[Federal Register Volume 69, Number 220 (Tuesday, November 16, 2004)]
[Proposed Rules]
[Pages 67075-67100]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-25237]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 31

[REG-155608-02]
RIN 1545-BB64


Revised Regulations Concerning Section 403(b) Tax-Sheltered 
Annuity Contracts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking, notice of proposed rulemaking by 
cross-reference to temporary regulations, and notice of public hearing.

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SUMMARY: This document contains proposed regulations under section 
403(b) of the Internal Revenue Code and under related provisions of 
sections 402(b), 402(g), 414(c), and 3121(a)(5)(D). The proposed 
regulations would provide updated guidance on section 403(b) contracts 
of public schools and tax-exempt organizations described in section 
501(c)(3). These regulations would provide the public with guidance 
necessary to comply with the law and will affect sponsors of section 
403(b) contracts, administrators, participants and beneficiaries. In 
the Rules and Regulations section of this issue of the Federal 
Register, the Treasury Department and IRS are issuing temporary 
regulations providing employment tax guidance to employers and 
employees on salary reduction agreements. This document also provides 
notice of a public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by February 14, 
2005. Outlines of topics to be discussed at the public hearing 
scheduled for February 15, 2005, to be held in the IRS Auditorium (7th 
Floor) must be received by January 25, 2005.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-155608-02), room 
5203, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
155608-02), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically via the IRS 
Internet site at http://www.irs.gov/regs or via the Federal eRulemaking 
Portal at http://www.regulations.gov (IRS-REG-155608-02). The public 
hearing will be held in the IRS Auditorium (7th Floor), Internal 
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
R. Lisa Mojiri-Azad or John Tolleris, (202) 622-6060; concerning the 
proposed regulations as applied to church-related entities, Robert 
Architect (202) 283-9634; concerning submission of comments, the 
hearing, and/or to be placed on the building access list to attend the 
hearing, Sonya Cruse, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of 
rulemaking has been previously 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 1545-1341.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    Regulations (TD 6783) under section 403(b) of the Internal Revenue 
Code (Code) were published in the Federal Register (29 FR 18356) on 
December 24, 1964 (1965-1 C.B. 180). These regulations provided 
guidance for complying with section 403(b) which had been enacted in 
1958 in section 23(a) of the Technical Amendments Act of 1958, Public 
Law 85-866 (1958), relating to tax-sheltered annuity arrangements 
established for employees by public schools and tax-exempt 
organizations described in section 501(c)(3). Since 1964, additional 
regulations have been issued under section 403(b) to reflect rules 
relating to eligible rollover distributions and minimum distributions 
under section 401(a)(9).
    These proposed regulations would amend the current regulations to

[[Page 67076]]

conform them to the numerous amendments made to section 403(b) by 
subsequent legislation, including section 1022(e) of the Employee 
Retirement Income Security Act of 1974 (ERISA) (88 Stat. 829), Public 
Law 93-406; section 251 of the Tax Equity and Fiscal Responsibility Act 
of 1982 (TEFRA) (96 Stat. 324,529), Public Law 97-248; section 1120 of 
the Tax Reform Act of 1986 (TRA '86) (100 Stat. 2085, 2463), Public Law 
99-514; section 1450(a) of the Small Business Job Protection Act of 
1996 (SBJPA) (110 Stat. 1755, 1814), Public Law 104-188; and sections 
632, 646, and 647 of the Economic Growth and Tax Relief Reconciliation 
Act of 2001 (EGTRRA) (115 Stat. 38, 113, 126, 127), Public Law 107-16.

Explanation of Provisions

Overview

    The purposes of these proposed regulations are to update the 
current regulations under section 403(b) to delete provisions that no 
longer have legal effect due to changes in law, to include in the 
regulations a number of items of interpretive guidance that have been 
issued under section 403(b) since the 1964 regulations,\1\ and 
generally to reflect the numerous legal changes that have been made in 
section 403(b). A major effect of the legal changes in section 403(b) 
has been to diminish the extent to which the rules governing section 
403(b) plans differ from the rules governing other arrangements that 
include salary reduction contributions, i.e., section 401(k) plans and 
section 457(b) plans for State and local governmental entities. Thus, 
these regulations will reflect the increasing similarity among these 
arrangements.
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    \1\ Since 1964, the existing regulations have been revised for 
certain specific changes in law, for example, regulations under 
section 403(b) have been issued in question and answer form to 
reflect changes relating to eligible rollover distributions (TD 
8619, September 15, 1995) and minimum distributions under section 
401(a)(9) (TD 8987, April 16, 2002).
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    Since the existing regulations were issued in 1964, a number of 
revenue rulings and other guidance under section 403(b) have become 
outdated as a result of changes in law. In addition, as a result of the 
inclusion in these proposed regulations of much of the guidance that 
the IRS has issued regarding section 403(b), it is anticipated that 
these regulations, when finalized, will supersede a number of revenue 
rulings and notices that have been issued under section 403(b). Thus, 
the IRS anticipates taking action to obsolete many revenue rulings, 
notices, and other guidance under section 403(b) when these regulations 
are issued in final form.\2\ However, the positions taken in certain 
rulings and other outstanding guidance are expected to be retained. For 
example, it is intended that a revenue ruling will be issued that 
substantially replicates and consolidates the existing rules \3\ for 
determining when employees are performing services for a public 
school.\4\
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    \2\ It is expected that the following guidance is outdated, or 
will be superseded, when these regulations are issued in final form: 
Rev. Rul. 64-333. 1964-2 C.B. 114; Rev. Rul. 65-200, 1965-2 C.B. 
141; Rev. Rul. 66-254, 1966-2 C.B. 125; Rev. Rul. 66-312, 1966-2 
C.B. 127; Rev. Rul. 67-78, 1967-1 C.B. 94; Rev. Rul. 67-69, 1967-1 
C.B. 93; Rev. Rul. 67-361, 1967-2 C.B. 153; Rev. Rul. 67-387, 1967-2 
C.B. 153; Rev. Rul. 67-388, 1967-2 C.B. 153; Rev. Rul. 68-179, 1968-
1 CB 179; Rev. Rul. 68-482, 1968-2 CB 186; Rev. Rul. 68-487, 1968-2 
CB 187; Rev. Rul. 68-488, 1968-2 C.B. 188; Rev. Rul. 69-629, 1969-2 
C.B. 101; Rev. Rul. 70-243, 1970-1 C.B. 107; Rev. Rul. 87-114, 1987-
2 C.B. 116; Notice 89-23, 1989-1 C.B. 654; Rev. Rul. 90-24, 1990-1 
C.B. 97; Notice 90-73, 1990-2 C.B. 353; Notice 92-36, 1992-2 C.B. 
364; and Announcement 95-48, 1995-23 I.R.B. 13. It is expected that 
the following guidance will not be superseded when these regulations 
are issued in final form: Rev. Rul. 66-254, 1966-2 C.B. 125; Rev. 
Rul. 68-33, 1968-1 C.B. 175; Rev. Rul 68-58, 1968-1 C.B. 176; Rev. 
Rul. 68-116, 1968-1 C.B. 177; Rev. Rul. 68-648, 1968-2 C.B. 49; Rev. 
Rul. 68-488, 1968-2 C.B. 188; and Rev. Rul. 69-146, 1969-1 C.B. 132. 
Comments are requested on whether any guidance items under section 
403(b) should be added to or deleted from either of the preceding 
lists. See the request for comments below under the heading Comments 
and Public Hearing.
    \3\ Rev. Rul. 73-607, 1973-2 C.B. 145 and Rev. Rul. 80-139, 
1980-1 C.B. 88.
    \4\ As discussed below (under the heading Controlled Group Rules 
For Tax-Exempt Entities), other guidance that may be reissued 
includes the controlled group safe harbor rules in paragraph 
(V)(B)(2)(b) of Notice 89-23.
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    The existing regulations include special rules for determining the 
amount of the contributions made for an employee under a defined 
benefit plan, based on the employee's pension under the plan. These 
rules are generally no longer applicable for section 403(b) because the 
limitations on contributions to a section 403(b) contract are no longer 
coordinated with accruals under a defined benefit plan. (See also the 
discussion of defined benefit plans below under the heading 
Miscellaneous Provisions.) However, the rules for determining the 
amount of contributions made for an employee under a defined benefit 
plan in the existing regulations under section 403(b) are also used for 
purposes of section 402(b) (relating to nonqualified plans funded 
through trusts) and, accordingly, these rules are proposed to be 
deleted from the regulations under section 403(b). New proposed 
regulations under section 402(b) would authorize the Commissioner to 
issue guidance for determining the amount of the contributions made for 
an employee under a defined benefit plan under section 402(b). See also 
the request for comments on this guidance under the heading Comments 
and Public Hearing.
    The proposed regulations also include controlled group rules under 
section 414(c) for entities that are tax-exempt under section 501(a).

