participant does
not have the choice to receive the contribution in cash or property.
Solely for purposes of section 457 and §§1.457-2 through 1.457-11, the
term [nonelective employer contribution]{.underline} includes employer
contributions that would be described in section 401(m) if they were
contributions to a qualified plan.

\(j\) [Participant]{.underline}. [Participant]{.underline} in an
eligible plan means an individual who is currently deferring
compensation, or who has previously deferred compensation under the plan
by salary reduction or by nonelective employer contribution and who has
not received a distribution of his or her entire benefit under the
eligible plan. Only individuals who perform services for the eligible
employer, either as an employee or as an independent contractor, may
defer compensation under the eligible plan.

\(k\) [Plan]{.underline}. [Plan]{.underline} includes any agreement or
arrangement between an eligible employer and a participant or
participants (including an individual employment agreement) under which
the payment of compensation is deferred (whether by salary reduction or
by nonelective employer contribution). The following types of plans are
not treated as agreements or arrangement under which compensation is
deferred: a bona fide vacation leave, sick leave, compensatory time,
severance pay, disability pay, or death benefit plan described in
section 457(e)(11)(A)(i) and any plan paying length of service awards to
bona fide volunteers (and their beneficiaries) on account of qualified
services performed by such volunteers as described in section
457(e)(11)(A)(ii). Further, the term [plan]{.underline} does not include
any of the following (and section 457 and §§1.457-2 through 1.457-11 do
not apply to any of the following)\--

\(1\) Any nonelective deferred compensation under which all individuals
(other than those who have not satisfied any applicable initial service
requirement) with the same relationship with the eligible employer are
covered under the same plan with no individual variations or options
under the plan as described in section 457(e)(12), but only to the
extent the compensation is attributable to services performed as an
independent contractor;

\(2\) An agreement or arrangement described in §1.457-11(b);

\(3\) Any plan satisfying the conditions in section 1107(c)(4) of the
Tax Reform Act of 1986 (100 Stat. 2494) (TRA '86) (relating to certain
plans for State judges); and

\(4\) Any of the following plans or arrangements (to which specific
transitional statutory exclusions apply)\--

\(i\) A plan or arrangement of a tax-exempt entity in existence prior to
January 1, 1987, if the conditions of section 1107(c)(3)(B) of the TRA
'86, as amended by section 1011(e)(6) of Technical and Miscellaneous
Revenue Act of 1988 (102 Stat. 3700) (TAMRA), are satisfied (see §
1.457-2(b)(4) for a special rule regarding such plan);

\(ii\) A collectively bargained nonelective deferred a compensation plan
in effect on December 31, 1987, if the conditions of section 6064(d)(2)
of TAMRA are satisfied;

\(iii\) Amounts described in section 6064(d)(3) of TAMRA (relating to
certain nonelective deferred compensation arrangements in effect before
1989); and

\(iv\) Any plan satisfying the conditions in section 1107(c)(4) or (5)
of TRA '86 (relating to certain plans for certain individuals with
respect to which the Service issued guidance before 1977).

\(l\) [State]{.underline}. [State]{.underline} means a State (treating
the District of Columbia as a State as provided under section
7701(a)(10)), a political subdivision of a State, and any agency or
instrumentality of a State.

\(m\) [Tax-exempt entity]{.underline}. [Tax-exempt entity]{.underline}
includes any organization exempt from tax under subtitle A of the
Internal Revenue Code, except that a governmental unit (including an
international governmental organization) is not a tax-exempt entity.

\(n\) [Trust]{.underline}. [Trust]{.underline} means a trust described
under section 457(g) and §1.457-8. Custodial accounts and contracts
described in section 401(f) are treated as trusts under the rules
described in §1.457-8(a)(2).

[§ 1.457-3 General introduction to eligible plans]{.underline}.

\(a\) [Compliance in form and operation]{.underline}. An eligible plan
is a written plan established and maintained by an eligible employer
that is maintained, in both form and operation, in accordance with the
requirements of §§1.457-4 through 1.457-10. An eligible plan must
contain all the material terms and conditions for benefits under the
plan. An eligible plan may contain certain optional features not
required for plan eligibility under section 457(b), such as
distributions for unforeseeable emergencies, loans, plan-to-plan
transfers, additional deferral elections, acceptance of rollovers to the
plan, and distributions of smaller accounts to eligible participants.
However, except as otherwise specifically provided in §§1.457-4 through
1.457-10, if an eligible plan contains any optional provisions, the
optional provisions must meet, in both form and operation, the relevant
requirements under section 457 and §§1.457-2 through 1.457-10.

\(b\) [Treatment as single plan]{.underline}. In any case in which
multiple plans are used to avoid or evade the requirements of §§1.457-4
through 1.457-10, the Commissioner may apply the rules under §§1.457-4
through 1.457-10 as if the plans were a single plan. See also
§1.457-4(c)(3)(v) (requiring an eligible employer to have no more than
one normal retirement age for each participant under all of the eligible
plans it sponsors), the second sentence of §1.457-4(e)(2) (treating
deferrals under all eligible plans under which an individual
participates by virtue of his or her relationship with a single employer
as a single plan for purposes of determining excess deferrals), and
§1.457-5 (combining annual deferrals under all eligible plans).

[§1.457-4 Annual deferrals, deferral limitations, and deferral
agreements under eligible plans]{.underline}.

\(a\) [Taxation of annual deferrals]{.underline}. Annual deferrals that
satisfy the requirements of paragraphs (b) and (c) of this section are
excluded from the gross income of a participant in the year deferred or
contributed and are not includible in gross income until paid to the
participant in the case of an eligible governmental plan, or until paid
or otherwise made available to the participant in the case of an
eligible plan of a tax-exempt entity. See §1.457-7.

\(b\) [Agreement for deferral]{.underline}. In order to be an eligible
plan, the plan must provide that compensation may be deferred for any
calendar month by salary reduction only if an agreement providing for
the deferral has been entered into before the first day of the month in
which the compensation is paid or made available. A new employee may
defer compensation payable in the calendar month during which the
participant first becomes an employee if an agreement providing for the
deferral is entered into on or before the first day on which the
participant performs services for the eligible employer. An eligible
plan may provide that if a participant enters into an agreement
providing for deferral by salary reduction under the plan, the agreement
will remain in effect until the participant revokes or alters the terms
of the agreement. Nonelective employer contributions are treated as
being made under an agreement entered into before the first day of the
calendar month.

\(c\) [Maximum deferral limitations]{.underline}\--(1) [Basic annual
limitation]{.underline}. (i) Except as described in paragraphs (c)(2)
and (3) of this section, in order to be an eligible plan, the plan must
provide that the annual deferral amount for a taxable year (the plan
ceiling) may not exceed the lesser of\--

\(A\) The applicable annual dollar amount specified in section
457(e)(15): \$11,000 for 2002; \$12,000 for 2003; \$13,000 for 2004;
\$14,000 for 2005; and \$15,000 for 2006 and thereafter. After 2006, the
\$15,000 amount is adjusted for cost-of-living in the manner described
in paragraph (c)(4) of this section; or

\(B\) 100 percent of the participant\'s includible compensation for the
taxable year.

\(ii\) The amount of annual deferrals permitted by the 100 percent of
includible compensation limitation under paragraph (c)(1)(i)(B) of this
section is determined under section 457(e)(5) and §1.457-2(g).

\(iii\) For purposes of determining the plan ceiling under this
paragraph (c), the annual deferral amount does not include any rollover
amounts received by the eligible plan under §1.457-10(e).

\(iv\) The provisions of this paragraph (c)(1) are illustrated by the
following examples:

[Example 1]{.underline} (i) [Facts]{.underline}. Participant A, who
earns \$14,000 a year, enters into a salary reduction agreement in 2006
with A's eligible employer and elects to defer \$13,000 of A's
compensation for that year. Participant A is not eligible for the
catch-up described in paragraph (c)(2) or (3) of this section,
participates in no other retirement plan, and has no other income
exclusions taken into account in computing includible compensation.

\(ii\) [Conclusion]{.underline}. The annual deferral limit for A in 2006
is the lesser of \$15,000 or 100 percent of includible compensation,
\$14,000. A's annual deferral of \$13,000 is permitted under the plan
because it is not in excess of \$14,000 and thus does not exceed 100
percent of A's includible compensation.

[Example 2]{.underline}. (i) [Facts]{.underline}. Assume the same facts
as in [Example 1]{.underline}, except that A's eligible employer
provides an immediately vested, matching employer contribution under the
plan for participants who make salary reduction deferrals under A's
eligible plan. The matching contribution is equal to 100 percent of
elective contributions, but not in excess of 10 percent of compensation
(in A's case, \$1,400).

\(ii\) [Conclusion]{.underline}. Participant A's annual deferral exceeds
the limitations of this paragraph (c)(1). A's maximum deferral
limitation in 2006 is \$14,000. A's salary reduction deferral of
\$13,000 combined with A's eligible employer's nonelective employer
contribution of \$1,400 exceeds the basic annual limitation of this
paragraph (c)(1) because A's annual deferrals total \$14,400. A has an
excess deferral for the taxable year of \$400, the amount exceeding A's
permitted annual deferral limitation. The \$400 excess deferral is
treated as described in paragraph (e) of this section.

[Example 3]{.underline}. (i) [Facts]{.underline}. Beginning in year
2002, Eligible Employer X contributes \$3,000 per year for five years to
Participant B's eligible plan account. B's interest in the account vests
in 2006. B has annual compensation of \$50,000 in each of the five years
2002 through 2006. Participant B is 41 years old. B is not eligible for
the catch-up described in paragraph (c)(2) or (3) of this section,
participates in no other retirement plan, and has no other income
exclusions taken into account in computing includible compensation.
Adjusted for gain or loss, the value of B's benefit when B's interest in
the account vests in 2006 is \$17,000.

\(ii\) [Conclusion]{.underline}. Under this vesting schedule, \$17,000
is taken into account as an annual deferral in 2006. B's annual
deferrals under the plan are limited to a maximum of \$15,000 in 2006.
Thus, the aggregate of the amounts deferred, \$17,000, is in excess of
the B's maximum deferral limitation by \$2,000. The \$2,000 is treated
as an excess deferral described in paragraph (e) of this section.

\(2\) [Age 50 catch-up]{.underline}\--(i) [In general]{.underline}. In
accordance with section 414(v) and the regulations thereunder, an
eligible governmental plan may provide for catch-up contributions for a
participant who is age 50 by the end of the year, provided that such age
50 catch-up contributions do not exceed the catch-up limit under section
414(v)(2) for the taxable year. The maximum amount of age 50 catch-up
contributions for a taxable year under section 414(v) is as follows:
\$1,000 for 2002; \$2,000 for 2003; \$3,000 for 2004; \$4,000 for 2005;
and \$5,000 for 2006 and thereafter. After 2006, the \$5,000 amount is
adjusted for cost-of-living. For additional guidance, see regulations
under section 414(v).

\(ii\) [Coordination with special section 457 catch-up]{.underline}. In
accordance with sections 414(v)(6)(C) and 457(e)(18), the age 50
catch-up described in this paragraph (c)(2) does not apply for any
taxable year for which a higher limitation applies under the special
section 457 catch-up under paragraph (c)(3) of this section. Thus, for
purposes of this paragraph (c)(2)(ii) and paragraph (c)(3) of this
section, the special section 457 catch-up under paragraph (c)(3) of this
section applies for any taxable year if and only if the plan ceiling
taking into account paragraph (c)(1) of this section and the special
section 457 catch-up described in paragraph (c)(3) of this section (and
disregarding the age 50 catch-up described in this paragraph (c)(2)) is
larger than the plan ceiling taking into account paragraph (c)(1) of
this section and the age 50 catch-up described in this paragraph (c)(2)
(and disregarding the special section 457 catch-up described in
paragraph (c)(3) of this section). Thus, if a plan so provides, a
participant who is eligible for the age 50 catch-up for a year and for
whom the year is also one of the participant\'s last three taxable years
ending before the participant attains normal retirement age is eligible
for the larger of\--

\(A\) The plan ceiling under paragraph (c)(1) of this section and the
age 50 catch-up described in this paragraph (c)(2) (and disregarding the
special section 457 catch-up described in paragraph (c)(3) of this
section) or

\(B\) The plan ceiling under paragraph (c)(1) of this section and the
special section 457 catch-up described in paragraph (c)(3) of this
section (and disregarding the age 50 catch-up described in this
paragraph (c)(2)).

\(iii\) [Examples]{.underline}. The provisions of this paragraph (c)(2)
are illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. Participant C, who is
55, is eligible to participate in an eligible governmental plan in 2006.
The plan provides a normal retirement age of 65. The plan provides
limitations on annual deferrals up to the maximum permitted under
paragraphs (c)(1) and (3) of this section and the age 50 catch-up
described in this paragraph (c)(2). For 2006, C will receive
compensation of \$40,000 from the eligible employer. C desires to defer
the maximum amount possible in 2006. The applicable basic dollar limit
of paragraph (c)(1)(i)(A) of this section is \$15,000 for 2006 and the
additional dollar amount permitted under the age 50 catch-up is \$5,000
for 2006.