Exclusion for Contributions to Section 403(b) Contracts

    Section 403(b) provides an exclusion from gross income for certain 
contributions made by certain types of employers for their employees to 
specific types of funding arrangements. There are three categories of 
funding arrangements to which section 403(b) applies: (1) Annuity 
contracts (as defined in section 401(g)) issued by an insurance 
company; (2) custodial accounts that are invested solely in mutual 
funds; and (3) retirement income accounts which are only permitted for 
church employees. The exclusion applies only if certain general 
requirements are satisfied. For purposes of most of these requirements, 
section 403(b)(5) provides that all section 403(b) contracts purchased 
for an individual by an employer are treated as purchased under a 
single contract. Other aggregation rules apply for certain specific 
purposes, including the aggregation rules under section 402(g) for 
purposes of satisfying the limitations on elective deferrals (which 
apply both on an individual basis and to all contributions made by an 
employer) and the controlled group rules of section 414(b) and (c) for 
purposes of the general nondiscrimination rules and the contribution 
limitations of section 415 (which generally apply on an employer-by-
employer basis).

Section 403(b) Requirements

    Section 403(b)(1)(C) requires that the contract be nonforfeitable 
except for the failure to pay future premiums. The proposed regulations 
define nonforfeitability based on the regulations under section 411(a) 
and clarify that if an annuity contract issued by an insurance company 
is purchased that would satisfy section 403(b) except for the failure 
to satisfy this nonforfeitability requirement, then the contract is 
treated as a contract to which section 403(c) applies. Section 403(c) 
provides that the value of a nonqualified contract is included in gross 
income under the rules of section 83, which generally does not occur 
before the employee's rights in the contract become substantially 
vested. Under the proposed regulations, on the date on which the 
employee's interest in that contract becomes nonforfeitable, the

[[Page 67077]]

contract may be treated as a section 403(b) contract if the contract 
has at all prior times satisfied the requirements of section 403(b) 
other than the nonforfeitability requirement. Solely for this purpose, 
if a participant's interest in a contract is only partially 
nonforfeitable in a year, then the portion that is nonforfeitable and 
the portion that fails to be nonforfeitable are bifurcated.
    Section 403(b)(12) requires a section 403(b) contract to make 
elective deferrals available to all employees (the universal 
availability rule) and requires other contributions to satisfy the 
general nondiscrimination requirements applicable to qualified plans. 
These rules are discussed further below under the heading Section 
403(b) Nondiscrimination and Universal Availability Rules.
    Section 403(b)(1)(E) requires a section 403(b) contract to satisfy 
the requirements of section 401(a)(30) relating to limitations on 
elective deferrals under section 402(g)(1). The proposed regulations 
provide that a contract only satisfies this requirement if the contract 
requires all elective deferrals for an employee to satisfy section 
402(g)(1), including elective deferrals for the employee under the 
contract and any other elective deferrals under the plan under which 
the contract is purchased and under all other plans, contracts, or 
arrangements of the employer that are subject to the limits of section 
402(g). This rule is the same as the rule for section 401(k) 
arrangements.
    A section 403(b) contract is also required to provide that it will 
satisfy the minimum required distribution requirements of section 
401(a)(9), the incidental benefit requirements of section 401(a), and 
the rollover distribution rules of section 402(c).
    The proposed regulations address the requirement that annual 
additions to the contract not exceed the applicable limitations of 
section 415(c) (treating contributions as annual additions). In 
accordance with the last sentence of section 415(a)(2), if an excess 
annual addition is made to a contract that otherwise satisfies the 
requirements of section 403(b), then the portion of the contract that 
includes the excess will fail to be a section 403(b) contract (and 
instead will be a contract to which section 403(c) applies) and the 
remaining portion of the contract that includes the contribution that 
is not in excess of the section 415 limitations is a section 403(b) 
contract. This rule under which only the excess annual addition is 
subject to section 403(c) does not apply unless, for the year of the 
excess and each year thereafter, the issuer of the contract maintains 
separate accounts for the portion that includes the excess and for the 
section 403(b) portion, i.e., the portion that includes the amount not 
in excess of the section 415 limitations.
    The proposed regulations require that these conditions for the 
exclusion be satisfied both in form and operation in the section 403(b) 
contract. Because several of these requirements are based on plan 
documents--in particular the requirements that elective deferrals 
satisfy a universal availability rule and that other contributions 
satisfy the nondiscrimination rules applicable to qualified plans--the 
proposed regulations require that the contract be maintained pursuant 
to a plan. For this purpose, it is intended that the plan would include 
all of the material provisions regarding eligibility, benefits, 
applicable limitations, the contracts available under the plan, and the 
time and form under which benefit distributions would be made. This 
rule does not require that there be a single plan document. For 
example, this requirement would be satisfied by complying with the plan 
document rules applicable to qualified plans.

Interaction Between Title I of ERISA and Section 403(b) of the Code

    The Treasury Department and the IRS have consulted with the 
Department of Labor concerning the interaction between Title I of the 
Employee Retirement Income Security Act of 1974 (ERISA) and section 
403(b) of the Code. The Department of Labor has advised the Treasury 
Department and the IRS that Title I of ERISA generally applies to ``any 
plan, fund, or program * * * established or maintained by an employer 
or by an employee organization, or by both, to the extent that * * * 
such plan, fund, or program * * * provides retirement income to 
employees, or * * * results in a deferral of income by employees for 
periods extending to the termination of covered employment or beyond.'' 
ERISA, section 3(2)(A). However, governmental plans and church plans 
are generally excluded from coverage under Title I of ERISA. See ERISA, 
section 4(b)(1) and (2). Therefore, section 403(b) contracts purchased 
or provided under a program that is either a ``governmental plan'' 
under section 3(32) of ERISA or a ``church plan'' under section 3(33) 
of ERISA are not generally covered under Title I. However, section 
403(b) of the Code is also available with respect to contracts 
purchased or provided by employers for employees of a section 501(c)(3) 
organization, and many programs for the purchase of section 403(b) 
contracts offered by such employers are covered under Title I of ERISA 
as part of an ``employee pension benefit plan'' within the meaning of 
section 3(2)(A) of ERISA. The Department of Labor has promulgated a 
regulation, 29 CFR 2510.3-2(f), describing circumstances under which an 
employer's program for the purchase of section 403(b) contracts for its 
employees, which is not otherwise excluded from coverage under Title I, 
will not be considered to constitute the establishment or maintenance 
of an ``employee pension benefit plan'' under Title I of ERISA.
    These proposed regulations are generally limited to the 
requirements imposed under section 403(b). In this regard, the proposed 
regulations require that a section 403(b) program be maintained 
pursuant to a plan, which for this purpose is defined as a written 
defined contribution plan which, in both form and operation, satisfies 
the regulatory requirements of section 403(b) and contains all the 
material terms and conditions for benefits under the plan. The 
Department of Labor has advised the Treasury Department and the IRS 
that, although it does not appear that the proposed regulations would 
mandate the establishment or maintenance of an employee pension benefit 
plan in order to satisfy its requirements, it leaves open the 
possibility that an employer may undertake responsibilities that would 
constitute establishing and maintaining an ERISA-covered plan. The 
Department of Labor has further advised the Treasury Department and the 
IRS that whether the manner in which any particular employer decides to 
satisfy particular responsibilities under these proposed regulations 
will cause the employer to be considered to have established or to 
maintain a plan that is covered under Title I of ERISA must be analyzed 
on a case-by-case basis, applying the criteria set forth in 29 CFR 
2510.3-2(f), including the employer's involvement as contemplated by 
the plan documents and in operation.
    To the extent that these proposed regulations may raise questions 
for employers concerning the scope and application of the regulation at 
29 CFR 2510.3-2(f), the Treasury Department and the IRS are requesting 
comments. See below under the heading Comments and Public Hearing.
    All employee pension benefit plans covered under Title I of ERISA, 
including plans that involve the purchase of section 403(b) contracts, 
must satisfy a number of requirements, including requirements relating 
to

[[Page 67078]]

reporting and disclosure, eligibility, vesting, benefit accrual, 
advance notice of contribution reductions, qualified joint and survivor 
annuities, minimum funding, fiduciary standards, fidelity bonds, and 
claims procedures. Authority to interpret many of the requirements in 
parts 2 and 3 of Title I of ERISA (specifically those relating to 
eligibility, vesting, benefit accrual, minimum funding, and qualified 
joint and survivor annuities) has been transferred to the Treasury 
Department and the IRS. See Reorganization Plan No. 4 of 1978, 43 FR 
47713, October 17, 1978. As a result, those section 403(b) contracts of 
a section 501(c)(3) organization that are part of an employee pension 
benefit plan are subject to requirements parallel to those imposed 
under sections 401(a)(11) through 401(a)(15), 410, 411, 412, and 417 of 
the Internal Revenue Code and the regulations promulgated thereunder, 
since regulations and other guidance issued under those Code sections 
are applicable for purposes of the parallel requirements in ERISA. 
Further, although specific references are made to Title I in these 
proposed regulations, this does not imply that other Title I issues are 
not applicable.