\(ii\) [Conclusion]{.underline}. C is eligible for the age 50 catch-up
in 2006 because C is 55 in 2006. However, C is not eligible for the
special section 457 catch-up under paragraph (c)(3) of this section in
2006 because 2006 is not one of the last three taxable years ending
before C attains normal retirement age. Accordingly, the maximum that C
may defer for 2006 is \$20,000.

[Example 2]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 1]{.underline}, except that, in 2006, C will attain age
62. The maximum amount that C can elect under the special section 457
catch-up under paragraph (c)(3) of this section is \$2,000 for 2006.

\(ii\) [Conclusion]{.underline}. The maximum that C may defer for 2006
is \$20,000. This is the sum of the basic plan ceiling under paragraph
(c)(1) of this section equal to \$15,000 and the age 50 catch-up equal
to \$5,000. The special section 457 catch-up under paragraph (c)(3) of
this section is not applicable since it provides a smaller plan ceiling.

[Example 3]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 2]{.underline}, except that the maximum additional amount
that C can elect under the special section 457 catch-up under paragraph
(c)(3) of this section is \$7,000 for 2006.

\(ii\) [Conclusion]{.underline}. The maximum that C may defer for 2006
is \$22,000. This is the sum of the basic plan ceiling under paragraph
(c)(1) of this section equal to \$15,000, plus the additional special
section 457 catch-up under paragraph (c)(3) of this section equal to
\$7,000. The additional dollar amount permitted under the age 50
catch-up is not applicable to C for 2006 because it provides a smaller
plan ceiling.

\(3\) [Special section 457 catch-up]{.underline}\--(i) [In
general]{.underline}. Except as provided in paragraph (c)(2)(ii) of this
section, an eligible plan may provide that, for one or more of the
participant\'s last three taxable years ending before the participant
attains normal retirement age, the plan ceiling is an amount not in
excess of the lesser of\--

\(A\) Twice the dollar amount in effect under paragraph (c)(1)(i)(A) of
this section; or

\(B\) The underutilized limitation determined under paragraph (c)(3)(ii)
of this section.

\(ii\) [Underutilized limitation]{.underline}. The underutilized amount
determined under this paragraph (c)(3)(ii) is the sum of\--

\(A\) The plan ceiling established under paragraph (c)(1) of this
section for the taxable year; plus (B) The plan ceiling established
under paragraph (c)(1) of this section (or under section 457(b)(2) for
any year before the applicability date of this section) for any prior
taxable year or years, less the amount of annual deferrals under the
plan for such prior taxable year or years (disregarding any annual
deferrals under the plan permitted under the age 50 catch-up under
paragraph (c)(2) of this section).

\(iii\) [Determining underutilized limitation under paragraph
(c)(3)(ii)(B) of this section]{.underline}. A prior taxable year is
taken into account under paragraph (c)(3)(ii)(B) of this section only if
it is a year beginning after December 31, 1978, in which the participant
was eligible to participate in the plan, and in which compensation
deferred (if any) under the plan during the year was subject to a plan
ceiling established under paragraph (c)(1) of this section. This
paragraph (c)(3)(iii) is subject to the special rules in paragraph
(c)(3)(iv) of this section.

\(iv\) [Special rules concerning application of the coordination limit
for years prior to 2002 for purposes of determining the underutilized
limitation]{.underline}\--(A) [General rule]{.underline}. For purposes
of determining the underutilized limitation for years prior to 2002,
participants remain subject to the rules in effect prior to the repeal
of the coordination limitation under section 457(c)(2). Thus, the
applicable basic annual limitation under paragraph (c)(1) of this
section and the special section 457 catch-up under this paragraph (c)(3)
for years in effect prior to 2002 are reduced, for purposes of
determining a participant's underutilized amount under a plan, by
amounts excluded from the participant's income for any prior taxable
year by reason of a nonelective employer contribution, salary reduction
or elective contribution under any other eligible section 457(b) plan,
or a salary reduction or elective contribution under any 401(k)
qualified cash or deferred arrangement, section 402(h)(1)(B) simplified
employee pension (SARSEP), section 403(b) annuity contract, and section
408(p) simple retirement account, or under any plan for which a
deduction is allowed because of a contribution to an organization
described in section 501(c)(18) (pre-2002 coordination plans).
Similarly, in applying the section 457(b)(2)(B) limitation for
includible compensation for years prior to 2002, the limitation is 33
1/3 percent of the participant's compensation includible in gross
income.

\(B\) [Coordination limitation applied to participant]{.underline}. For
purposes of determining the underutilized limitation for years prior to
2002, the coordination limitation applies to pre-2002 coordination plans
of all employers for whom a participant has performed services, whether
or not those are plans of the participant's current eligible employer.
Thus, for purposes of determining the amount excluded from a
participant's gross income in any prior taxable year under paragraph
(c)(3)(ii)(B) of this section, the participant's annual deferrals under
an eligible plan, and salary reduction or elective deferrals under all
other pre-2002 coordination plans, must be determined on an aggregate
basis. To the extent that the combined deferrals for years prior to 2002
exceeded the maximum deferral limitations, the amount is treated as an
excess deferral under paragraph (e) of this section for those prior
years.

\(C\) [Special rule where no annual deferrals under the eligible
plan]{.underline}. A participant who, although eligible, did not defer
any compensation under the eligible plan in any year before 2002 is not
subject to the coordinated deferral limit, even though the participant
may have deferred compensation under one of the other pre-2002
coordination plans. An individual is treated as not having deferred
compensation under an eligible plan for a prior taxable year if all
annual deferrals under the plan are distributed in accordance with
paragraph (e) of this section. Thus, to the extent that a participant
participated solely in one or more of the other pre-2002 coordination
plans during a prior taxable year (and not the eligible plan), the
participant is not subject to the coordinated limitation for that prior
taxable year. However, the participant is treated as having deferred an
amount in a prior taxable year, for purposes of determining the
underutilized limitation for that prior taxable year under this
paragraph (c)(3)(iv)(C), to the extent of the participant's aggregate
salary reduction contributions and elective deferrals under all pre-2002
coordination plans up to the maximum deferral limitations in effect
under section 457(b) for that prior taxable year. To the extent an
employer did not offer an eligible plan to an individual in a prior
given year, no underutilized limitation is available to the individual
for that prior year, even if the employee subsequently becomes eligible
to participate in an eligible plan of the employer.

\(D\) [Examples]{.underline}. The provisions of this paragraph
(c)(3)(iv) are illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. In 2001 and in years
prior to 2001, Participant D earned \$50,000 a year and was eligible to
participate in both an eligible plan and a section 401(k) plan. However,
D had always participated only in the section 401(k) plan and had always
deferred the maximum amount possible. For each year before 2002, the
maximum amount permitted under section 401(k) exceeded the limitation of
paragraph (c)(3)(i) of this section. In 2002, D is in the 3-year period
prior to D's attainment of the eligible plan's normal retirement age of
65, and D now wants to participate in the eligible plan and make annual
deferrals of up to \$30,000 under the plan's special section 457
catch-up provisions.

\(ii\) [Conclusion]{.underline}. Participant D is treated as having no
underutilized amount under paragraph (c)(3)(ii)(B) of this section for
2002 for purposes of the catch-up limitation under section 457(b)(3) and
paragraph (c)(3) of this section because, in each of the years before
2002, D has deferred an amount equal to or in excess of the limitation
of paragraph (c)(3)(i) of this section under all of D's coordinated
plans .

[Example 2]{.underline}. (i) [Facts]{.underline}. Assume the same facts
as in [Example 1]{.underline}, except that D only deferred \$2,500 per
year under the section 401(k) plan for one year before 2002.

\(ii\) [Conclusion]{.underline}. D is treated as having an underutilized
amount under paragraph (c)(3)(ii)(B) of this section for 2002 for
purposes of the special section 457 catch-up limitation. This is because
D has deferred an amount for prior years that is less than the
limitation of paragraph (c)(1)(i) of this section under all of D's
coordinated plans.

[Example 3]{.underline}. (i) [Facts]{.underline}. Participant E, who
earned \$15,000 for 2000, entered into a salary reduction agreement in
2000 with E's eligible employer and elected to defer \$3,000 for that
year under E's eligible plan. For 2000, E's eligible employer provided
an immediately vested, matching employer contribution under the plan for
participants who make salary reduction deferrals under E's eligible
plan. The matching contribution was equal to 67 percent of elective
contributions, but not in excess of 10 percent of compensation before
salary reduction deferrals (in E's case, \$1,000). For 2000, E was not
eligible for any catch-up contribution, participated in no other
retirement plan, and had no other income exclusions taken into account
in computing taxable compensation.

\(ii\) [Conclusion]{.underline}. Participant E's annual deferral equaled
the maximum limitation of section 457(b) for 2000. E's maximum deferral
limitation in 2000 was \$4,000 because E's includible compensation was
\$12,000 (\$15,000 minus the deferral of \$3,000) and the applicable
limitation for 2000 was one third of the individual's includible
compensation (one-third of \$12,000 equals \$4,000). E's salary
reduction deferral of \$3,000 combined with E's eligible employer's
matching contribution of \$1,000 equals the limitation of section 457(b)
for 2000 because E's annual deferrals totaled \$4,000. E's underutilized
amount for 2000 is zero.

\(v\) [Normal retirement age]{.underline}\--(A) [General
rule]{.underline}. For purposes of the special section 457 catch-up in
this paragraph (c)(3), a plan must specify the normal retirement age
under the plan. A plan may define normal retirement age as any age that
is on or after the earlier of age 65 or the age at which participants
have the right to retire and receive, under the basic defined benefit
pension plan of the State or tax-exempt entity (or a money purchase
pension plan in which the participant also participates if the
participant is not eligible to participate in a defined benefit plan),
immediate retirement benefits without actuarial or similar reduction
because of retirement before some later specified age, and that is not
later than age 70 ½. Alternatively, a plan may provide that a
participant is allowed to designate a normal retirement age within these
ages. For purposes of the special section 457 catch-up in this paragraph
(c)(3), an entity sponsoring more than one eligible plan may not permit
a participant to have more than one normal retirement age under the
eligible plans it sponsors.

\(B\) [Special rule for eligible plans of qualified police or
firefighters]{.underline}. An eligible plan with participants that
include qualified police or firefighters as defined under section
415(b)(2)(H)(ii)(I) may designate a normal retirement age for such
qualified police or firefighters that is earlier than the earliest
normal retirement age designated under the general rule of paragraph
(c)(3)(i)(A) of this section, but in no event may the normal retirement
age be earlier than age 40. Alternatively, a plan may allow a qualified
police or firefighter participant to designate a normal retirement age
that is between age 40 and age 70 ½.

\(vi\) [Examples]{.underline}. The provisions of this paragraph (c)(3)
are illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. Participant F, who
will turn 61 on April 1, 2006, becomes eligible to participate in an
eligible plan on January 1, 2006. The plan provides a normal retirement
age of 65. The plan provides limitations on annual deferrals up to the
maximum permitted under paragraphs (c)(1) through (3) of this section.
For 2006, F will receive compensation of \$40,000 from the eligible
employer. F desires to defer the maximum amount possible in 2006. The
applicable basic dollar limit of paragraph (c)(1)(i)(A) of this section
is \$15,000 for 2006 and the additional dollar amount permitted under
the age 50 catch-up in paragraph (c)(2) of this section for an
individual who is at least age 50 is \$5,000 for 2006.

\(ii\) [Conclusion]{.underline}. F is not eligible for the special
section 457 catch-up under paragraph (c)(3) of this section in 2006
because 2006 is not one of the last three taxable years ending before F
attains normal retirement age. Accordingly, the maximum that F may defer
for 2006 is \$20,000. See also paragraph (c)(2)(iii) [Example
1]{.underline} of this section.

[Example 2]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 1]{.underline} except that, in 2006, F elects to defer
only \$2,000 under the plan (rather than the maximum permitted amount of
\$20,000). In addition, assume that the applicable basic dollar limit of
paragraph (c)(1)(i)(A) of this section continues to be \$15,000 for 2007
and the additional dollar amount permitted under the age 50 catch-up in
paragraph (c)(2) of this section for an individual who is at least age
50 continues to be \$5,000 for 2007. In F\'s taxable year 2007, which is
one of the last three taxable years ending before F attains the plan's
normal retirement age of 65, F again receives a salary of \$40,000 and
elects to defer the maximum amount permissible under the plan\'s
catch-up provisions prescribed under paragraph (c) of this section.

\(ii\) [Conclusion]{.underline}. For 2007, which is one of the last
three taxable years ending before F attains the plan's normal retirement
age of 65, the applicable limit on deferrals for F is the larger of the
amount under the special section 457 catch-up or \$20,000, which is the
basic annual limitation (\$15,000) and the age 50 catch-up limit of
section 414(v) (\$5,000). For 2007, F's special section 457 catch-up
amount is the lesser of two times the basic annual limitation (\$30,000)
or the sum of the basic annual limitation (\$15,000) plus the \$13,000
underutilized limitation under paragraph (c)(3)(ii) of this section (the
\$15,000 plan ceiling in 2006, minus the \$2,000 contributed for F in
2006), or \$28,000. Thus, the maximum amount that F may defer in 2007 is
\$28,000.