Comparison With Section 401(k) Elective Deferrals

    Section 1450(a) of SBJPA provides that the rules applicable to cash 
or deferred elections under section 401(k) are to apply under section 
403(b) for purposes of determining the frequency with which an employee 
may enter into a salary reduction agreement, the salary to which such 
an agreement may apply, and the ability to revoke such an agreement. 
Based in part on this provision, and taking into account the guidance 
that has been issued since SBJPA,\5\ the proposed regulations would 
clarify the extent to which section 403(b) elective deferrals are like 
elective deferrals under proposed and final rules under section 401(k). 
Specifically, the rules are fundamentally similar with respect to the 
frequency with which a deferral election can be made, changed, or 
revoked, including automatic enrollment (plan provisions under which 
elective deferrals are automatically made for employees unless they 
elect otherwise), the ability for a deferral election that has been 
made in one year to be carried forward to subsequent periods until 
modified, the rule under which irrevocable elections are not treated as 
elective deferrals, and the requirement that employees have an annual 
effective opportunity to make, revoke, or modify a deferral election. 
The rules are also fundamentally similar with respect to the 
compensation with respect to which the election can be made, e.g., 
allowing a deferral election to be made for compensation up to the day 
before the compensation is currently available. Likewise, the proposed 
regulations explicitly provide that, for purposes of sections 402(g) 
and 403(b), an elective deferral with respect to a section 403(b) 
contract is limited to contributions made pursuant to a cash or 
deferred election, as defined in regulations under section 401(k).
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    \5\ See, for example, Rev. Rul. 2000-35, 2000-2 C.B. 138, 
relating to automatic enrollment in section 403(b) plans.
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    These proposed regulations also include a rule comparable to the 
anti-conditioning rule at section 401(k)(4). Finally, the proposed 
regulations include rules similar to those for section 401(k) plans 
regarding plan limitations to comply with section 401(a)(30) and to pay 
out section 403(b) elective deferrals in excess of the related section 
402(g) limitation.
    As a result, under the proposed regulations, the three major 
differences between the rules applicable to section 403(b) elective 
deferrals and the rules applicable to elective deferrals under section 
401(k) are:
    <bullet> Section 403(b) is limited to certain specific employers 
and employees (i.e., employees of a State public school, employees of a 
section 501(c)(3) organization, and certain ministers), whereas section 
401(k) is available to all employers, except a State or local 
government or any political subdivision, agency, or instrumentality 
thereof.
    <bullet> Unlike section 401(k), contributions under section 403(b) 
can only be made to certain funding arrangements, i.e., an insurance 
annuity contract, custodial account that is limited to mutual fund 
shares, or church retirement income account, and not to a trust or 
custodial account that fails to satisfy the custodial account rules at 
section 403(b)(7) or the retirement income account rules at section 
403(b)(9) for churches.
    <bullet> A universal availability rule applies to section 403(b) 
elective deferrals, whereas an average deferral percentage rule (the 
ADP test) and a minimum coverage rule (section 410(b)) apply with 
respect to elective deferrals under section 401(k).\6\
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    \6\ Other differences between the rules applicable to elective 
deferrals under section 403(b) and elective deferrals under section 
401(k) include the following: the consequences of failing to satisfy 
the rules of section 403(b) (described below under the heading 
Failure to satisfy section 403(b)); the definition of compensation 
(including the five-year rule) at section 403(b)(3); the special 
section 403(b) catch-up elective deferral at section 402(g)(7); the 
section 415 aggregation rules; and the general inapplicability of 
stock ownership for State entities (and some nonprofit entities), 
including the related inapplicability of employee stock ownership 
plans and the use of stock ownership to determine common control. An 
additional difference is discussed below, under the heading 
Severance From Employment.
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Failure To Satisfy Section 403(b)

    The regulations clarify that if the requirements of section 403(b) 
fail to be satisfied with respect to an employer contribution, then the 
contribution is subject either to the rules under section 403(c) 
(relating to nonqualified annuities) if the contribution is for an 
annuity contract issued by an insurance company, or is subject to the 
rules under section 61, 83, or 402(b) if the contribution is to a 
custodial account or retirement income account that fails to satisfy 
the requirements of section 403(b).
    Issues have been raised about the application of section 403(b) to 
tax-exempt entities that have State or local government features. These 
proposed regulations do not attempt to address when an entity is a 
State (treating a local government or other subdivision as a State) and 
when it is a section 501(c)(3) organization that is not a State.\7\ 
Thus, for example, these regulations do not provide guidance on the 
conditions under which a tax-exempt charter school is, or is not, a 
State entity.
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    \7\ Similarly, the proposed regulations do not address the 
conditions under which a plan is a governmental plan under section 
414(d).
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    Based on the wording of section 401(k)(4)(B)(i) and (ii), an entity 
that is both a section 501(c)(3) organization and an instrumentality of 
a State cannot have a section 401(k) plan. Under sections 457(b)(6) and 
457(g), an entity that is both an instrumentality of a State and a 
section 501(c)(3) organization can have an eligible plan under section 
457(b) only if it is funded. However, under section 403(b)(1)(A)(i) and 
(ii), an entity that is both an instrumentality of a State and a 
section 501(c)(3) organization could cover any of its employees, 
regardless of whether they are performing services for a public school.

Maximum Contribution Limitations

    The exclusion provided under section 403(b) applies only to the 
extent that all amounts contributed by the employer for the purchase of 
an annuity contract for the participant do not exceed the applicable 
limit under section 415 and, with respect to section 403(b) elective 
deferrals, only if the contract is purchased under a plan that includes 
the limits under section 402(g), including aggregation under all plans 
of

[[Page 67079]]

the employer. The proposed regulations require a section 403(b) 
contract to include this limit on section 403(b) elective deferrals, as 
imposed by section 402(g).

Catch-Up Contributions

    A section 403(b) contract may provide for additional catch-up 
contributions for a participant who is age 50 by the end of the year, 
provided that those age 50 catch-up contributions do not exceed the 
catch-up limit under section 414(v) for the taxable year (which is 
$3,000 for 2004). In addition, an employee of a qualified organization 
who has at least 15 years of service (disregarding any period during 
which an individual is not an employee of the eligible employer) is 
entitled to a special section 403(b) catch-up limit. Under the special 
section 403(b) catch-up limit, the section 402(g) limit is increased by 
the lowest of the following three amounts: (i) $3,000; (ii) the excess 
of $15,000 over the total special section 403(b) catch-up elective 
deferrals made for the qualified employee by the qualified organization 
for prior taxable years; or (iii) the excess of (A) $5,000 multiplied 
by the number of years of service of the employee with the qualified 
organization, over (B) the total elective deferrals made for the 
qualified employee by the qualified organization for prior taxable 
years. For this purpose, a qualified organization is an eligible 
employer that is a school, hospital, health and welfare service agency 
(including a home health service agency), or a church-related 
organization. In the case of a church-related organization, all 
entities that are in such a church-related organization are treated as 
a single qualified organization, so that years of service and any 
section 403(b) catch-up elective deferrals previously made for a 
qualified employee for any such church are taken into account for 
purposes of determining the amount of section 403(b) catch-up elective 
deferrals to which an employee is entitled under any section 403(b) 
plan maintained by another entity in the same church-related 
organization. A health and welfare service agency is defined as either 
an organization whose primary activity is to provide medical care as 
defined in section 213(d)(1) (such as a hospice), or a section 
501(c)(3) organization whose primary activity is the prevention of 
cruelty to individuals or animals, or which provides substantial 
personal services to the needy as part of its primary activity (such as 
a section 501(c)(3) organization that provides meals to needy 
individuals).
    The proposed regulations provide that any catch-up contribution for 
an employee who is eligible for both an age 50 catch-up and the special 
section 403(b) catch-up is treated first as a special section 403(b) 
catch-up to the extent a special section 403(b) catch-up is permitted, 
and then as an amount contributed as an age 50 catch-up (to the extent 
the age 50 catch-up amount exceeds the maximum special section 403(b) 
catch-up).
    Any contribution made for a participant to a section 403(b) 
contract for a taxable year that exceeds either the section 415 maximum 
annual contribution limit or the section 402(g) elective deferral limit 
constitutes an excess contribution that is included in gross income for 
that taxable year (or, if later, the taxable year in which the contract 
becomes nonforfeitable). The proposed regulations provide that a 
section 403(b) contract or the section 403(b) plan may provide that any 
excess deferral as a result of a failure to comply with the section 
402(g) elective deferral limit for the taxable year with respect to any 
section 403(b) elective deferral made for a participant by the employer 
will be distributed to the participant, with allocable net income, no 
later than April 15 or otherwise in accordance with section 402(g).