[Example 3]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Examples 1]{.underline} and [2]{.underline}, except that F does
not make any contributions to the plan before 2010. In addition, assume
that the applicable basic dollar limitation of paragraph (c)(1)(i)(A) of
this section continues to be \$15,000 for 2010 and the additional dollar
amount permitted under the age 50 catch-up in paragraph (c)(2) of this
section for an individual who is at least age 50 continues to be \$5,000
for 2010. In F\'s taxable year 2010, the year in which F attains age 65
(which is the normal retirement age under the plan), F desires to defer
the maximum amount possible under the plan. F's compensation for 2010 is
again \$40,000.

\(ii\) [Conclusion]{.underline}. For 2010, the maximum amount that F may
defer is \$20,000. The special section 457 catch-up provisions under
paragraph (c)(3) of this section are not applicable because 2010 is not
a taxable year ending before the year in which F attains normal
retirement age.

\(4\) [Cost-of-living adjustment]{.underline}. For years beginning after
December 31, 2006, the \$15,000 dollar limitation in paragraph
(c)(1)(i)(A) of this section will be adjusted to take into account
increases in the cost-of-living. The adjustment in the dollar limitation
is made at the same time and in the same manner as under section 415(d)
(relating to qualified plans under section 401(a)), except that the base
period is the calendar quarter beginning July 1, 2005 and any increase
which is not a multiple of \$500 will be rounded to the next lowest
multiple of \$500.

\(d\) [Deferral of sick, vacation, and back pay under an eligible
plan]{.underline}\--(1) [In general]{.underline}. An eligible plan may
provide that a participant may elect to defer accumulated sick pay,
accumulated vacation pay, and back pay under an eligible plan if the
requirements of section 457(b) are satisfied. For example, the plan must
provide, in accordance with paragraph (b) of this section, that these
amounts may be deferred for any calendar month only if an agreement
providing for the deferral is entered into before the beginning of the
month in which the amounts would otherwise be paid or made available and
the participant is an employee in that month. In the case of accumulated
sick pay, vacation pay, or back pay that is payable before the
participant has a severance from employment, the requirements of the
preceding sentence are deemed to be satisfied if the agreement providing
for the deferral is entered into before the amount is currently
available (as defined in regulations under section 401(k)).

\(2\) [Examples]{.underline}. The provisions of this paragraph (d) are
illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. Participant G, who is
age 62 in 2003, is an employee who participates in an eligible plan
providing a normal retirement age of 65. Under the terms of G's
employer's eligible plan and G's sick leave plan, G may, during November
of 2003 (which is one of the three years prior to normal retirement
age), make a one-time election to contribute amounts representing
accumulated sick pay to the eligible plan in December of 2003 (within
the maximum deferral limitations). Alternatively, such amounts may
remain in the "bank" under the sick leave plan. No cash out of the sick
pay is available until the month in which a participant ceases to be
employed by the employer. The total value of G's accumulated sick pay
(determined, in accordance with the terms of the sick leave plan, by
reference to G's current salary) is \$4,000 in December of 2003.

\(ii\) [Conclusion]{.underline}. Under the terms of the eligible plan
and sick leave plan, G may elect before December of 2003 to defer the
\$4,000 value of accumulated sick pay under the eligible plan, provided
that G's other annual deferrals to the eligible plan for 2003, when
added to the \$4,000, do not exceed G's maximum deferral limitation for
the year.

[Example 2]{.underline}. (i) [Facts.]{.underline} Same facts as in
[Example 1]{.underline}, except that G will separate from service on
January 17, 2004, and elects, on January 4, 2004, to defer G's
accumulated sick and vacation pay (which totals \$12,000) that is
payable on January 15, 2004.

\(ii\) [Conclusion]{.underline}. G may elect before January 15, 2004 to
defer the accumulated sick and vacation pay under the eligible plan,
even if the election is made after the beginning of January, because the
agreement providing for the deferral is entered into before the amount
is currently available and G does not cease to be an employee before the
amount is currently available. G will have \$12,000 of includible
compensation in 2004 because the deferral is taken into account in the
definition of includible compensation.

[Example 3]{.underline}. (i) [Facts]{.underline}. Employer X maintains
an eligible plan and a vacation leave plan. Under the terms of the
vacation leave plan, employees generally accrue three weeks of vacation
per year. Up to one week's unused vacation may be carried over from one
year to the next, so that in any single year an employee may have a
maximum of four weeks vacation time. At the beginning of each calendar
year, under the terms of the eligible plan (which constitutes an
agreement providing for the deferral), the value of any unused vacation
time from the prior year in excess of one week is automatically
contributed to the eligible plan, to the extent of the employee's
maximum deferral limitations. Amounts in excess of the maximum deferral
limitations are forfeited.

\(ii\) [Conclusion]{.underline}. The value of the unused vacation pay
contributed to X's eligible plan pursuant to the terms of the plan and
the terms of the vacation leave plan is treated as an annual deferral to
the eligible plan in the calendar year the contribution is made. No
amounts contributed to the eligible plan will be considered made
available to a participant in X's eligible plan.

\(e\) [Excess deferrals under an eligible plan]{.underline}\--(1) [In
general]{.underline}. Any amount deferred under an eligible plan for the
taxable year of a participant that exceeds the maximum deferral
limitations set forth in paragraphs (c)(1) through (3) of this section,
and any amount that exceeds the individual limitation under §1.457-5,
constitutes an excess deferral that is taxable in accordance with
§1.457-11 for that taxable year. Thus, an excess deferral is includible
in gross income in the taxable year deferred or, if later, the first
taxable year in which there is no substantial risk of forfeiture.

\(2\) [Excess deferrals under an eligible governmental plan other than
as a result of the individual limitation.]{.underline} In order to be an
eligible governmental plan, the plan must provide that any excess
deferral resulting from a failure of a plan to apply the limitations of
paragraphs (c)(1) through (3) of this section to amounts deferred under
the eligible plan (computed without regard to the individual limitation
under §1.457-5) will be distributed to the participant, with allocable
net income, as soon as administratively practicable after the plan
determines that the amount is an excess deferral. For purposes of
determining whether there is an excess deferral resulting from a failure
of a plan to apply the limitations of paragraphs (c)(1) through (3) of
this section, all plans under which an individual participates by virtue
of his or her relationship with a single employer are treated as a
single plan (without regard to any differences in funding). An eligible
governmental plan does not fail to satisfy the requirements of
paragraphs (a) through (d) of this section or §§1.457-6 through 1.457-10
(including the distribution rules under §1.457-6 and the funding rules
under §1.457-8) solely by reason of a distribution made under this
paragraph (e)(2). If such excess deferrals are not corrected by
distribution under this paragraph (e)(2), the plan will be an ineligible
plan under which benefits are taxable in accordance with §1.457-11.

\(3\) [Excess deferrals under an eligible plan of a tax-exempt employer
other than as a result of the individual limitation.]{.underline} If a
plan of a tax-exempt employer fails to comply with the limitations of
paragraphs (c)(1) through (3) of this section, the plan will be an
ineligible plan under which benefits are taxable in accordance with
§1.457-11. However, a plan may distribute to a participant any excess
deferrals (and any income allocable to such amount) not later than the
first April 15 following the close of the taxable year of the excess
deferrals. In such a case, the plan will continue to be treated as an
eligible plan. However, any excess deferral is included in the gross
income of a participant for the taxable year of the excess deferral. If
the excess deferrals are not corrected by distribution under this
paragraph (e)(3), the plan is an ineligible plan under which benefits
are taxable in accordance with §1.457-11. For purposes of determining
whether there is an excess deferral resulting from a failure of a plan
to apply the limitations of paragraphs (c)(1) through (3) of this
section, all eligible plans under which an individual participates by
virtue of his or her relationship with a single employer are treated as
a single plan.

\(4\) [Excess deferrals arising from application of the individual
limitation]{.underline}. An eligible plan may provide that an excess
deferral that is a result solely of a failure to comply with the
individual limitation under §1.457-5 for a taxable year may be
distributed to the participant, with allocable net income, as soon as
administratively practicable after the plan determines that the amount
is an excess deferral. An eligible plan does not fail to satisfy the
requirements of paragraphs (a) through (d) of this section or §§1.457-6
through 1.457-10 (including the distribution rules under §1.457-6 and
the funding rules under §1.457-8) solely by reason of a distribution
made under this paragraph (e)(4). Although a plan will still maintain
eligible status if excess deferrals are not distributed under this
paragraph (e)(4), a participant must include the excess amounts in
income as provided in paragraph (e)(1) of this section.

\(5\) [Examples]{.underline}. The provisions of this paragraph (e) are
illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. In 2006, the eligible
plan of State Employer X in which Participant H participates permits a
maximum deferral of the lesser of \$15,000 or 100 percent of includible
compensation. In 2006, H, who has compensation of \$28,000, nevertheless
defers \$16,000 under the eligible plan. Participant H is age 45 and
normal retirement age under the plan is age 65. For 2006, the applicable
dollar limit under paragraph (c)(1)(i)(A) of this section is \$15,000.
Employer X discovers the error in January of 2007 when it completes H's
2006 Form W-2 and promptly distributes \$1,022 to H (which is the sum of
the \$1,000 excess and \$22 of allocable net income).

\(ii\) [Conclusion]{.underline}. Participant H has deferred \$1,000 in
excess of the \$15,000 limitation provided for under the plan for 2006.
The \$1,000 excess must be included by H in H's income for 2006. In
order to correct the failure and still be an eligible plan, the plan
must distribute the excess deferral, with allocable net income, as soon
as administratively practicable after determining that the amount
exceeds the plan deferral limitations. In this case, \$22 of the
distribution of \$1,022 is included in H's gross income for 2007 (and is
not an eligible rollover distribution). If the excess deferral were not
distributed, the plan would be an ineligible plan with respect to which
benefits are taxable in accordance with §1.457-11.

[Example 2]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 1]{.underline}, except that X uses a number of separate
arrangements with different trustees and annuity insurers to permit
employees to defer and H elects deferrals under several of the funding
arrangements none of which exceeds \$15,000 for any individual funding
arrangement, but which total \$16,000.

\(ii\) [Conclusion]{.underline}. The conclusion is the same as in
[Example 1]{.underline}.

[Example 3]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 1]{.underline}, except that H's deferral under the
eligible plan is limited to \$11,000 and H also makes a salary reduction
contribution of \$5,000 to an annuity contract under section 403(b) with
the same Employer X.

\(ii\) [Conclusion]{.underline}. H's deferrals are within the plan
deferral limitations of Employer X. Because of the repeal of the
application of the coordination limitation under former paragraph (2) of
section 457(c), H's salary reduction deferrals under the annuity
contract are no longer considered in determining H's applicable deferral
limits under paragraphs (c)(1) through (3) of this section.

[Example 4]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 1]{.underline}, except that H's deferral under the
eligible governmental plan is limited to \$14,000 and H also makes a
deferral of \$4,000 to an eligible governmental plan of a different
employer. Participant H is age 45 and normal retirement age under both
eligible plans is age 65.

\(ii\) [Conclusion]{.underline}. Because of the application of the
individual limitation under §1.457-5, H has an excess deferral of
\$3,000 (the sum of \$14,000 plus \$4,000 equals \$18,000, which is
\$3,000 in excess of the dollar limitation of \$15,000). The \$3,000
excess deferral, with allocable net income, may be distributed from
either plan as soon as administratively practicable after determining
that the combined amount exceeds the deferral limitations. If the
\$3,000 excess deferral is not distributed to H, each plan will continue
to be an eligible plan, but the \$3,000 must be included by H in H's
income for 2006.

[Example 5]{.underline}. (i) [Facts]{.underline}. Assume the same facts
as in [Example 3]{.underline} , except that H's deferral under the
eligible governmental plan is limited to \$14,000 and H also makes a
deferral of \$4,000 to an eligible plan of Employer Y, a tax-exempt
entity.

\(ii\) [Conclusion]{.underline}. The results are the same as in [Example
3]{.underline}, namely, because of the application of the individual
limitation under §1.457-5, H has an excess deferral of \$3,000. If the
\$3,000 excess deferral is not distributed to H, each plan will continue
to be an eligible plan, but the \$3,000 must be included by H in H's
income for 2006.

[Example 6]{.underline}. (i) Facts. Assume the same facts as in [Example
5]{.underline}, except that X is a tax-exempt entity and thus its plan
is an eligible plan of a tax-exempt entity.

\(ii\) [Conclusion.]{.underline} The results are the same as in Example
5, namely, because of the application of the individual limitation under
§1.457-5, H has an excess deferral of \$3,000. If the \$3,000 excess
deferral is not distributed to H, each plan will continue to be an
eligible plan, but the \$3,000 must be included by H into H's income for
2006.

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

[§1.457-5 Individual limitation for combined annual deferrals under
multiple eligible plans]{.underline}

\(a\) [General rule]{.underline}. The individual limitation under
section 457(c) and this section equals the basic annual deferral
limitation under §1.457-4(c)(1)(i)(A), plus either the age 50 catch-up
amount under §1.457-4(c)(2), or the special section 457 catch-up amount
under §1.457-4(c)(3), applied by taking into account the combined annual
deferral for the participant for any taxable year under all eligible
plans. While an eligible plan may include provisions under which it will
limit deferrals to meet the individual limitation under section 457(c)
and this section, annual deferrals by a participant that exceed the
individual limit under section 457(c) and this section (but do not
exceed the limits under § 1.457-4(c)) will not cause a plan to lose its
eligible status. However, to the extent the combined annual deferrals
for a participant for any taxable year exceed the individual limitation
under section 457(c) and this section for that year, the amounts are
treated as excess deferrals as described in §1.457-4(e).