Determination of Years of Service Under Section 403(b)

    For purposes of determining a participant's includible compensation 
and years of service--used both for the special section 403(b) catch-up 
contributions and for employer contributions for former employees--an 
employee's number of years of service include each full year during 
which the individual is a full-time employee of the eligible employer 
plus a fraction of a year for each part of a year during which the 
individual is a full-time or part-time employee of the eligible 
employer. A year of service is based on the employer's annual work 
period, not the employee's taxable year. Thus, in determining whether a 
university professor is employed full-time, the annual work period is 
the school's academic year. In determining whether an individual is 
employed full-time, the amount of work actually performed is compared 
with the amount of work that is normally required of individuals 
performing similar services from which substantially all of their 
annual compensation is derived. An individual is treated as performing 
a fraction of a year of service for each annual work period during 
which he or she is a full-time employee for part of the annual work 
period or for each annual work period during which he or she is a part-
time employee either for the entire annual work period or for a part of 
the annual work period.
    In measuring the amount of work of an individual performing 
particular services, the work performed is determined based on the 
individual's hours of service (as defined under section 410(a)(3)(C)), 
except that a plan may use a different measure of work if appropriate 
under the facts and circumstances. For example, a plan may provide for 
a university professor's work to be measured by the number of courses 
taught during an annual work period if that individual's work 
assignment is generally based on a specified number of courses to be 
taught.
    In determining years of service, any period during which an 
individual is not an employee of the eligible employer is disregarded, 
except that, for a section 403(b) contract of an eligible employer that 
is a church-related organization, any period during which an individual 
is an employee of that eligible employer and any other eligible 
employer that is within the same church-related organization with that 
eligible employer is taken into account on an aggregated basis. In the 
case of a part-time employee or a full-time employee who is employed 
for only part of the year, the employee's most recent periods of 
service are aggregated to determine his or her most recent one-year 
period of service, as follows: the employee's service during the annual 
work period for which the last year of service's includible 
compensation is being determined is taken into account first; then the 
employee's service during the next preceding annual work period based 
on whole months is taken into account; and so forth, until the 
employee's service equals, in the aggregate, one year of service.

Special Rule for Former Employees

    Under section 403(b)(3), a former employee is deemed to have 
monthly includible compensation for the period through the end of the 
taxable year of the employee in which he or she ceases to be an 
employee and through the end of each of the next five taxable years of 
the employee. The amount of the monthly includible compensation is 
equal to \1/12\ of the former employee's includible compensation during 
the former employee's most recent year of service. Accordingly, a plan 
may provide that nonelective employer contributions are continued for 
up to five years for a former employee, up to the lesser of the dollar 
amount in section 415(c)(1)(A) or the former

[[Page 67080]]

employee's annual includible compensation based on the former 
employee's compensation during his or her most recent year of service.

Other Contributions for Former Employees

    The proposed regulations do not address the extent, if any, to 
which the exclusion from gross income provided by section 403(b) 
applies to contributions made for former employees (e.g., whether a 
contribution may be made for a former employee if the contribution is 
with respect to compensation that would otherwise be paid for a payroll 
period that begins after severance from employment) other than as 
provided under the five-year rule at section 403(b)(3), described above 
under the heading Special Rule for Former Employees. The Treasury 
Department and the IRS expect to issue separate guidance on this issue, 
potentially addressing this question with respect to not only section 
403(b), but also sections 401(k), 457(b) (for eligible governmental 
plans), and 415(c).

Section 403(b) Nondiscrimination and Universal Availability Rules

Nondiscrimination
    Section 403(b)(12)(A)(i) requires that employer contributions and 
employee after-tax contributions made under a section 403(b) contract 
satisfy a specified series of requirements (the nondiscrimination 
requirements) in the same manner as a qualified plan under section 
401(a). These proposed regulations do not adopt the good faith 
reasonable standard of Notice 89-23 for purposes of satisfying the 
nondiscrimination requirements of section 403(b)(12)(A)(i). These 
nondiscrimination requirements include rules relating to 
nondiscrimination in contributions, benefits, and coverage (sections 
401(a)(4) and 410(b)), a limitation on the amount of compensation that 
can be taken into account (section 401(a)(17)), and the average 
contribution percentage rules of section 401(m) (relating to matching 
and after-tax contributions). The nondiscrimination requirements are 
generally tested using compensation as defined in section 414(s) and 
are applied on an aggregated basis taking into account all plans of the 
employer. See the discussion below under the heading Controlled Group 
Rules For Tax-Exempt Entities.
    The nondiscrimination requirements do not apply to section 403(b) 
elective deferrals. In addition, the only nondiscrimination requirement 
that applies to a governmental plan, within the meaning of section 
414(d), is the limitation on compensation (section 401(a)(17)).
Universal Availability
    Under section 403(b)(12)(A)(ii), a universal availability 
requirement applies under which all employees of the eligible employer 
must be permitted to elect to have section 403(b) elective deferrals 
contributed on their behalf if any employee of the eligible employer 
may elect to have the organization make section 403(b) elective 
deferrals. Under the proposed regulations, the universal availability 
requirement is not satisfied unless the contributions are made pursuant 
to a plan and the plan permits elective deferrals that satisfy the 
universal availability requirement. The proposed regulations generally 
provide that the universal availability requirement applies separately 
to each common law entity, i.e., to each section 501(c)(3) 
organization, or, in the case of a section 403(b) plan that covers the 
employees of more than one State entity, to each entity that is not 
part of a common payroll. The proposed regulations allow an employer 
that historically has treated one or more of its various geographically 
distinct units as separate for employee benefit purposes to treat each 
unit as a separate organization if the unit is operated independently 
on a day-to-day basis.
    The proposed regulations include the statutory categories that are 
exceptions to the universal availability rule, and provide that, if any 
employee listed in any excludable category has the right to have 
section 403(b) elective deferrals made on his or her behalf, then no 
employees in that category may be excluded. The categories generally 
are: employees who are eligible to participate in an eligible 
governmental plan under section 457(b) which permits contributions or 
deferrals at the election of the employee or a plan of the employer 
offering a qualified cash or deferred election under section 401(k); 
employees who are non-resident aliens; employees who are students 
performing services described in section 3121(b)(10); and employees who 
normally work fewer than 20 hours per week. Additionally, Notice 89-23 
included transition rules for certain other exclusions that are not in 
the statute: employees who make a one-time election to participate in a 
governmental plan instead of a section 403(b) plan; employees covered 
by a collective bargaining agreement; visiting professors for up to one 
year under certain circumstances; and employees affiliated with a 
religious order who have taken a vow of poverty. The proposed 
regulations do not adopt these transition rules. See the reference to 
these exclusions below under the heading
Comments and Public Hearing
    The nondiscrimination and the universal availability requirements 
do not apply to a section 403(b) contract purchased by a church, which 
is specially defined for this purpose, and generally does not include a 
university, hospital, or nursing home.
    The nondiscrimination and universal availability requirements are 
in addition to other applicable legal requirements. Specifically, these 
requirements do not reflect the requirements of Title I of ERISA that 
may apply with respect to a section 403(b) plan, such as the ERISA 
vesting requirements. Another example is that, while employees who 
normally work fewer than 20 hours per week may be excluded under the 
universal availability rule, employers who maintain plans that are 
subject to Title I of ERISA should be aware that Title I of ERISA 
includes limitations on the conditions under which employees can be 
excluded from a plan on account of not working full time and that these 
limitations would generally not permit an exclusion for employees who 
normally work fewer than 20 hours per week. See section 202(a)(1) of 
ERISA and regulations under section 410(a) of the Code (which interpret 
section 202 of ERISA).

Timing of Distributions and Benefits

    The proposed regulations reflect the statutory rules regarding when 
distributions can be made from a section 403(b) contract. Thus, amounts 
held in a custodial contract attributable to employer contributions 
(that are not section 403(b) elective deferrals) may not be paid to a 
participant before the participant has a severance from employment, 
becomes disabled (within the meaning of section 72(m)(7)), or attains 
age 59\1/2\. This rule also applies to amounts transferred out of a 
custodial account (i.e., to an annuity contract or retirement income 
account), including earnings thereon. In addition, distributions of 
amounts attributable to section 403(b) elective deferrals may not be 
paid to a participant earlier than when the participant has a severance 
from employment, has a hardship, becomes disabled (within the meaning 
of section 72(m)(7)), or attains age 59\1/2\. Hardship is generally 
defined under regulations issued under section 401(k).
    The proposed regulations would reflect the requirements of section 
402(f) relating to the written explanation

[[Page 67081]]

requirements for distributions that qualify as eligible rollover 
distributions, including conforming the timing rule to the rule for 
qualified plans.
    Where the distribution restrictions do not apply, a section 403(b) 
contract is permitted to distribute retirement benefits to the 
participant after severance from employment or upon the prior 
occurrence of an event, such as after a fixed number of years, the 
attainment of a stated age, or disability. The proposed regulations 
include a number of exceptions to the timing restrictions, e.g., the 
rule for elective deferrals does not apply to distributions of section 
403(b) elective deferrals (not including earnings thereon) that were 
contributed before January 1, 1989.