\(b\) [Limitation applied to participant]{.underline}. The individual
limitation in this section applies to eligible plans of all employers
for whom a participant has performed services, including both eligible
governmental plans and eligible plans of a tax-exempt entity and both
eligible plans of the employer and eligible plans of other employers.
Thus, for purposes of determining the amount excluded from a
participant's gross income in any taxable year (including the
underutilized limitation under §1.457-4 (c)(3)(ii)(B)), the
participant's annual deferral under an eligible plan, and the
participant's annual deferrals under all other eligible plans, must be
determined on an aggregate basis. To the extent that the combined annual
deferral amount exceeds the maximum deferral limitation applicable under
§1.457-4 (c)(1)(i)(A), (c)(2), or (c)(3), the amount is treated as an
excess deferral under §1.457-4(e).

\(c\) [Special rules for catch-up amounts under multiple eligible
plans]{.underline}. For purposes of applying section 457(c) and this
section, the special section 457 catch-up under §1.457-4 (c)(3) is taken
into account only to the extent that an annual deferral is made for a
participant under an eligible plan as a result of plan provisions
permitted under §1.457-4 (c)(3). In addition, if a participant has
annual deferrals under more than one eligible plan and the applicable
catch-up amount under §1.457-4 (c)(2) or (3) is not the same for each
such eligible plan for the taxable year, section 457(c) and this section
are applied using the catch-up amount under whichever plan has the
largest catch-up amount applicable to the participant.

\(d\) [Examples]{.underline}. The provisions of this section are
illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. Participant F is age
62 in 2006 and participates in two eligible plans during 2006, Plans J
and K, which are each eligible plans of two different governmental
entities. Each plan includes provisions allowing the maximum annual
deferral permitted under §1.457-4(c)(1) through (3). For 2006, the
underutilized amount under §1.457-4 (c)(3)(ii)(B) is \$20,000 under Plan
J and is \$40,000 under Plan K. Normal retirement age is age 65 under
both plans. Participant F defers \$15,000 under each plan. Participant
F's includible compensation is in each case in excess of the deferral.
Neither plan designates the \$15,000 contribution as a catch-up
permitted under each plan's special section 457 catch-up provisions.

\(ii\) [Conclusion]{.underline}. For purposes of applying this section
to Participant F for 2006, the maximum exclusion is \$20,000. This is
equal to the sum of \$15,000 plus \$5,000, which is the age 50 catch-up
amount. Thus, F has an excess amount of \$10,000 which is treated as an
excess deferral for Participant F for 2006 under §1.457-4(e).

[Example 2]{.underline}. (i) [Facts]{.underline}. Participant E, who
will turn 63 on April 1, 2006, participates in four eligible plans
during 2006: Plan W which is an eligible governmental plan; and Plans X,
Y, and Z which are each eligible plans of three different tax-exempt
entities. For 2006, the limitation that applies to Participant E under
all four plans under §1.457-4 (c)(1)(i)(A) is \$15,000. For 2006, the
additional age 50 catch-up limitation that applies to Participant E
under all four plans under §1.457-4 (c)(2) is \$5,000. Further, for
2006, different limitations under §1.457-4(c)(3) and (c)(3)(ii)(B) apply
to Participant E under each of these plans, as follows: under Plan W,
the underutilized limitation under §1.457-4 (c)(3)(ii)(B) is \$7,000;
under Plan X, the underutilized limitation under §1.457-4 (c)(3)(ii)(B)
is \$2,000; under Plan Y, the underutilized limitation under §1.457-4
(c)(3)(ii)(B) is \$8,000; and under Plan Z, §1.457-4 (c)(3) is not
applicable since normal retirement age is age 62 under Plan Z.
Participant E's includible compensation is in each case in excess of any
applicable deferral.

\(ii\) [Conclusion]{.underline}. For purposes of applying this section
to Participant E for 2006, Participant E could elect to defer \$23,000
under Plan Y, which is the maximum deferral limitation under §1.457-4
(c)(1) through (3), and to defer no amount under Plans W, X, and Z. The
\$23,000 maximum amount is equal to the sum of \$15,000 plus \$8,000,
which is the catch-up amount applicable to Participant E under Plan Y
and which is the largest catch-up amount applicable to Participant E
under any of the four plans for 2006. Alternatively, Participant E could
instead elect to defer the following combination of amounts: an
aggregate total of \$20,000 to any of the four plans; or \$22,000 to
Plan W and none to any of the other three plans.

\(iii\) If the underutilized amount under Plans W, X, and Y for 2006
were in each case zero (because E had always contributed the maximum
amount or E was a new participant) or an amount not in excess of
\$5,000, the maximum exclusion under this section would be \$20,000 for
Participant E for 2006 (\$15,000 plus the \$5,000 age 50 catch-up
amount), which Participant E could contribute to any of the plans.

[§1.457-6 Timing of distributions under eligible plans]{.underline}.

\(a\) [In general]{.underline}. Except as provided in paragraph (c) of
this section (relating to distributions on account of an unforeseeable
emergency), paragraph (e) of this section (relating to distributions of
small accounts), §1.457-10(a) (relating to plan terminations), or
§1.457-10(c) (relating to domestic relations orders), amounts deferred
under an eligible governmental plan may not be paid to a participant or
beneficiary before the participant has a severance from employment with
the eligible employer or when the participant attains age 70 ½ , if
earlier. For rules relating to loans, see paragraph (f) of this section.
This section does not apply to distributions of excess amounts under §
1.457-4(e). However, except to the extent set forth by the Commissioner
in revenue rulings, notices, and other guidance published in the
Internal Revenue Bulletin, this section applies to amounts held in a
separate account for eligible rollover distributions maintained by an
eligible governmental plan as described in § 1.457-10(e)(2).

\(b\) [Severance from employment]{.underline}\--(1)
[Employees]{.underline}. An employee has a severance from employment
with the eligible employer if the employee dies, retires, or otherwise
has a severance from employment with the eligible employer. See
regulations under section 401(k) for additional guidance concerning
severance from employment.

\(2\) [Independent contractors]{.underline}\--(i) [In
general]{.underline}. An independent contractor is considered to have a
severance from employment with the eligible employer upon the expiration
of the contract (or in the case of more than one contract, all
contracts) under which services are performed for the eligible employer
if the expiration constitutes a good-faith and complete termination of
the contractual relationship. An expiration does not constitute a good
faith and complete termination of the contractual relationship if the
eligible employer anticipates a renewal of a contractual relationship or
the independent contractor becoming an employee. For this purpose, an
eligible employer is considered to anticipate the renewal of the
contractual relationship with an independent contractor if it intends to
contract again for the services provided under the expired contract, and
neither the eligible employer nor the independent contractor has
eliminated the independent contractor as a possible provider of services
under any such new contract. Further, an eligible employer is considered
to intend to contract again for the services provided under an expired
contract if the eligible employer\'s doing so is conditioned only upon
incurring a need for the services, the availability of funds, or both.

\(ii\) [Special rule]{.underline}. Notwithstanding paragraph (b)(2)(i)
of this section, the plan is considered to satisfy the requirement
described in paragraph (a) of this section that no amounts deferred
under the plan be paid or made available to the participant before the
participant has a severance from employment with the eligible employer
if, with respect to amounts payable to a participant who is an
independent contractor, an eligible plan provides that\--

\(A\) No amount will be paid to the participant before a date at least
12 months after the day on which the contract expires under which
services are performed for the eligible employer (or, in the case of
more than one contract, all such contracts expire); and

\(B\) No amount payable to the participant on that date will be paid to
the participant if, after the expiration of the contract (or contracts)
and before that date, the participant performs services for the eligible
employer as an independent contractor or an employee.

\(c\) [Rules applicable to distributions for unforeseeable
emergencies]{.underline}\--(1) [In general]{.underline}. An eligible
plan may permit a distribution to a participant or beneficiary faced
with an unforeseeable emergency. The distribution must satisfy the
requirements of paragraph (c)(2) of this section.

\(2\) [Requirements]{.underline}\--(i) [Unforeseeable emergency
defined]{.underline}. An unforeseeable emergency must be defined in the
plan as a severe financial hardship of the participant or beneficiary
resulting from an illness or accident of the participant or beneficiary,
the participant's or beneficiary's spouse, or the participant's or
beneficiary's dependent (as defined in section 152(a)); loss of the
participant\'s or beneficiary's property due to casualty (including the
need to rebuild a home following damage to a home not otherwise covered
by homeowner's insurance, e.g., as a result of a natural disaster); or
other similar extraordinary and unforeseeable circumstances arising as a
result of events beyond the control of the participant or the
beneficiary. For example, the imminent foreclosure of or eviction from
the participant\'s or beneficiary's primary residence may constitute an
unforeseeable emergency. In addition, the need to pay for medical
expenses, including non-refundable deductibles, as well as for the cost
of prescription drug medication, may constitute an unforeseeable
emergency. Finally, the need to pay for the funeral expenses of a spouse
or a dependent (as defined in section 152(a)) may also constitute an
unforeseeable emergency. Except as otherwise specifically provided in
this paragraph (c)(2)(i), the purchase of a home and the payment of
college tuition are not unforeseeable emergencies under this paragraph
(c)(2)(i).

\(ii\) [Unforeseeable emergency distribution standard]{.underline}.
Whether a participant or beneficiary is faced with an unforeseeable
emergency permitting a distribution under this paragraph (c) is to be
determined based on the relevant facts and circumstances of each case,
but, in any case, a distribution on account of unforeseeable emergency
may not be made to the extent that such emergency is or may be relieved
through reimbursement or compensation from insurance or otherwise, by
liquidation of the participant\'s assets, to the extent the liquidation
of such assets would not itself cause severe financial hardship, or by
cessation of deferrals under the plan.

\(iii\) [Distribution necessary to satisfy emergency need]{.underline}.
Distributions because of an unforeseeable emergency must be limited to
the amount reasonably necessary to satisfy the emergency need (which may
include any amounts necessary to pay any federal, state, or local income
taxes or penalties reasonably anticipated to result from the
distribution).

\(d\) [Minimum required distributions for eligible plans]{.underline}.
In order to be an eligible plan, a plan must meet the distribution
requirements of section 457(d)(1) and (2). Under section 457(d)(2), a
plan must meet the minimum distribution requirements of section
401(a)(9). See section 401(a)(9) and the regulations thereunder for
these requirements. Section 401(a)(9) requires that a plan begin
lifetime distributions to a participant no later than April 1 of the
calendar year following the later of the calendar year in which the
participant attains age 70 ½ or the calendar year in which the
participant retires.

\(e\) [Distributions of smaller accounts]{.underline}\--(1) [In
general]{.underline}. An eligible plan may provide for a distribution of
all or a portion of a participant's benefit if this paragraph (e)(1) is
satisfied. This paragraph (e)(1) is satisfied if the participant's total
amount deferred (the participant's total account balance) which is not
attributable to rollover contributions (as defined in section
411(a)(11)(D)) is not in excess of the dollar limit under section
411(a)(11)(A), no amount has been deferred under the plan by or for the
participant during the two-year period ending on the date of the
distribution, and there has been no prior distribution under the plan to
the participant under this paragraph (e). An eligible plan is not
required to permit distributions under this paragraph (e).

\(2\) [Alternative provisions possible]{.underline}. Consistent with the
provisions of paragraph (e)(1) of this section, a plan may provide that
the total amount deferred for a participant or beneficiary will be
distributed automatically to the participant or beneficiary if the
requirements of paragraph (e)(1) of this section are met. Alternatively,
if the requirements of paragraph (e)(1) of this section are met, the
plan may provide for the total amount deferred for a participant or
beneficiary to be distributed to the participant or beneficiary only if
the participant or beneficiary so elects. The plan is permitted to
substitute a specified dollar amount that is less than the total amount
deferred. In addition, these two alternatives can be combined; for
example, a plan could provide for automatic distributions for up to
\$500, but allow participants or beneficiary to elect a distribution if
the total account balance is above \$500.

\(f\) [Loans from eligible plans]{.underline}\--(1) [Eligible plans of
tax-exempt entities]{.underline}. If a participant or beneficiary
receives (directly or indirectly) any amount deferred as a loan from an
eligible plan of a tax-exempt entity, that amount will be treated as
having been paid or made available to the individual as a distribution
under the plan, in violation of the distribution requirements of section
457(d).

\(2\) [Eligible governmental plans]{.underline}. The determination of
whether the availability of a loan, the making of a loan, or a failure
to repay a loan made from a trustee (or a person treated as a trustee
under section 457(g)) of an eligible governmental plan to a participant
or beneficiary is treated as a distribution (directly or indirectly) for
purposes of this section, and the determination of whether the
availability of the loan, the making of the loan, or a failure to repay
the loan is in any other respect a violation of the requirements of
section 457(b) and the regulations, depends on the facts and
circumstances. Among the facts and circumstances are whether the loan
has a fixed repayment schedule and bears a reasonable rate of interest,
and whether there are repayment safeguards to which a prudent lender
would adhere. Thus, for example, a loan must bear a reasonable rate of
interest in order to satisfy the exclusive benefit requirement of
section 457(g)(1) and §1.457-8(a)(1). See also §1.457-7(b)(3) relating
to the application of section 72(p) with respect to the taxation of a
loan made under an eligible governmental plan, and §1.72(p)-1 relating
to section 72(p)(2).