Severance From Employment

    The proposed regulations define severance from employment in a 
manner that is generally the same as the proposed regulations under 
section 401(k),\8\ but provide that a severance from employment occurs 
on any date on which the employee ceases to be employed by an eligible 
employer that maintains the section 403(b) plan. Thus, a severance from 
employment would occur when an employee ceases to be employed by an 
eligible employer even though the employee may continue to be employed 
by an entity that is part of the same controlled group but that is not 
an eligible employer, or on any date on which the employee works in a 
capacity that is not employment with an eligible employer. Examples of 
the situations that constitute a severance from employment include: an 
employee transferring from a section 501(c)(3) organization to a for-
profit subsidiary of the section 501(c)(3) organization; an employee 
ceasing to work for a public school, but continuing to be employed by 
the same State; and an individual employed as a minister for an entity 
that is neither a State nor a section 501(c)(3) organization ceasing to 
perform services as a minister, but continuing to be employed by the 
same entity.
---------------------------------------------------------------------------

    \8\ See proposed Sec.  1.401(k)-1(d)(2), REG-108639-99, 68 FR 
42476 (July 17, 2003).
---------------------------------------------------------------------------

Section 401(a)(9)

    The proposed regulations include rules similar to those in the 
existing regulations relating to the minimum distribution requirements 
of section 401(a)(9), but with some minor changes (for example, 
omitting the special rules for 5-percent owners). Thus, section 403(b) 
contracts must satisfy the incidental benefit rules. Existing revenue 
rulings provide guidance with respect to the application of the 
incidental benefit requirements to permissible nonretirement benefits 
such as life, accident, or health benefits.\9\
---------------------------------------------------------------------------

    \9\ See, for example, Rev. Rul. 61-121, 1961-2 C.B. 65; Rev. 
Rul. 68-304, 1968-1 C.B. 179; Rev. Rul. 72-240, 1972-1 C.B. 108; 
Rev. Rul. 72-241, 1972-1 C.B. Rev. Rul. 73-239, 1973-1 C.B. 201; and 
Rev. Rul. 74- 115, 1974-1 C.B. 100. (see Sec.  601(d)(2)(ii)(b) of 
this chapter).
---------------------------------------------------------------------------

Loans

    The proposed regulations include rules reflecting that loans can be 
made to participants from a section 403(b) contract.

QDROs

    The proposed regulations include limited rules relating to 
qualified domestic relations orders (QDROs) under section 414(p). 
Section 414(p)(9) provides that the QDRO rules only apply to plans that 
are subject to the anti-alienation provisions of section 401(a)(13), 
except that section 414(p)(9) also provides that, except to the extent 
set forth in regulations--there are currently no regulations under 
section 414(p)--the section 414(p) QDRO rules apply to a section 403(b) 
contract. These proposed section 403(b) regulations clarify that the 
section 414(p) QDRO rules apply to section 403(b) contracts for 
purposes of applying section 403(b).

Taxation of Distributions and Benefits From a Section 403(b) Contract

    The proposed regulations include a number of rules regarding the 
taxation of distributions and benefits from section 403(b) contracts, 
including the statutory provision that only amounts actually 
distributed from a section 403(b) contract are generally includible in 
the gross income of the recipient for the year in which distributed 
under section 72, relating to annuities. The regulations also reflect 
the rule that any payment that constitutes an eligible rollover 
distribution is not taxed in the year distributed to the extent the 
payment is directly rolled over or transferred to an eligible 
retirement plan. The payor must withhold 20 percent Federal income tax, 
however, if an eligible rollover distribution is not rolled over in a 
direct rollover. Another provision requires the payor to give proper 
written notice to the section 403(b) participant or beneficiary 
concerning the eligible rollover distribution provision. Notice 2002-3 
(2002-2 I.R.B. 289), provides a sample of the safe-harbor notice that 
the payor may furnish to satisfy this requirement.

Funding of Section 403(b) Arrangements

Annuity Contracts
    As described above, section 403(b) only applies to contributions 
made to certain funding arrangements, namely: amounts held in an 
annuity contract, in a custodial account that is treated as an annuity 
contract under section 403(b)(7), or in a church retirement income 
account that is treated as an annuity contract under section 403(b)(9). 
The proposed regulations require that contributions to a section 403(b) 
plan be transferred to the insurance company issuing the annuity 
contract (or the entity holding assets of any custodial or retirement 
income account that is treated as an annuity contract) within a period 
that is not longer than is reasonable for the proper administration of 
the plan, such as transferring elective deferrals within 15 business 
days following the month in which these amounts would otherwise have 
been paid to the participant.
    The proposed regulations provide that, except where a custodial or 
retirement income account is treated as an annuity contract, an annuity 
contract means a contract that is issued by an insurance company 
qualified to issue annuities in a State and that includes payment in 
the form of an annuity, but does not include a contract that is a life 
insurance contract, as defined in section 7702, an endowment contract, 
a health or accident insurance contract, or a property, casualty, or 
liability insurance contract. The regulations include a special 
transition rule relating to life insurance contracts issued before the 
effective date.
    Rev. Rul. 67-361 (1967-2 C.B. 153), and Rev. Rul. 67-387 (1967-2 
C.B. 153), provided for certain State plans to be treated as qualifying 
as annuities under section 403(b). Rev. Rul. 82-102 (1982-1 C.B. 62), 
revoked this interpretation (in connection with the 1974 enactment of 
section 403(b)(7) which allowed custodial accounts), but provides 
section 7805(b) relief for arrangements established in reliance on 
these rulings, i.e., for arrangements established on or before May 17, 
1982. The proposed regulations contemplate that the section 7805(b) 
relief provided by these rulings would be continued. This relief would 
be limited to State section 403(b) plans established on or before May 
17, 1982 satisfying either of the following requirements: (i) benefits 
under the contract are provided from a separately funded retirement 
reserve that is subject to supervision of the State insurance 
department or (ii) benefits under the contract are provided from a fund 
that is separate from the fund used to

[[Page 67082]]

provide statutory benefits payable under a State retirement system and 
that is part of a State teachers retirement system to purchase benefits 
that are unrelated to the basic benefits provided under the retirement 
system, and the death benefit provided under the contract cannot at any 
time exceed the larger of the reserve or the contribution made for the 
employee.
Custodial Accounts
    The proposed regulations define a custodial account as a plan, or a 
separate account under a plan, in which an amount attributable to 
section 403(b) contributions (or amounts rolled over to a section 
403(b) contract) is held by a bank or a person who satisfies the 
conditions in section 401(f)(2), if amounts held in the account are 
invested in stock of a regulated investment company (as defined in 
section 851(a) relating to mutual funds), the special restrictions on 
distributions with respect to a custodial account are satisfied, the 
assets held in the account cannot be used for, or diverted to, purposes 
other than for the exclusive benefit of plan participants or their 
beneficiaries, and the account is not part of a retirement income 
account, as described below. This requirement limiting investments to 
mutual funds is not satisfied if the account includes any assets other 
than stock of a regulated investment company.

Special Rules for Church Plans

Retirement Income Accounts
    The proposed regulations include a number of special rules for 
church plans. Under section 403(b)(9), a retirement income account for 
employees of a church-related organization is treated as an annuity 
contract for purposes of section 403(b) and these regulations. Under 
the proposed regulations, the rules for a retirement income account are 
based largely on the legislative history to TEFRA. The proposed 
regulations define a retirement income account as a defined 
contribution program established or maintained by a church-related 
organization under which (i) there is separate accounting for the 
retirement income account's interest in the underlying assets (i.e., it 
must be possible at all times to determine the retirement income 
account's interest in the underlying assets and distinguish that 
interest from any interest that is not part of the retirement income 
account), (ii) investment performance is based on gains and losses on 
those assets, and (iii) the assets held in the account cannot be used 
for, or diverted to, purposes other than for the exclusive benefit of 
plan participants or their beneficiaries. For this purpose, assets are 
treated as diverted to the employer if the employer borrows assets from 
the account. A retirement income account must be maintained pursuant to 
a program which is a plan and the plan document must state (or 
otherwise evidence in a similarly clear manner) the intent to 
constitute a retirement income account.
    If any asset of a retirement income account is owned or used by a 
participant or beneficiary, then that ownership or use is treated as a 
distribution to that participant or beneficiary. The proposed 
regulations provide that a retirement income account that is treated as 
an annuity contract is not a custodial account (even if it is invested 
in stock of a regulated investment company).
    A life annuity can generally only be provided from an individual 
account by the purchase of an insurance annuity contract. However, in 
light of the special rules applicable to church retirement income 
accounts, the proposed regulations permit a life annuity to be paid 
from such an account if certain conditions are satisfied. The 
conditions are that the amount of the distribution form have an 
actuarial present value, at the annuity starting date, that is equal to 
the participant's or beneficiary's accumulated benefit, based on 
reasonable actuarial assumptions, including assumptions regarding 
interest and mortality, and that the plan sponsor guarantee benefits in 
the event that a payment is due that exceeds the participant's or 
beneficiary's accumulated benefit.

Commingling Assets

    Under these proposed regulations, both custodial accounts and 
retirement income accounts would be subject to an exclusive benefit 
requirement similar to the exclusive benefit requirement applicable to 
qualified plans. Section 403(b)(7)(B) provides for a custodial account 
to be treated as a tax exempt.
    When these regulations are issued as final regulations, to the 
extent permitted by the Commissioner in future guidance, assets held 
under a custodial account or a retirement income account may be pooled 
with trust assets held under qualified plans.