\(3\) [Example]{.underline}. The provisions of paragraph (f)(2) of this
section are illustrated by the following example:

[Example]{.underline}. (i) [Facts]{.underline}. Eligible Plan X of State
Y is funded through Trust Z. Plan X permits an employee's account
balance under Plan X to be paid in a single sum at severance from
employment with State Y. Plan X includes a loan program under which any
active employee with a vested account balance may receive a loan from
Trust Z. Loans are made pursuant to plan provisions regarding loans that
are set forth in the plan under which loans bear a reasonable rate of
interest and are secured by the employee's account balance. In order to
avoid taxation under §1.457-7(b)(3) and section 72(p)(1), the plan
provisions limit the amount of loans and require loans to be repaid in
level installments as required under section 72(p)(2). Participant J's
vested account balance under Plan X is \$50,000. J receives a loan from
Trust Z in the amount of \$5,000 on December 1, 2003, to be repaid in
level installments made quarterly over the 5-year period ending on
November 30, 2008. Participant J makes the required repayments until J
has a severance from employment from State Y in 2005 and subsequently
fails to repay the outstanding loan balance of \$2,250. The \$2,250 loan
balance is offset against J's \$80,000 account balance benefit under
Plan X, and J elects to be paid the remaining \$77,750 in 2005.

\(ii\) [Conclusion]{.underline}. The making of the loan to J will not be
treated as a violation of the requirements of section 457(b) or the
regulations. The cancellation of the loan at severance from employment
does not cause Plan X to fail to satisfy the requirements for plan
eligibility under section 457. In addition, because the loan satisfies
the maximum amount and repayment requirements of section 72(p)(2), J is
not required to include any amount in income as a result of the loan
until 2005, when J has income of \$2,250 as a result of the offset
(which is a permissible distribution under this section) and income of
\$77,750 as a result of the distribution made in 2005.

[§1.457-7 Taxation of distributions under eligible plans]{.underline}.

\(a\) [General rules for when amounts are included in gross
income]{.underline}. The rules for determining when an amount deferred
under an eligible plan is includible in the gross income of a
participant or beneficiary depend on whether the plan is an eligible
governmental plan or an eligible plan of a tax-exempt entity. Paragraph
(b) of this section sets forth the rules for an eligible governmental
plan. Paragraph (c) of this section sets forth the rules for an eligible
plan of a tax-exempt entity.

\(b\) [Amounts included in gross income under an eligible governmental
plan]{.underline}\--(1) [Amounts included in gross income in year paid
under an eligible governmental plan]{.underline}. Except as provided in
paragraphs (b)(2) and (3) of this section (or in §1.457-10(c) relating
to payments to a spouse or former spouse pursuant to a qualified
domestic relations order), amounts deferred under an eligible
governmental plan are includible in the gross income of a participant or
beneficiary for the taxable year in which paid to the participant or
beneficiary under the plan.

\(2\) [Rollovers to individual retirement arrangements and other
eligible retirement plans]{.underline}. A trustee-to-trustee transfer in
accordance with section 401(a)(31) (generally referred to as a direct
rollover) from an eligible government plan is not includible in gross
income of a participant or beneficiary in the year transferred. In
addition, any payment made from an eligible government plan in the form
of an eligible rollover distribution (as defined in section 402(c)(4))
is not includible in gross income in the year paid to the extent the
payment is transferred to an eligible retirement plan (as defined in
section 402(c)(8)(B)) within 60 days, including the transfer to the
eligible retirement plan of any property distributed from the eligible
governmental plan. For this purpose, the rules of section 402(c)(2)
through (7) and (9) apply. Any trustee-to-trustee transfer under this
paragraph (b)(2) from an eligible government plan is a distribution that
is subject to the distribution requirements of §1.457-6.

\(3\) [Amounts taxable under section 72(p)(1)]{.underline}. In
accordance with section 72(p), the amount of any loan from an eligible
governmental plan to a participant or beneficiary (including any pledge
or assignment treated as a loan under section 72(p)(1)(B)) is treated as
having been received as a distribution from the plan under section
72(p)(1), except to the extent set forth in section 72(p)(2) (relating
to loans that do not exceed a maximum amount and that are repayable in
accordance with certain terms) and §1.72(p)-1. Thus, except to the
extent a loan satisfies section 72(p)(2), any amount loaned from an
eligible governmental plan to a participant or beneficiary (including
any pledge or assignment treated as a loan under section 72(p)(1)(B)) is
includible in the gross income of the participant or beneficiary for the
taxable year in which the loan is made. See generally §1.72(p)-1.

\(4\) [Examples]{.underline}. The provisions of this paragraph (b) are
illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. Eligible Plan G of a
governmental entity permits distribution of benefits in a single sum or
in installments of up to 20 years, with such benefits to commence at any
date that is after severance from employment (up to the later of
severance from employment or the plan's normal retirement age of 65).
Effective for participants who have a severance from employment after
December 31, 2001, Plan X allows an election\--as to both the date on
which payments are to begin and the form in which payments are to be
made\--to be made by the participant at any time that is before the
commencement date selected. However, Plan X chooses to require elections
to be filed at least 30 days before the commencement date selected in
order for Plan X to have enough time to be able to effectuate the
election.

\(ii\) [Conclusion]{.underline}. No amounts are included in gross income
before actual payments begin. If installment payments begin (and the
installment payments are payable over at least 10 years so as not to be
eligible rollover distributions), the amount included in gross income
for any year is equal to the amount of the installment payment paid
during the year.

[Example 2]{.underline}. (i) [Facts]{.underline}. Same facts as in
[Example 1]{.underline}, except that the same rules are extended to
participants who had a severance from employment before January 1, 2002.

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

\(c\) [Amounts included in gross income under an eligible plan of a
tax-exempt entity]{.underline}\--(1) [Amounts included in gross income
in year paid or made available under an eligible plan of a tax-exempt
entity]{.underline}. Amounts deferred under an eligible plan of a
tax-exempt entity are includible in the gross income of a participant or
beneficiary for the taxable year in which paid or otherwise made
available to the participant or beneficiary under the plan. Thus,
amounts deferred under an eligible plan of a tax-exempt entity are
includible in the gross income of the participant or beneficiary in the
year the amounts are first made available under the terms of the plan,
even if the plan has not distributed the amounts deferred. Amounts
deferred under an eligible plan of a tax-exempt entity are not
considered made available to the participant or beneficiary solely
because the participant or beneficiary is permitted to choose among
various investments under the plan.

\(2\) [When amounts deferred are considered to be made available under
an eligible plan of a tax-exempt entity]{.underline}\--(i) [General
rule]{.underline}. Except as provided in paragraphs (c)(2)(ii) through
(iv) of this section, amounts deferred under an eligible plan of a
tax-exempt entity are considered made available (and, thus, are
includible in the gross income of the participant or beneficiary under
this paragraph (c)) at the earliest date, on or after severance from
employment, on which the plan allows distributions to commence, but in
no event later than the date on which distributions must commence
pursuant to section 401(a)(9). For example, in the case of a plan that
permits distribution to commence on the date that is 60 days after the
close of the plan year in which the participant has a severance from
employment with the eligible employer, amounts deferred are considered
to be made available on that date. However, distributions deferred in
accordance with paragraphs (c)(2)(ii) through (iv) of this section are
not considered made available prior to the applicable date under
paragraphs (c)(2)(ii) through (iv) of this section. In addition, no
portion of a participant or beneficiary's account is treated as made
available (and thus currently includible in income) under an eligible
plan of a tax-exempt entity merely because the participant or
beneficiary under the plan may elect to receive a distribution in any of
the following circumstances:

\(A\) A distribution in the event of an unforeseeable emergency to the
extent the distribution is permitted under §1.457-6(c).

\(B\) A distribution from an account for which the total amount deferred
is not in excess of the dollar limit under section 411(a)(11)(A) to the
extent the distribution is permitted under §1.457-6(e).

\(ii\) [Initial election to defer commencement of
distributions]{.underline}\--(A) [In general]{.underline}. An eligible
plan of a tax-exempt entity may provide a period for making an initial
election during which the participant or beneficiary may elect, in
accordance with the terms of the plan, to defer the payment of some or
all of the amounts deferred to a fixed or determinable future time. The
period for making this initial election must expire prior to the first
time that any such amounts would be considered made available under the
plan under paragraph (c)(2)(i) of this section.

\(B\) [Failure to make initial election to defer commencement of
distributions]{.underline}. Generally, if no initial election is made by
a participant or beneficiary under this paragraph (c)(2)(ii), then the
amounts deferred under an eligible plan of a tax-exempt entity are
considered made available and taxable to the participant or beneficiary
in accordance with paragraph (c)(2)(i) of this section at the earliest
time, on or after severance from employment ( but in no event later than
the date on which distributions must commence pursuant to section
401(a)(9)), that distribution is permitted to commence under the terms
of the plan. However, the plan may provide for a default payment
schedule that applies if no election is made. If the plan provides for a
default payment schedule, the amounts deferred are includible in the
gross income of the participant or beneficiary in the year the amounts
deferred are first made available under the terms of the default payment
schedule.

\(iii\) [Additional election to defer commencement of
distribution]{.underline}. An eligible plan of a tax-exempt entity is
permitted to provide that a participant or beneficiary who has made an
initial election under paragraph (c)(2)(ii)(A) of this section may make
one additional election to defer (but not accelerate) commencement of
distributions under the plan before distributions have commenced in
accordance with the initial deferral election under paragraph
(c)(2)(ii)(A) of this section. Amounts payable to a participant or
beneficiary under an eligible plan of a tax-exempt entity are not
treated as made available merely because the plan allows the participant
to make an additional election under this paragraph (c)(2)(iii). A
participant or beneficiary is not precluded from making an additional
election to defer commencement of distributions merely because the
participant or beneficiary has previously received a distribution under
§1.457-6(c) because of an unforeseeable emergency, has received a
distribution of smaller amounts under §1.457-6(e), has made (and
revoked) other deferral or method of payment elections within the
initial election period, or is subject to a default payment schedule
under which the commencement of benefits is deferred (for example, until
a participant is age 65).

\(iv\) [Election as to method of payment]{.underline}. An eligible plan
of a tax-exempt entity may provide that an election as to the method of
payment under the plan may be made at any time prior to the time the
amounts are distributed in accordance with the participant or
beneficiary's initial or additional election to defer commencement of
distributions under paragraph (c)(2)(ii) or (iii) of this section. Where
no method of payment is elected, the entire amount deferred will be
includible in the gross income of the participant or beneficiary when
the amounts first become made available in accordance with a
participant's initial or additional elections to defer under paragraphs
(c)(2)(ii) and (iii) of this section, unless the eligible plan provides
for a default method of payment (in which case amounts are considered
made available and taxable when paid under the terms of the default
payment schedule). A method of payment means a distribution or a series
of periodic distributions commencing on a date determined in accordance
with paragraph (c)(2)(ii) or (iii) of this section.

\(3\) [Examples]{.underline}. The provisions of this paragraph (c) are
illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. Eligible Plan X of a
tax-exempt entity provides that a participant's total account balance,
representing all amounts deferred under the plan, is payable to a
participant in a single sum 60 days after severance from employment
throughout these examples, unless, during a 30-day period immediately
following the severance, the participant elects to receive the single
sum payment at a later date (that is not later than the plan's normal
retirement age of 65) or elects to receive distribution in 10 annual
installments to begin 60 days after severance from employment (or at a
later date, if so elected, that is not later than the plan's normal
retirement age of 65). On November 13, 2004, participant K, a calendar
year taxpayer, has a severance from employment with the eligible
employer. K does not, within the 30-day window period, elect to postpone
distributions to a later date or to receive payment in 10 fixed annual
installments.

\(ii\) [Conclusion]{.underline}. The single sum payment is payable to K
60 days after the date K has a severance from employment (January 12,
2005), and is includible in the gross income of K in 2005 under section
457(a).

[Example 2]{.underline}. (i) [Facts]{.underline}. The terms of eligible
Plan X are the same as described in [Example 1]{.underline}. Participant
L participates in eligible Plan X. On November 11, 2003, L has a
severance from the employment of the eligible employer. On November 24,
2003, L makes an initial deferral election not to receive the single-sum
payment payable 60 days after the severance, and instead elects to
receive the amounts in 10 annual installments to begin 60 days after
severance from employment.

\(ii\) [Conclusion]{.underline}. No portion of L's account is considered
made available in 2003 or 2004 before a payment is made and no amount is
includible in the gross income of L until distributions commence. The
annual installment payable in 2004 will be includible in L's gross
income in 2004.

[Example 3]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 1]{.underline}, except that eligible Plan X also provides
that those participants who are receiving distributions in 10 annual
installments may, at any time and without restriction, elect to receive
a cash out of all remaining installments. Participant M elects to
receive a distribution in 10 annual installments commencing in 2004.