Controlled Group Rules for Tax-Exempt Entities

    The proposed regulations include controlled group rules under 
section 414(c) for entities that are tax-exempt under section 501(a). 
Under these rules, the employer for a plan maintained by a section 
501(c)(3) organization (or any other tax-exempt organization under 
section 501(a)) includes not only the organization whose employees 
participate in the plan, but also any other exempt organization that is 
under common control with such organization, based on 80 percent of the 
directors or trustees being either representatives of or directly or 
indirectly controlled by an exempt organization. The proposed 
regulations include an anti-abuse rule and would also allow tax exempt 
organizations to choose to be aggregated if they maintain a single plan 
covering one or more employees from each organization and the 
organizations regularly coordinate their day to day exempt activities. 
For a section 501(c)(3) organization that makes contributions to a 
section 403(b) contract, these rules would be generally relevant for 
purposes of the nondiscrimination requirements, as well as the section 
415 contribution limitations, the special section 403(b) catch-up 
contributions, and the section 401(a)(9) minimum distribution rules.
    These controlled group rules for tax-exempt entities generally do 
not apply to certain church entities. Comments are requested below 
under the heading Comment and Public Hearing on whether these rules 
should be extended to such church entities.
    The proposed regulations do not include controlled group rules for 
public schools. As noted above (under the heading Overview), it is 
anticipated that, when these regulations are issued as final 
regulations, guidance may be issued providing controlled group safe 
harbors for public schools taking into account the existing safe 
harbors in Notice 89-23.

Miscellaneous Provisions

    The proposed regulations include a number of rules that address the 
circumstances under which a section 403(b) plan may be terminated or 
assets may be exchanged or transferred.

Plan Termination

    The proposed regulations, if adopted as final regulations, would 
not only permit an employer to amend its section 403(b) plan to 
eliminate future contributions for existing participants, but would 
allow plan provisions that permit plan termination with a resulting 
distribution of accumulated benefits. In general, the distribution of 
accumulated benefits would be permitted only if the employer (taking 
into account all entities that are treated as the employer under 
section 414 on the date of the termination) does not make contributions 
to another section 403(b)

[[Page 67083]]

contract that is not part of the plan (based generally on contributions 
made to a section 403(b) contract during the 12 months before and after 
the date of plan termination). In order for a section 403(b) plan to be 
considered terminated, all accumulated benefits under the plan must be 
distributed to all participants and beneficiaries as soon as 
administratively practicable after termination of the plan. A 
distribution includes delivery of a fully paid individual insurance 
annuity contract. Eligible rollover distributions would not be subject 
to current income inclusion if rolled over to an eligible retirement 
plan.
    The proposed regulations prohibit an employer that ceases to be an 
eligible employer from making any further contributions to the section 
403(b) contract for subsequent periods. In this event, the contract can 
be held under a frozen plan or the plan could be terminated in 
accordance with the rules regarding plan termination.

Exchanges and Transfers

    Under certain conditions, the proposed regulations permit the 
following exchanges or transfers:
    <bullet> A section 403(b) contract is permitted to be exchanged for 
another section 403(b) contract held under the same section 403(b) plan 
if the following conditions are satisfied: (1) The plan provides for 
the exchange, (2) the participant or beneficiary has an accumulated 
benefit immediately after the exchange at least equal to the 
accumulated benefit of that participant or beneficiary immediately 
before the exchange (taking into account the accumulated benefit of 
that participant or beneficiary under both section 403(b) contracts 
immediately before the exchange), and (3) the contract received in the 
exchange provides that, to the extent a contract that is exchanged is 
subject to any section 403(b) distribution restrictions, the contract 
received in the exchange imposes restrictions on distributions to the 
participant or beneficiary that are not less stringent than those 
imposed on the contract being exchanged.
    <bullet> A section 403(b) contract is permitted to be transferred 
to another section 403(b) plan (i.e., the section 403(b) contracts held 
thereunder, including any assets held in a custodial account or 
retirement income account that are treated as section 403(b) contracts) 
if the following conditions are satisfied: (1) The participant or 
beneficiary whose assets are being transferred is an employee of the 
employer providing the receiving plan, (2) the transferor plan provides 
for transfers, (3) the receiving plan provides for the receipt of 
transfers, (4) the participant or beneficiary whose assets are being 
transferred has an accumulated benefit immediately after the transfer 
at least equal to the accumulated benefit with respect to that 
participant or beneficiary immediately before the transfer, and (5) the 
receiving plan provides that, to the extent any amount transferred is 
subject to any section 403(b) distribution restrictions, the receiving 
plan imposes restrictions on distributions to the participant or 
beneficiary whose assets are being transferred that are not less 
stringent than those imposed on the transferor plan. In addition, if a 
plan-to-plan transfer does not constitute a complete transfer of the 
participant's or beneficiary's interest in the section 403(b) plan, 
then the transferee plan must treat the amount transferred as a 
continuation of a pro rata portion of the participant's or 
beneficiary's interest in the transferor section 403(b) plan (e.g., a 
pro rata portion of the participant's or beneficiary's interest in any 
after-tax employee contributions).
    <bullet> A section 403(b) plan may provide for the transfer of its 
assets to a qualified plan under section 401(a) to purchase permissive 
service credit under a defined benefit governmental plan or to make a 
repayment to a defined benefit governmental plan.
However, neither a qualified plan nor an eligible plan under section 
457 may transfer assets to a section 403(b) plan, and a section 403(b) 
plan may not accept such a transfer. In addition, a section 403(b) 
contract may not be exchanged for an annuity contract that is not a 
section 403(b) contract. Neither a plan-to-plan transfer nor a contract 
exchange permitted under the proposed regulations is treated as a 
distribution for purposes of the section 403(b) distribution 
restrictions (so that such a transfer or exchange may be made before 
severance from employment or another distribution event).
    Additional plan-to-plan transfer rules may apply in the event that 
a plan-to-plan transfer is made to or from a section 403(b) arrangement 
that is subject to Title I of ERISA. See section 208 of ERISA and 
regulations under section 414(l) of the Internal Revenue Code (which 
are the regulations interpreting section 208 of ERISA).

Defined Benefit Plans

    These proposed regulations generally require a section 403(b) plan 
to be a defined contribution plan. This requirement would not apply to 
certain church plans. Specifically, section 251(e)(5) of TEFRA permits 
a church arrangement in effect on September 3, 1982 (the date TEFRA was 
enacted) to not be treated as failing to satisfy the exclusion 
allowance limitations of section 403(b)(2) merely because it is a 
defined benefit plan and these regulations would allow such a plan to 
be continued. Any other defined benefit plan in existence on the 
effective date of these regulations that has taken the position, based 
on a reasonable interpretation of the statute, that it satisfies 
section 403(b) would not be subject to the requirement in these 
regulations that the plan be a defined contribution plan for pre-
effective date accruals, and such a plan might seek to take the 
position that it satisfies the section 401 qualified plan rules for 
subsequent accruals (assuming it satisfies those rules with respect to 
those accruals).

Section 3121(a)(5)(D)

    These proposed regulations also include proposed amendments to 
regulations under section 3121(a)(5)(D), defining salary reduction 
agreement for purposes of the Federal Insurance Contributions Act 
(FICA). The text of the proposed amendments is the same as that of 
temporary regulations being issued under section 3121(a)(5)(D) in this 
same issue of the Federal Register. The proposed regulations under 
section 3121(a)(5)(D) would be applicable on November 16, 2004.

Proposed Effective Date

    These regulations (other than the proposed amendments to 
regulations under section 3121(a)(5)(D)) are proposed to be generally 
applicable for taxable years beginning after December 31, 2005. 
However, there are certain transition rules. Under one transition rule, 
for a section 403(b) contract maintained pursuant to a collective 
bargaining agreement that is ratified and in effect when the final 
regulations are issued, the regulations would not apply until the 
collective bargaining agreement terminates (determined without regard 
to any extension thereof after the date of publication of final 
regulations). Under another transition rule, for a section 403(b) 
contract maintained by a church-related organization for which the 
authority to amend the contract is held by a church convention (within 
the meaning of section 414(e)), the regulations would not apply before 
the earlier of (i) January 1, 2007 or (ii) 60 days following the 
earliest church convention that occurs after the date of publication of 
final regulations. These proposed regulations cannot be relied upon 
until adopted in final form.

[[Page 67084]]