\(ii\) [Conclusion]{.underline}. M's total account balance, representing
the total of the amounts deferred under the plan, is considered made
available and is includible in M's gross income in 2004.

[Example 4]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 3]{.underline}, except that, instead of providing for an
unrestricted cashout of remaining payments, the plan provides that
participants or beneficiaries who are receiving distributions in 10
annual installments may accelerate the payment of the amount remaining
payable to the participant upon the occurrence of an unforeseeable
emergency as described in §1.457-6(c)(1) in an amount not exceeding that
described in §1.457-6(c)(2).

\(ii\) [Conclusion]{.underline}. No amount is considered made available
to participant M on account of M\'s right to accelerate payments upon
the occurrence of an unforeseeable emergency.

[Example 5.]{.underline} (i) [Facts]{.underline}. Eligible Plan Y of a
tax-exempt entity provides that distributions will commence 60 days
after a participant's severance from employment unless the participant
elects, within a 30-day window period following severance from
employment, to defer distributions to a later date (but no later than
the year following the calendar year the participant attains age 70 ½).
The plan provides that a participant who has elected to defer
distributions to a later date may make an election as to form of
distribution at any time prior to the 30^th^ day before distributions
are to commence.

\(ii\) [Conclusion]{.underline}. No amount is considered made available
prior to the date distributions are to commence by reason of a
participant's right to defer or make an election as to the form of
distribution.

[Example 6]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 1]{.underline}, except that the plan also permits
participants who have made an initial election to defer distribution to
make one additional deferral election at any time prior to the date
distributions are scheduled to commence. Participant N has a severance
from employment at age 50. The next day, during the 30-day period
provided in the plan, N elects to receive distribution in the form of 10
annual installment payments beginning at age 55. Two weeks later, within
the 30-day window period, N makes a new election permitted under the
plan to receive 10 annual installment payments beginning at age 60
(instead of age 55). When N is age 59, N elects under the additional
deferral election provisions, to defer distributions until age 65.

\(ii\) [Conclusion]{.underline}. In this example, N's election to defer
distributions until age 65 is a valid election. The two elections N
makes during the 30-day window period are not additional deferral
elections described in paragraph (c)(2)(iii) of this section because
they are made before the first permissible payout date under the plan.
Therefore, the plan is not precluded from allowing N to make the
additional deferral election. However, N can make no further election to
defer distributions beyond age 65 (or accelerate distribution before age
65) because this additional deferral election can only be made once.

[§1.457-8 Funding rules for eligible plans]{.underline}.

\(a\) [Eligible governmental plans]{.underline}\--(1) [In
general]{.underline}. In order to be an eligible governmental plan, all
amounts deferred under the plan, all property and rights purchased with
such amounts, and all income attributable to such amounts, property, or
rights, must be held in trust for the exclusive benefit of participants
and their beneficiaries. A trust described in this paragraph (a) that
also meets the requirements of §§1.457-3 through 1.457-10 is treated as
an organization exempt from tax under section 501(a), and a
participant's or beneficiary's interest in amounts in the trust is
includible in the gross income of the participants and beneficiaries
only to the extent, and at the time, provided for in section 457(a) and
§§1.457-4 through 1.457-10.

\(2\) [Trust requirement]{.underline}. (i) A trust described in this
paragraph (a) must be established pursuant to a written agreement that
constitutes a valid trust under State law. The terms of the trust must
make it impossible, prior to the satisfaction of all liabilities with
respect to participants and their beneficiaries, for any part of the
assets and income of the trust to be used for, or diverted to, purposes
other than for the exclusive benefit of participants and their
beneficiaries.

\(ii\) Amounts deferred under an eligible governmental plan must be
transferred to a trust within a period that is not longer than is
reasonable for the proper administration of the participant accounts (if
any). For purposes of this requirement, the plan may provide for amounts
deferred for a participant under the plan to be transferred to the trust
within a specified period after the date the amounts would otherwise
have been paid to the participant. For example, the plan could provide
for amounts deferred under the plan at the election of the participant
to be contributed to the trust within 15 business days following the
month in which these amounts would otherwise have been paid to the
participant.

\(3\) [Custodial accounts and annuity contracts treated as
trusts]{.underline}\--(i) [In general.]{.underline} For purposes of the
trust requirement of this paragraph (a), custodial accounts and annuity
contracts described in section 401(f) that satisfy the requirements of
this paragraph (a)(3) are treated as trusts under rules similar to the
rules of section 401(f). Therefore, the provisions of §1.401(f)-1(b)
will generally apply to determine whether a custodial account or an
annuity contract is treated as a trust. The use of a custodial account
or annuity contract as part of an eligible governmental plan does not
preclude the use of a trust or another custodial account or annuity
contract as part of the same plan, provided that all such vehicles
satisfy the requirements of section 457(g)(1) and (3) and paragraphs
(a)(1) and (2) of this section and that all assets and income of the
plan are held in such vehicles.

\(ii\) [Custodial accounts]{.underline}\--(A) [In general]{.underline}.
A custodial account is treated as a trust, for purposes of section
457(g)(1) and paragraphs (a)(1) and (2) of this section, if the
custodian is a bank, as described in section 408(n), or a person who
meets the nonbank trustee requirements of paragraph (a)(3)(ii)(B) of
this section, and the account meets the requirements of paragraphs
(a)(1) and (2) of this section, other than the requirement that it be a
trust.

\(B\) [Nonbank trustee status]{.underline}. The custodian of a custodial
account may be a person other than a bank only if the person
demonstrates to the satisfaction of the Commissioner that the manner in
which the person will administer the custodial account will be
consistent with the requirements of section 457(g)(1) and (3). To do so,
the person must demonstrate that the requirements of §1.408-2(e)(2)
through (6) (relating to nonbank trustees) are met. The written
application must be sent to the address prescribed by the Commissioner
in the same manner as prescribed under §1.408-2(e). To the extent that a
person has already demonstrated to the satisfaction of the Commissioner
that the person satisfies the requirements of §1.408-2(e) in connection
with a qualified trust (or custodial account or annuity contract) under
section 401(a), that person is deemed to satisfy the requirements of
this paragraph (a)(3)(ii)(B).

\(iii\) [Annuity contracts]{.underline}. An annuity contract is treated
as a trust for purposes of section 457(g)(1) and paragraph (a)(1) of
this section if the contract is an annuity contract, as defined in
section 401(g), that has been issued by an insurance company qualified
to do business in the State, and the contract meets the requirements of
paragraphs (a)(1) and (2) of this section, other than the requirement
that it be a trust. An annuity contract does not include a life, health
or accident, property, casualty, or liability insurance contract.

\(4\) [Combining assets]{.underline}. \[Reserved\]

\(b\) [Eligible plans maintained by tax-exempt entity]{.underline}\--(1)
[General rule]{.underline}. In order to be an eligible plan of a
tax-exempt entity, the plan must be unfunded and plan assets must not be
set aside for participants or their beneficiaries. Under section
457(b)(6) and this paragraph (b), an eligible plan of a tax-exempt
entity must provide that all amounts deferred under the plan, all
property and rights to property (including rights as a beneficiary of a
contract providing life insurance protection) purchased with such
amounts, and all income attributable to such amounts, property, or
rights, must remain (until paid or made available to the participant or
beneficiary) solely the property and rights of the eligible employer
(without being restricted to the provision of benefits under the plan),
subject only to the claims of the eligible employer\'s general
creditors.

\(2\) [Additional requirements.]{.underline} For purposes of a paragraph
(b)(1) of this section, the plan must be unfunded regardless of whether
or not the amounts were deferred pursuant to a salary reduction
agreement between the eligible employer and the participant. Any funding
arrangement under an eligible plan of a tax-exempt entity that sets
aside assets for the exclusive benefit of participants violates this
requirement, and amounts deferred are generally immediately includible
in the gross income of plan participants and beneficiaries. Nothing in
this paragraph (b) prohibits an eligible plan from permitting
participants and their beneficiaries to make an election among different
investment options available under the plan, such as an election
affecting the investment of the amounts described in paragraph (b)(1) of
this section.

[§1.457-9 Effect on eligible plans when not administered in accordance
with eligibility requirements]{.underline}.

\(a\) [Eligible governmental plans]{.underline}. A plan of a State
ceases to be an eligible governmental plan on the first day of the first
plan year beginning more than 180 days after the date on which the
Commissioner notifies the State in writing that the plan is being
administered in a manner that is inconsistent with one or more of the
requirements of §§1.457-3 through 1.457-8, or 1.457-10. However, the
plan may correct the plan inconsistencies specified in the written
notification before the first day of that plan year and continue to
maintain plan eligibility. If a plan ceases to be an eligible
governmental plan, amounts subsequently deferred by participants will be
includible in income when deferred, or, if later, when the amounts
deferred cease to be subject to a substantial risk of forfeiture, as
provided at §1.457-11. Amounts deferred before the date on which the
plan ceases to be an eligible governmental plan, and any earnings
thereon, will be treated as if the plan continues to be an eligible
governmental plan and will not be includible in participant's or
beneficiary's gross income until paid to the participant or beneficiary.

\(b\) [Eligible plans of tax-exempt entities]{.underline}. A plan of a
tax-exempt entity ceases to be an eligible plan on the first day that
the plan fails to satisfy one or more of the requirements of §§1.457-3
through 1.457-8, or §1.457-10. See §1.457-11 for rules regarding the
treatment of an ineligible plan.

[§1.457-10 Miscellaneous provisions]{.underline}.

\(a\) [Plan terminations and frozen plans]{.underline}\--(1) [In
general]{.underline}. An eligible employer may amend its plan to
eliminate future deferrals for existing participants or to limit
participation to existing participants and employees. An eligible plan
may also contain provisions that permit plan termination and permit
amounts deferred to be distributed on termination. In order for a plan
to be considered terminated, amounts deferred under an eligible plan
must be distributed to all plan participants and beneficiaries as soon
as administratively practicable after termination of the eligible plan.
The mere provision for, and making of, distributions to participants or
beneficiaries upon a plan termination will not cause an eligible plan to
cease to satisfy the requirements of section 457(b) or the regulations.

\(2\) [Employers that cease to be eligible employers]{.underline}\--(i)
[Plan not terminated]{.underline}. An eligible employer that ceases to
be an eligible employer may no longer maintain an eligible plan. If the
employer was a tax-exempt entity and the plan is not terminated as
permitted under a paragraph (a)(2)(ii) of this section, the tax
consequences to participants and beneficiaries in the previously
eligible (unfunded) plan of an ineligible employer are determined in
accordance with either section 451 if the employer becomes an entity
other than a State or §1.457-11 if the employer becomes a State. If the
employer was a State and the plan is neither terminated as permitted
under paragraph (a)(2)(ii) of this section nor transferred to another
eligible plan of that State as permitted under paragraph (b) of this
section, the tax consequences to participants in the previously eligible
governmental plan of an ineligible employer, the assets of which are
held in trust pursuant to §1.457-8(a), are determined in accordance with
section 402(b) (section 403(c) in the case of an annuity contract) and
the trust is no longer to be treated as a trust that is exempt from tax
under section 501(a).

\(ii\) [Plan termination]{.underline}. As an alternative to determining
the tax consequences to the plan and participants under paragraph
(a)(2)(i) of this section, the employer may terminate the plan and
distribute the amounts deferred (and all plan assets) to all plan
participants as soon as administratively practicable in accordance with
paragraph (a)(1) of this section. Such distribution may include eligible
rollover distributions in the case of a plan that was an eligible
governmental plan. In addition, if the employer is a State, another
alternative to determining the tax consequences under paragraph
(a)(2)(i) of this section is to transfer the assets of the eligible
governmental plan to an eligible governmental plan of another eligible
employer within the same State under the plan-to-plan transfer rules of
paragraph (b) of this section.

\(3\) [Examples]{.underline}. The provisions of this paragraph (a) are
illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. Employer Y, a
corporation that owns a State hospital, sponsors an eligible
governmental plan funded through a trust. Employer Y is acquired by a
for-profit hospital and Employer Y ceases to be an eligible employer
under section 457(e)(1) or §1.457-2(e). Employer Y terminates the plan
and, during the next 6 months, distributes to participants and
beneficiaries all amounts deferred that were under the plan.

\(ii\) [Conclusion]{.underline}. The termination and distribution does
not cause the plan to fail to be an eligible governmental plan. Amounts
that are distributed as eligible rollover distributions may be rolled
over to an eligible retirement plan described in section 402(c)(8)(B).

[Example 2]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 1]{.underline}, except that Employer Y decides to
continue to maintain the plan.

\(ii\) [Conclusion]{.underline}. If Employer Y continues to maintains
the plan, the tax consequences to participants and beneficiaries will be
determined in accordance with either section 402(b) if the compensation
deferred is funded through a trust, section 403(c) if the compensation
deferred is funded through annuity contracts, or §1.457-11 if the
compensation deferred is not funded through a trust or annuity contract.
In addition, if Employer Y continues to maintain the plan, the trust
will no longer be treated as exempt from tax under section 501(a).