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
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. This certification is based upon 
the determination that respondents will need to spend minimal time (an 
average of \1/2\ hour per year) giving the statutorily required notice 
to departing employees. Therefore, a Regulatory Flexibility Analysis is 
not required under the Regulatory Flexibility Act (5 U.S.C. chapter 6).
    Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on their 
impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. Comments are requested on all aspects of the proposed 
regulations. In addition, comments are specifically requested on the 
clarity of the proposed regulations and how they can be revised to be 
more easily understood. All comments will be available for public 
inspection and copying.
    Comments are also requested on the following:
    <bullet> As indicated above, the IRS expects to obsolete a number 
of revenue rulings, notices, and other guidance when these regulations 
are issued in final form, including guidance that is now outdated as a 
result of changes in the law, and guidance that will become outdated by 
final regulations. Other previously issued guidance is expected to 
continue in effect. Comments are requested as to whether any previously 
issued guidance should be added or deleted from either list, with 
respect to the scope of this obsolescence, and also with respect to 
whether there are any aspects that should to be preserved in the 
guidance that is expected to be obsolete.
    <bullet> The Treasury Department and the IRS are requesting 
comments describing the issues and suggesting methods of clarifying the 
interaction between the employer activities required under these 
proposed regulations for an arrangement to satisfy section 403(b) and 
the employer conduct that will give rise to the establishment and 
maintenance of an employee pension benefit plan covered under Title I 
of ERISA. The Treasury Department and the IRS will forward a copy of 
the comments on this issue to the Department of Labor.
    <bullet> These proposed regulations authorize the Commissioner to 
issue rules to determine the amount of contributions for a participant 
in a defined benefit plan under section 402(b) (relating to the tax 
treatment of contributions to nonqualified plans). Comments are 
requested on the methodology and assumptions that should be used for 
this purpose, including specifically whether the methodology and 
assumptions should be the same as those currently in the regulations 
under section 403(b), whether revisions should be made to reflect the 
possibility that a nonqualified plan might include an early retirement 
subsidy, and whether the assumptions currently applicable under the 
section 403(b) regulations should be updated (for example, to match the 
assumptions in Rev. Proc. 2004-37 (2004-2 I.R.B. 26), relating to 
determining the extent to which certain pension payments made to a 
nonresident alien are not U.S. source income).
    <bullet> With respect to includible compensation, comments are 
requested on whether the Treasury Department and IRS have the authority 
to permit 403(b) plans to use compensation, as defined in section 
415(c)(3) without regard to section 415(c)(3)(E), in lieu of the 
definition of includible compensation under section 403(b)(3) and, if 
so, whether this should be done.
    <bullet> With respect to the universal availability rule, comments 
are requested on whether the requirement should apply separately to 
employees covered by a collective bargaining unit. Comments are also 
requested on whether plans that exclude any of the following additional 
types of employees (as has been permitted under Notice 89-23) should be 
permitted to continue to exclude these types of employees for at least 
some period of time: employees who make a one-time election to 
participate in a governmental plan described in section 414(d) instead 
of a section 403(b) plan; professors who are providing services on a 
temporary basis to another public school for up to one year and for 
whom section 403(b) contributions are being made at a rate no greater 
than the rate each such professor would receive under the section 
403(b) plan of the original public school; employees who are affiliated 
with a religious order and who have taken a vow of poverty where the 
religious order provides for the support of such employees in their 
retirement; and employees who are covered by a collective bargaining 
agreement.
    <bullet> The controlled group rules in these proposed regulations 
for tax-exempt entities generally do not apply to certain church 
entities. Comments are requested on whether these rules should be 
extended to such church entities.
    A public hearing has been scheduled for February 15, 2005, at 10 
a.m. in the IRS Auditorium (7th Floor), Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington DC. All visitors must present 
photo identification to enter the building. Because of access 
restrictions, visitors will not be admitted beyond the immediate 
entrance area at the Constitution Avenue entrance more than 30 minutes 
before the hearing starts. For information about having your name 
placed on the building access list to attend the hearing, see the FOR 
FURTHER INFORMATION CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons who wish to present oral comments at the hearing must 
submit electronic or written comments and an outline of the topics to 
be discussed and the time to be devoted to each topic (a signed 
original and eight (8) copies) by January 25, 2005. A period of 10 
minutes will be allotted to each person for making comments. An agenda 
showing the scheduling of the speakers will be prepared after the 
deadline for receiving outlines has passed. Copies of the agenda will 
be available free of charge at the hearing.

Drafting Information

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

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 31

    Employment taxes, Income taxes, Penalties, Pensions, Railroad 
retirement,

[[Page 67085]]

Reporting and recordkeeping requirements, Social security, Unemployment 
compensation.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 31 are proposed to be amended as 
follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
removing the entry for Sec.  1.403(b)-3 and adding entries in numerical 
order to read, in part, as follows:

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

Sec.  1.403(b)-6 Also issued under 26 U.S.C. 403(b)(10). * * *

Sec.  1.414(c)-5 Also issued under 26 U.S.C. 414(b), (c), and (o). * * 
*

    Par. 2. Section 1.402(b)-1 is amended by revising paragraphs (a)(2) 
and (b)(2)(ii) to read as follows:


Sec.  1.402(b)-1  Treatment of beneficiary of a trust not exempt under 
section 501(a).

    (a) * * *
    (2) Determination of amount of employer contributions. If, for an 
employee, the actual amount of employer contributions referred to in 
paragraph (a)(1) of this section for any taxable year of the employee 
is not determinable or for any other reason is not known, such amount 
shall be the amount applicable under rules prescribed by the 
Commissioner in revenue rulings, notices, or other guidance published 
in the Internal Revenue Bulletin (see Sec.  601.601(d)(2)(ii)(b) of 
this chapter).
    (b) * * *
    (2) * * *
    (ii) If a separate account in a trust for the benefit of two or 
more employees is not maintained for each employee, the value of the 
employee's interest in such trust is determined in accordance with 
rules prescribed by the Commissioner under the authority in paragraph 
(a)(2) of this section.
* * * * *
    Par. 3. Section 1.402(g)(3)-1 is added to read as follows:


Sec.  1.402(g)(3)-1  Employer contributions to purchase a section 
403(b) contract under a salary reduction agreement.

    (a) General rule. With respect to an annuity contract under section 
403(b), except as provided in paragraph (b) of this section, an 
elective deferral means an employer contribution to purchase an annuity 
contract under section 403(b) under a salary reduction agreement within 
the meaning of Sec.  31.3121(a)(5)-2(a) of this chapter.
    (b) Special rule. Notwithstanding paragraph (a) of this section, 
for purposes of section 402(g)(3)(C), an elective deferral only 
includes a contribution that is made pursuant to a cash or deferred 
election (as defined at Sec.  1.401(k)-1(a)(3)). Thus, for purposes of 
section 402(g)(3)(C), an elective deferral does not include a 
contribution that is made pursuant to an employee's one-time 
irrevocable election made on or before the employee's first becoming 
eligible to participate under the employer's plan or a contribution 
made as a condition of employment that reduces the employee's 
compensation.
    (c) Effective date. This section is applicable for taxable years 
beginning after December 31, 2005.
    Par. 4. Section 1.403(b)-0 is added to read as follows:

Sec.  1.403(b)-0  Taxability under an annuity purchased by a section 
501(c)(3) organization or a public school.

Sec.  1.403(b)-1 General overview of taxability under an annuity 
contract purchased by a section 501(c)(3) organization or a public 
school.

Sec.  1.403(b)-2 Definitions.

Sec.  1.403(b)-3 Exclusion for contributions to purchase section 
403(b) contracts.

Sec.  1.403(b)-4 Contribution limitations.

Sec.  1.403(b)-5 Nondiscrimination rules.

Sec.  1.403(b)-6 Timing of distributions and benefits.

Sec.  1. 403(b)-7 Taxation of distributions and benefits.

Sec.  1.403(b)-8 Funding.

Sec.  1.403(b)-9 Special rules for church plans.

Sec.  1.403(b)-10 Miscellaneous provisions.

Sec.  1.403(b)-11 Effective date.

    Par. 5. Sections 1.403(b)-1, 1.403(b)-2 and 1.403(b)-3 are revised 
to read as follows:


Sec.  1.403(b)-1  General overview of taxability under an annuity 
contract purchased by a section 501(c)(3) organization or a public 
school.

    Section 403(b) and Sec. Sec.  1.403(b)-2 through 1.403(b)-10 
provide rules for the Federal income tax treatment of an annuity 
purchased for an employee by an employer that is either a tax-exempt 
entity under section 501(c)(3) (relating to certain religious, 
charitable, scientific, or other types of organizations) or a public 
school, or for a minister described in section 414(e)(5)(A). See 
section 403(a) (relating to qualified annuities) for rules regarding 
the taxation of an annuity purchased under a qualified annuity plan 
that meets the requirements of section 404(a)(2), and see section 
403(c) (relating to nonqualified annuities) for rules regarding the 
taxation of other types of annuities.


Sec.  1.403(b)-2  Definitions.

    (a) This section sets forth the definitions that are applicable for 
purposes of Sec. Sec.  1.403(b)-1 through 1.403(b)-11.
    (1) Accumulated benefit means the total benefit to which a 
participant or beneficiary is entitled under a section 403(b) contract, 
including all contributions made to the contract and all earnings 
thereon.
    (2) Annuity contract means a contract that is issued by an 
insurance company qualified to issue annuities in a State and that 
includes payment in the form of an annuity. See Sec.  1.401(f)-1(d)(2) 
and (e) for the definition of an annuity, and see Sec.  1.403(b)-
8(c)(3) for a special rule for certain State plans. See also Sec. Sec.  
1.403(b)-8(d) and 1.403(b)-9(a) for additional rules regarding the 
treatment of custodial accounts and retirement income accounts as 
annuity contracts.
    (3) Beneficiary means a person who is entitled to benefits in 
respect of a participant following the participant's death or an 
alternate payee pursuant to a qualified domestic relations order, as 
described in Sec.  1.403(b)-10(c).
    (4) Catch-up amount or catch-up limitation for a participant for a 
taxable year means a section 403(b) elective deferral permitted under 
section 414(v) (as described in Sec.  1.403(b)-4(c)(2)), or section 
402(g)(7) (as described in Sec.  1.403(b)-4(c)(3)).
    (5) Church means a church as defined in section 3121(w)(3)(A) and a 
qualified church-controlled organization as defined in section 
3121(w)(3)(B).
    (6) Church-related organization means a church or convention or 
association of churches as described in section 414(e)(3)(A).
    (7) Elective deferral means an elective deferral under Sec.  
1.402(g)(3)-1 (with respect to an employer contribution to a section 
403(b) contract) and any other amount that constitutes an elective 
deferral under section 402(g)(3).
    (8)(i) Eligible employer means--
    (A) A State, but only with respect to an employee of the State 
performing services for a public school;
    (B) A section 501(c)(3) organization with respect to any employee 
of the section 501(c)(3) organization;
    (C) Any employer of a minister described in section 414(e)(5)(A), 
but only with respect to the minister; or
    (D) A minister described in section 414(e)(5)(A), but only with 
respect to a retirement income account established for the minister.