[Example 3]{.underline}. (i) [Facts]{.underline}. Employer Z, a
corporation that owns a tax-exempt hospital, sponsors an unfunded
eligible plan. Employer Z is acquired by a for-profit hospital and is no
longer an eligible employer under section 457(e)(1) or §1.457-2(e).
Employer Z terminates the plan and distributes all amounts deferred
under the eligible plan to participants and beneficiaries within a
one-year period.

\(ii\) [Conclusion]{.underline}. Distributions under the plan are
treated as made under an eligible plan of a tax-exempt entity and the
distributions of the amounts deferred are includible in the gross income
of the participant or beneficiary in the year distributed.

[Example 4]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 3]{.underline}, except that Employer Z decides to
maintain instead of terminate the plan.

\(ii\) [Conclusion]{.underline}. If Employer Z maintains the plan, the
tax consequences to participants and beneficiaries in the plan will
thereafter be determined in accordance with section 451.

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

\(2\) [Requirements for post-severance plan-to-plan transfers among
eligible governmental plans]{.underline}. A transfer under paragraph
(b)(1) of this section from an eligible governmental plan to another
eligible governmental plan is permitted if the following conditions are
met \--

\(i\) The transferor plan provides for transfers;

\(ii\) The receiving plan provides for the receipt of transfers;

\(iii\) The participant or beneficiary whose amounts deferred are being
transferred will have an amount deferred immediately after the transfer
at least equal to the amount deferred with respect to that participant
or beneficiary immediately before the transfer; and

\(iv\) In the case of a transfer for a participant, the participant has
had a severance from employment with the transferring employer and is
performing services for the entity maintaining the receiving plan.

\(3\) [Requirements for plan-to-plan transfers of all plan assets of
eligible governmental plan]{.underline}. A transfer under paragraph
(b)(1) of this section from an eligible governmental plan to another
eligible governmental plan is permitted if the following conditions are
met \--

\(i\) The transfer is from an eligible governmental plan to another
eligible governmental plan within the same State;

\(ii\) All of the assets held by the transferor plan are transferred;

> \(iii\) The transferor plan provides for transfers;

\(iv\) The receiving plan provides for the receipt of transfers;

\(v\) The participant or beneficiary whose amounts deferred are being
transferred will have an amount deferred immediately after the transfer
at least equal to the amount deferred with respect to that participant
or beneficiary immediately before the transfer; and

\(vi\) The participants or beneficiaries whose deferred amounts are
being transferred are not eligible for additional annual deferrals in
the receiving plan unless they are performing services for the entity
maintaining the receiving plan.

\(4\) [Requirements for plan-to-plan transfers among eligible
governmental plans of the same employer]{.underline}. A transfer under
paragraph (b)(1) of this section from an eligible governmental plan to
another eligible governmental plan is permitted if the following
conditions are met \--

\(i\) The transfer is from an eligible governmental plan to another
eligible governmental plan of the same employer (and, for this purpose,
the employer is not treated as the same employer if the participant's
compensation is paid by a different entity);

> \(ii\) The transferor plan provides for transfers;

\(iii\) The receiving plan provides for the receipt of transfers;

\(iv\) The participant or beneficiary whose amounts deferred are being
transferred will have an amount deferred immediately after the transfer
at least equal to the amount deferred with respect to that participant
or beneficiary immediately before the transfer; and

\(v\) The participant or beneficiary whose deferred amounts are being
transferred is not eligible for additional annual deferrals in the
receiving plan unless the participant or beneficiary is performing
services for the entity maintaining the receiving plan.

\(5\) [Requirements for post-severance plan-to-plan transfers among
eligible plans of tax-exempt entities]{.underline}. A transfer under
paragraph (b)(1) of this section from an eligible plan of a tax-exempt
employer to another eligible plan of a tax-exempt employer is permitted
if the following conditions are met \--

\(i\) The transferor plan provides for transfers;

\(ii\) The receiving plan provides for the receipt of transfers;

\(iii\) The participant or beneficiary whose amounts deferred are being
transferred will have an amount deferred immediately after the transfer
at least equal to the amount deferred with respect to that participant
or beneficiary immediately before the transfer; and

\(iv\) In the case of a transfer for a participant, the participant has
had a severance from employment with the transferring employer and is
performing services for the entity maintaining the receiving plan.

\(6\) [Treatment of amount transferred following a plan-to-plan transfer
between eligible plans]{.underline}. Following a transfer of any amount
between eligible plans under paragraphs (b)(1) through (b)(5) of this
section \--

\(i\) the transferred amount is subject to the restrictions of §1.457-6
(relating to when distributions are permitted to be made to a
participant under an eligible plan) in the receiving plan in the same
manner as if the transferred amount had been originally been deferred
under the receiving plan if the participant is performing services for
the entity maintaining the receiving plan, and

\(ii\) in the case of a transfer between eligible plans of tax-exempt
entities, except as otherwise determined by the Commissioner, the
transferred amount is subject to §1.457-7(c)(2) (relating to when
amounts are considered to be made available under an eligible plan of a
tax-exempt entity) in the same manner as if the elections made by the
participant or beneficiary under the transferor plan had been made under
the receiving plan.

\(7\) [Examples]{.underline}. The provisions of paragraphs (b)(1)
through (6) of this section are illustrated by the following examples:

[Example 1.]{.underline} (i) [Facts]{.underline}. Participant A, the
president of City X's hospital, has accepted a position with another
hospital which is a tax-exempt entity. A participates in the eligible
governmental plan of City X. A would like to transfer the amounts
deferred under City X's eligible governmental plan to the eligible plan
of the tax-exempt hospital.

\(ii\) [Conclusion]{.underline}. City X's plan may not transfer A's
amounts deferred to the tax-exempt employer's eligible plan. In
addition, because the amounts deferred would no longer be held in trust
for the exclusive benefit of participants and their beneficiaries, the
transfer would violate the exclusive benefit rule of section 457(g) and
§1.457-8(a).

[Example 2]{.underline}. (i) [Facts]{.underline}. County M, located in
State S, operates several health clinics and maintains an eligible
governmental plan for employees of those clinics. One of the clinics
operated by County M is being acquired by a hospital operated by State
S, and employees of that clinic will become employees of State S. County
M permits those employees to transfer their balances under County M's
eligible governmental plan to the eligible governmental plan of State S.

\(ii\) [Conclusion]{.underline}. If the eligible governmental plans of
County M and State S provide for the transfer and acceptance of the
transfer (and the other requirements of paragraph (b)(1) of this section
are satisfied), then the requirements of paragraph (b)(2) of this
section are satisfied and, thus, the transfer will not cause either plan
to violate the requirements of section 457 or these regulations.

[Example 3]{.underline}. (i) [Facts]{.underline}. City Employer Z, a
hospital, sponsors an eligible governmental plan. City Employer Z is
located in State B. All of the assets of City Employer Z are being
acquired by a tax-exempt hospital. City Employer Z, in accordance with
the plan-to-plan transfer rules of paragraph (b) of this section, would
like to transfer the total amount of assets deferred under City Employer
Z's eligible governmental plan to the acquiring tax-exempt entity\'s
eligible plan.

\(ii\) [Conclusion]{.underline}. City Employer Z may not permit
participants to transfer the amounts to the eligible plan of the
tax-exempt entity. In addition, because the amounts deferred would no
longer be held in trust for the exclusive benefit of participants and
their beneficiaries, the transfer would violate the exclusive benefit
rule of section 457(g) and §1.457-8(a).

[Example 4.]{.underline} (i) [Facts]{.underline}. The facts are the same
as in [Example 3]{.underline}, except that City Employer Z, instead of
transferring all of its assets to the eligible plan of the tax-exempt
entity, decides to transfer all of the amounts deferred under City Z's
eligible governmental plan to the eligible governmental plan of County B
in which City Z is located. County B's eligible plan does not cover
employees of City Z, but is willing to allow the assets of City Z's plan
to be transferred to County B's plan, a related state government entity,
also located in State B.

\(ii\) [Conclusion]{.underline}. If City Employer Z's (transferor)
eligible governmental plan provides for such transfer and the eligible
governmental plan of County B permits the acceptance of such a transfer
(and the other requirements of paragraph (b)(1) of this section are
satisfied), then the requirements of paragraph (b)(3) of this section
are satisfied and, thus, City Employer Z may transfer the total amounts
deferred under its eligible governmental plan, prior to termination of
that plan, to the eligible governmental plan maintained by County B.
However, the participants of City Employer Z whose deferred amounts are
being transferred are not eligible to participate in the eligible
governmental plan of County B, the receiving plan, unless they are
performing services for County B.

[Example 5]{.underline}. (i) [Facts]{.underline}. State C has an
eligible governmental plan. Employees of City U in State C are among the
eligible employees for State C's plan and City U decides to adopt
another eligible governmental plan only for its employees. State C
decides to allow employees to elect to transfer all of the amounts
deferred for an employee under State C's eligible governmental plan to
City U's eligible governmental plan.

\(ii\) Conclusion. If State C's (transferor) eligible governmental plan
provides for such transfer and the eligible governmental plan of City U
permits the acceptance of such a transfer (and the other requirements of
paragraph (b)(1) of this section are satisfied), then the requirements
of paragraph (b)(4) of this section are satisfied and, thus, State C may
transfer the total amounts deferred under its eligible governmental plan
to the eligible governmental plan maintained by City U.

\(8\) [Purchase of permissive past service credit by plan-to-plan
transfers from an eligible governmental plan to a qualified
plan]{.underline}\--(i) [General rule]{.underline}. An eligible
governmental plan of a State may provide for the transfer of amounts
deferred by a participant or beneficiary to a defined benefit
governmental plan (as defined in section 414(d)), and no amount shall be
includible in gross income by reason of the transfer, if the conditions
in paragraph (b)(8)(ii) of this section are met. A transfer under this
paragraph (b)(8) is not treated as a distribution for purposes of
§1.457-6. Therefore, such a transfer may be made before severance from
employment.

\(ii\) [Conditions for plan-to-plan transfers from an eligible
governmental plan to a qualified plan]{.underline}. A transfer may be
made under this paragraph (b)(8) only if the transfer is either\--

\(A\) For the purchase of permissive past service credit (as defined in
section 415(n)(3)(A)) under the receiving defined benefit governmental
plan; or

\(B\) A repayment to which section 415 does not apply by reason of
section 415(k)(3).

\(iii\) [Example]{.underline}. The provisions of this paragraph (b)(8)
are illustrated by the following example:

[Example.]{.underline} (i) [Facts]{.underline}. Plan X is an eligible
governmental plan maintained by County Y for its employees. Plan X
provides for distributions only in the event of death, an unforeseeable
emergency, or severance from employment with County Y (including
retirement from County Y). Plan S is a qualified defined benefit plan
maintained by State T for its employees. County Y is within State T.
Employee A is an employee of County Y and is a participant in Plan X.
Employee A previously was an employee of State T and is still entitled
to benefits under Plan S. Plan S includes provisions allowing
participants in certain plans, including Plan X, to transfer assets to
Plan S for the purchase of past service credit under Plan S and does not
permit the amount transferred to exceed the amount necessary to fund the
benefit resulting from the past service credit. Although not required to
do so, Plan X allows Employee A to transfer assets to Plan S to provide
a past service benefit under Plan S.

\(ii\) [Conclusion]{.underline}. The transfer is permitted under this
paragraph (b)(8).

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

\(2\) [Examples]{.underline}. The provisions of this paragraph (c) are
illustrated by the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. Participant C and C's
spouse D are divorcing. C is employed by State S and is a participant in
an eligible plan maintained by State S. C has an account valued at
\$100,000 under the plan. Pursuant to the divorce, a court issues a
qualified domestic relations order on September 1, 2003 that allocates
50 percent of C's \$100,000 plan account to D and specifically provides
for an immediate distribution to D of D's share within 6 months of the
order. Payment is made to D in January of 2004.

\(ii\) [Conclusion]{.underline}. State S's eligible plan does not become
an ineligible plan described in section 457(f) and §1.457-11 solely
because its administrator or sponsor complies with the qualified
domestic relations order requiring the immediate distribution to D in
advance of the general rules for eligible plan distributions under
§1.457-6. In accordance with section 402(e)(1)(A), D (not C) must
include the distribution in gross income. The distribution is includible
in D's gross income in 2004. If the qualified domestic relations order
were to provide for distribution to D at a future date, amounts deferred
attributable to D's share will be includible in D's gross income when
paid to D.

[Example 2]{.underline}. (i) [Facts]{.underline}. The facts are the same
as in [Example 1]{.underline}, except that S is a tax-exempt entity,
instead of a State.

\(ii\) [Conclusion]{.underline}. State S's eligible plan does not become
an ineligible plan described in section 457(f) and §1.457-11 solely
because its administrator or sponsor complies with the qualified
domestic relations order requiring the immediate distribution to D in
advance of the general rules for eligible plan distributions under §
1.457-6. In accordance with section 402(e)(1)(A), D (not C) must include
the distribution in gross income. The distribution is includible in D's
gross income in 2004, assuming that the plan did not make the
distribution available to D in 2003. If the qualified domestic relations
order were to provide for distribution to D at a future date, amounts
deferred attributable to D's share would be includible in D's gross
income when paid or made available to D.

\(d\) [Death benefits and life insurance proceeds]{.underline}. A death
benefit plan under section 457(e)(11) is not an eligible plan. In
addition, no amount paid or made available under an eligible plan as
death benefits or life insurance proceeds is excludable from gross
income under section 101.

\(e\) [Rollovers to eligible governmental plans]{.underline}\--(1)
[General rule]{.underline}. An eligible governmental plan may accept
contributions that are eligible rollover distributions (as defined in
section 402(c)(4)) made from another eligible retirement plan (as
defined in section 402(c)(8)(B)) if the conditions in paragraph (e)(2)
of this section are met. Amounts contributed to an eligible governmental
plan as eligible rollover distributions are not taken into account for
purposes of the annual limit on annual deferrals by a participant in
**§**1.457-4(c) or §1.457-5, but are otherwise treated in the same
manner as amounts deferred under section 457 for purposes of §§1.457-3
through 1.457-9 and this section.

\(2\) [Conditions for rollovers to an eligible governmental
plan]{.underline}. An eligible governmental plan that permits eligible
rollover distributions made from another eligible retirement plan to be
paid into the eligible governmental plan is required under this
paragraph (e)(2) to provide that it will separately account for any
eligible rollover distributions it receives. A plan does not fail to
satisfy this requirement if it separately accounts for particular types
of eligible rollover distributions (for example, if it maintains a
separate account for eligible rollover distributions attributable to
annual deferrals that were made under other eligible governmental plans
and a separate account for amounts attributable to other eligible
rollover distributions), but this requirement is not satisfied if any
such separate account includes any amount that is not attributable to an
eligible rollover distribution.

\(3\) [Example]{.underline}. The provisions of this paragraph (e) are
illustrated by the following example:

[Example.]{.underline} (i) [Facts]{.underline}. Plan T is an eligible
governmental plan that provides that employees who are eligible to
participate in Plan T may make rollover contributions to Plan T from
amounts distributed to an employee from an eligible retirement plan. An
eligible retirement plan is defined in Plan T as another eligible
governmental plan, a qualified section 401(a) or 403(a) plan, or a
section 403(b) contract, or an individual retirement arrangement (IRA)
that holds such amounts. Plan T requires rollover contributions to be
paid by the eligible retirement plan directly to Plan T (a direct
rollover) or to be paid by the participant within 60 days after the date
on which the participant received the amount from the other eligible
retirement plan. Plan T does not take rollover contributions into
account for purposes of the plan's limits on amounts deferred that
conform to §1.457-4(c). Rollover contributions paid to Plan T are
invested in the trust in the same manner as amounts deferred under Plan
T and rollover contributions (and earnings thereon) are available for
distribution to the participant at the same time and in the same manner
as amounts deferred under Plan T. In addition, Plan T provides that, for
each participant who makes a rollover contribution to Plan T, the Plan T
record-keeper is to establish a separate account for the participant's
rollover contributions. The record-keeper calculates earnings and losses
for investments held in the rollover account separately from earnings
and losses on other amounts held under the plan and calculates
disbursements from and payments made to the rollover account separately
from disbursements from and payments made to other amounts held under
the plan.

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

\(f\) [Deemed IRAs under eligible governmental plans]{.underline}. See
regulations under section 408(q) for guidance regarding the treatment of
separate accounts or annuities as individual retirement plans (IRAs).

[§1.457‑11 Tax treatment of participants if plan is not an eligible
plan]{.underline}.

\(a\) [In general]{.underline}. Under section 457(f), if an eligible
employer provides for a deferral of compensation under any agreement or
arrangement that is an ineligible plan‑‑

\(1\) Compensation deferred under the agreement or arrangement is
includible in the gross income of the participant or beneficiary for the
first taxable year in which there is no substantial risk of forfeiture
(within the meaning of section 457(f)(3)(B)) of the rights to such
compensation;

\(2\) If the compensation deferred is subject to a substantial risk of
forfeiture, the amount includible in gross income for the first taxable
year in which there is no substantial risk of forfeiture includes
earnings thereon to the date on which there is no substantial risk of
forfeiture;

\(3\) Earnings credited on the compensation deferred under the agreement
or arrangement that are not includible in gross income under paragraph
(a)(2) of this section are includible in the gross income of the
participant or beneficiary only when paid or made available to the
participant or beneficiary, provided that the interest of the
participant or beneficiary in any assets (including amounts deferred
under the plan) of the entity sponsoring the agreement or arrangement is
not senior to the entity\'s general creditors; and

\(4\) Amounts paid or made available to a participant or beneficiary
under the agreement or arrangement are includible in the gross income of
the participant or beneficiary under section 72, relating to annuities.

\(b\) [Exceptions]{.underline}. Paragraph (a) of this section does not
apply with respect to‑‑

\(1\) A plan described in section 401(a) which includes a trust exempt
from tax under section 501(a);

\(2\) An annuity plan or contract described in section 403;

\(3\) That portion of any plan which consists of a transfer of property
described in section 83;

\(4\) That portion of any plan which consists of a trust to which
section 402(b) applies; or

\(5\) A qualified governmental excess benefit arrangement described in
section 415(m).

\(c\) [Amount included in income]{.underline}. The amount included in
gross income on the applicable date under paragraphs (a)(1) and (a)(2)
of this section is equal to the present value of the compensation
(including earnings to the extent provided in paragraph (a)(2) of this
section) on that date. For purposes of applying section 72 on the
applicable date under paragraphs (a)(3) and (4) of this section, the
participant is treated as having paid investment in the contract (or
basis) to the extent that the deferred compensation has been taken into
account by the participant in accordance with paragraphs (a)(1) and
(a)(2) of this section.

\(d\) [Coordination of section 457(f) with section 83]{.underline}\--
(1) [General rules]{.underline}. Under paragraph (b)(3) of this section,
section 457(f) and paragraph (a) of this section do not apply to that
portion of any plan which consists of a transfer of property described
in section 83. For this purpose, a transfer of property described in
section 83 means a transfer of property to which section 83 applies.
Section 457(f) and paragraph (a) of this section do not apply if the
date on which there is no substantial risk of forfeiture with respect to
compensation deferred under an agreement or arrangement that is not an
eligible plan is on or after the date on which there is a transfer of
property to which section 83 applies. However, section 457(f) and
paragraph (a) of this section apply if the date on which there is no
substantial risk of forfeiture with respect to compensation deferred
under an agreement or arrangement that is not an eligible plan precedes
the date on which there is a transfer of property to which section 83
applies. If deferred compensation payable in property is includible in
gross income under section 457(f), then, as provided in section 72, the
amount includible in gross income when that property is later
transferred or made available to the service provider is the excess of
the value of the property at that time over the amount previously
included in gross income under section 457(f).

\(2\) [Examples]{.underline}. The provisions of this paragraph (d) are
illustrated in the following examples:

[Example 1]{.underline}. (i) [Facts]{.underline}. As part of an
arrangement for the deferral of compensation, an eligible employer
agrees on December 1, 2002 to pay an individual rendering services for
the eligible employer a specified dollar amount on January 15, 2005. The
arrangement provides for the payment to be made in the form of property
having a fair market value equal to the specified dollar amount. The
individual\'s rights to the payment are not subject to a substantial
risk of forfeiture (within the meaning of section 457(f)(3)(B)).

\(ii\) [Conclusion]{.underline}. In this [Example 1]{.underline},
because there is no substantial risk of forfeiture with respect to the
agreement to transfer property in 2005, the present value (as of
December 1, 2002) of the payment is includible in the individual\'s
gross income for 2002. Under paragraph (a)(4) of this section, when the
payment is made on January 15, 2005, the amount includible in the
individual\'s gross income is equal to the excess of the fair market
value of the property when paid, over the amount that was includible in
gross income for 2002 (which is the basis allocable to that payment).

[Example 2]{.underline}. (i) [Facts]{.underline}. As part of an
arrangement for the deferral of compensation, individuals A and B
rendering services for a tax‑exempt entity each receive in 2010 property
that is subject to a substantial risk of forfeiture (within the meaning
of section 457(f)(3)(B) and within the meaning of section 83(c)(1)).
Individual A makes an election to include the fair market value of the
property in gross income under section 83(b) and individual B does not
make this election. The substantial risk of forfeiture for the property
transferred to individual A lapses in 2012 and the substantial risk of
forfeiture for the property transferred to individual B also lapses in
2012. Thus, the property transferred to individual A is included in A\'s
gross income for 2010 when A makes an section 83(b) election and the
property transferred to individual B is included in B\'s gross income
for 2012 when the substantial risk of forfeiture for the property
lapses.

\(ii\) [Conclusion]{.underline}. In this [Example 2]{.underline}, in
each case, the compensation deferred is not subject to section 457(f) or
this section because section 83 applies to the transfer of property on
or before the date on which there is no substantial risk of forfeiture
with respect to compensation deferred under the arrangement.

[Example 3]{.underline}. (i) [Facts]{.underline}. In 2004, Z, a
tax‑exempt entity, grants an option to acquire property to employee C.
The option lacks a readily ascertainable fair market value, within the
meaning of section 83(e)(3), has a value on the date of grant equal to
\$100,000, and is not subject to a substantial risk of forfeiture
(within the meaning of section 457(f)(3)(B) and within the meaning of
section 83(c)(1)). Z exercises the option in 2012 by paying an exercise
price of \$75,000 and receives property that has a fair market value
(for purposes of section 83) equal to \$300,000.

\(ii\) [Conclusion]{.underline}. In this [Example 3]{.underline}, under
section 83(e)(3), section 83 does not apply to the grant of the option.
Accordingly, C has income of \$100,000 in 2004 under section 457(f). In
2012, C has income of \$125,000, which is the value of the property
transferred in 2012, minus the allocable portion of the basis that
results from the \$100,000 of income in 2004 and the \$75,000 exercise
price.

[Example 4]{.underline}. (i) [Facts]{.underline}. In 2010, X, a
tax‑exempt entity, agrees to pay deferred compensation to employee D.
The amount payable is \$100,000 to be paid 10 years later in 2020. The
commitment to make the \$100,000 payment is not subject to a substantial
risk of forfeiture. In 2010, the present value of the \$100,000 is
\$50,000. In 2018, X transfers to D property having a fair market value
(for purposes of section 83) equal to \$70,000. The transfer is in
partial settlement of the commitment made in 2010 and, at the time of
the transfer in 2018, the present value of the commitment is \$80,000.
In 2020, X pays D the \$12,500 that remains due.

\(ii\) [Conclusion]{.underline}. In this [Example 4]{.underline}, D has
income of \$50,000 in 2010. In 2018, D has income of \$30,000, which is
the amount transferred in 2018, minus the allocable portion of the basis
that results from the \$50,000 of income in 2010. (Under section
72(e)(2)(B), income is allocated first. The income is equal to \$30,000
(\$80,000 minus the \$50,000 basis), with the result that the allocable
portion of the basis is equal to \$40,000 (\$70,000 minus the \$30,000
of income).) In 2020, D has income of \$2,500 (\$12,500 minus \$10,000,
which is the excess of the original \$50,000 basis over the \$40,000
basis allocated to the transfer made in 2018).

[§ 1.457‑12 Effective dates]{.underline}.

\(a\) [General effective date]{.underline}. Except as otherwise provided
in this section, §§1.457‑1 through 1.457‑11 apply for taxable years
beginning after December 31, 2001.

\(b\) [Transition period for eligible plans to comply with
EGTRRA]{.underline}. For taxable years beginning after December 31,
2001, and before January 1, 2004, a plan does not fail to be an eligible
plan as a result of requirements imposed by the Economic Growth and Tax
Relief Reconciliation Act of 2001 (115 Stat. 385) (EGTRRA) (Public Law
107-16) June 7, 2001, if it is operated in accordance with a reasonable,
good faith interpretation of EGTRRA.

\(c\) [Special rule for distributions from rollover
accounts]{.underline}. The last sentence of §1.457‑6(a) (relating to
distributions of amounts held in a separate account for eligible
rollover distributions) applies for taxable years beginning after
December 31, 2003.

\(d\) [Special rule for options]{.underline}. Section 1.457‑11(d) does
not apply with respect to an option without a readily ascertainable fair
market value (within the meaning of section 83(e)(3)) that was granted
on or before May 8, 2002.

\(e\) [Special rule for qualified domestic relations
orders]{.underline}. Section 1.457‑10(c) (relating to qualified domestic
relations orders) applies for transfers, distributions, and payments
made after December 31, 2001.

Part 602\--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 4. The authority citation for part 602 continues to read as
follows:

Authority: 26 U.S.C. 7805.

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

[§602.101 OMB Control numbers]{.underline}.

\* \* \* \* \*

\(b\) \* \* \*

\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\--

CFR part or section where Current OMB

identified and described control No.

\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\--

\* \* \* \* \*

1.457-8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .1545-1580

\* \* \* \* \*

\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\--

Robert E. Wenzel,

Deputy Commissioner for Services and Enforcement

Approved: July 2, 2003.

> Pamela F. Olson,
>
> Assistant Secretary of Treasury (Tax Policy)

[^1]:
    > See generally the [Report to the Congress on the Tax Treatment of
    > Deferred Compensation under Section 457]{.underline}, Department
    > of the Treasury, January 1992 (available from the Office of Tax
    > Policy, Room 5315, Treasury Department, 1500 Pennsylvania Avenue
    > NW., Washington DC 20220).