[[Page 67086]]

    (ii) An entity is not an eligible employer under paragraph 
(a)(8)(i)(A) of this section if it treats itself as not being a State 
for any other purpose of the Internal Revenue Code, and a subsidiary or 
other affiliate of an eligible employer is not an eligible employer 
under paragraph (a)(8)(i) of this section if the subsidiary or other 
affiliate is not an entity described in paragraph (a)(8)(i) of this 
section.
    (9) Employee means a common-law employee performing services for 
the employer, and does not include a former employee or an independent 
contractor. Subject to any rules in Sec. Sec.  1.403(b)-1 through 
1.403(b)-11 that are specifically applicable to ministers, an employee 
also includes a minister described in section 414(e)(5)(A) when 
performing services in the exercise of his or her ministry.
    (10) Employee performing services for a public school means an 
employee performing services as an employee for a public school of a 
State. This definition is not applicable unless the employee's 
compensation for performing services for a public school is paid by the 
State. Further, a person occupying an elective or appointive public 
office is not an employee performing services for a public school 
unless such office is one to which an individual is elected or 
appointed only if the individual has received training, or is 
experienced, in the field of education. The term public office includes 
any elective or appointive office of a State.
    (11) Includible compensation means the employee's compensation 
received from an eligible employer that is includible in the 
participant's gross income for Federal income tax purposes (computed 
without regard to section 911) for the most recent period that is a 
year of service. Includible compensation for a minister who is self-
employed means the minister's earned income as defined in section 
401(c)(2) (computed without regard to section 911) for the most recent 
period that is a year of service. Includible compensation does not 
include any compensation received during a period when the employer is 
not an eligible employer. Includible compensation also includes any 
elective deferral and any amount contributed or deferred by the 
eligible employer at the election of the employee that is not 
includible in the gross income of the employee by reason of section 
125, 132(f)(4), or 457. The amount of includible compensation is 
determined without regard to any community property laws. See Sec.  
1.403(b)-4(d) for a special rule regarding former employees.
    (12) Participant means an employee for whom a section 403(b) 
contract is currently being purchased, or an employee or former 
employee for whom a section 403(b) contract has previously been 
purchased and who has not received a distribution of his or her entire 
benefit under the contract.
    (13) Plan means a plan as described in Sec.  1.403(b)-3(b)(3).
    (14) Public school means a State-sponsored educational organization 
described in section 170(b)(1)(A)(ii) (relating to educational 
organizations that normally maintain a regular faculty and curriculum 
and normally have a regularly enrolled body of pupils or students in 
attendance at the place where educational activities are regularly 
carried on).
    (15) Retirement income account means a defined contribution program 
established or maintained by a church-related organization to provide 
benefits under section 403(b) for its employees or their beneficiaries 
as described in Sec.  1.403(b)-9.
    (16) Section 403(b) contract; section 403(b) plan--(i) Section 
403(b) contract means a contract described in Sec.  1.403(b)-3. If for 
any taxable year an employer contributes to more than one section 
403(b) contract for a participant or beneficiary, then, under section 
403(b)(5), all such contracts are treated as one contract for purposes 
of section 403(b) and Sec. Sec.  1.403(b)-2 through 1.403(b)-10. See 
also Sec.  1.403(b)-3(b)(1).
    (ii) Section 403(b) plan means the plan of the employer under which 
the section 403(b) contracts for its employees are maintained.
    (17) Section 403(b) elective deferral means an elective deferral 
that is an employer contribution to a section 403(b) contract for an 
employee. See Sec.  1.403(b)-5(b) for additional rules with respect to 
a section 403(b) elective deferral.
    (18) Section 501(c)(3) organization means an organization that is 
described in section 501(c)(3) (relating to certain religious, 
charitable, scientific, or other types of organizations) and exempt 
from tax under section 501(a).
    (19) Severance from employment means that the employee ceases to be 
employed by the employer maintaining the plan. See regulations under 
section 401(k) for additional guidance concerning severance from 
employment. See also Sec.  1.403(b)-6(h) for a special rule under which 
severance from employment is determined by reference to employment with 
the eligible employer.
    (20) State means a State, a political subdivision of a State, or 
any agency or instrumentality of a State. For this purpose, the 
District of Columbia is treated as a State, as provided under section 
7701(a)(10). In addition, for purposes of determining whether an 
individual is an employee performing services for a public school, an 
Indian tribal government is treated as a State, as provided under 
section 7871(a)(6)(B). See also section 1450(b) of the Small Business 
Job Protection Act of 1996 (110 Stat. 1755, 1814) for special rules 
treating certain contracts purchased in a plan year beginning before 
January 1, 1995, that include contributions by an Indian tribal 
government as section 403(b) contracts, whether or not those 
contributions are for employees performing services for a public 
school.
    (21) Years of service means each full year during which an 
individual is a full-time employee of an eligible employer, plus 
fractional credit for each part of a year during which the individual 
is either a full-time employee of an eligible employer for a part of 
the year or a part-time employee of an eligible employer. See Sec.  
1.403(b)-4(e) for rules for determining years of service.
    (b) [Reserved].


Sec.  1.403(b)-3  Exclusion for contributions to purchase section 
403(b) contracts.

    (a) Exclusion for section 403(b) contracts. Amounts contributed by 
an eligible employer for the purchase of an annuity contract for an 
employee are excluded from the gross income of the employee under 
section 403(b) only if each of the requirements in paragraphs (a)(1) 
through (9) of this section is satisfied. In addition, amounts 
contributed by an eligible employer for the purchase of an annuity 
contract for an employee pursuant to a cash or deferred election are 
not includible in an employee's gross income at the time the cash would 
have been includible in the employee's gross income (but for the cash 
or deferred election) if each of the requirements in paragraphs (a)(1) 
through (9) of this section is satisfied.
    (1) Not a contract issued under qualified plan or eligible 
governmental plan. The contract is not purchased under a qualified plan 
(under section 401(a) or 404(a)(2)) or an eligible governmental plan 
under section 457(b).
    (2) Nonforfeitability. The rights of the employee under the 
contract (disregarding rights to future premiums) are nonforfeitable. 
An employee's rights under a contract fail to be nonforfeitable unless 
the participant for whom the contract is purchased has at all times a 
fully vested and nonforfeitable right (as defined under Sec.  1.411(a)-
4) to all benefits provided under the contract. See paragraph (c) of 
this section for

[[Page 67087]]

additional rules regarding the nonforfeitability requirement of this 
paragraph (a)(2).
    (3) Nondiscrimination and universal availability. In the case of a 
contract purchased by an eligible employer other than a church, the 
contract is purchased under a plan that satisfies section 403(b)(12) 
(relating to nondiscrimination and universal availability 
requirements). See Sec.  1.403(b)-5.
    (4) Limitations on elective deferrals. In the case of an elective 
deferral, the contract satisfies section 401(a)(30) (relating to 
limitations on elective deferrals). A contract does not satisfy section 
401(a)(30) as required under this paragraph (a)(4) unless the contract 
requires all elective deferrals for an employee to not exceed the 
limits of section 402(g)(1), including elective deferrals for the 
employee under the contract and any other elective deferrals under the 
plan under which the contract is purchased and under all other plans, 
contracts, or arrangements of the employer.
    (5) Nontransferability. The contract is not transferable. This 
paragraph (a)(5) does not apply to a contract issued before January 1, 
1963. See section 401(g).
    (6) Minimum required distributions. The contract satisfies the 
requirements of section 401(a)(9) (relating to minimum required 
distributions). See Sec.  1.403(b)-6(e).
    (7) Rollover distributions. The contract provides that, if the 
distributee of an eligible rollover distribution elects to have the 
distribution paid directly to an eligible retirement plan, as defined 
in section 402(c)(8)(B), and specifies the eligible retirement plan to 
which the distribution is to be paid, then the distribution will be 
paid to that eligible retirement plan in a direct rollover. See Sec.  
1.403(b)-7(b)(2).
    (8) Limitation on incidental benefits. The contract satisfies the 
incidental benefit requirements of section 401(a). See Sec.  1.403(b)-
6(g).
    (9) Maximum annual additions. The annual additions to the contract 
do not exceed the applicable limitations of section 415(c) (treating 
contributions and other additions as annual additions). See paragraph 
(b) of this section and Sec.  1.403(b)-4(b).
    (b) Application of requirements--(1) Aggregation of contracts. In 
accordance with section 403(b)(5), for purposes of determining whether 
this section is satisfied, all section 403(b) contracts purchased for 
an individual by an employer are treated as purchased under a single 
contract. Additional aggregation rules apply under section 402(g) for 
purposes of satisfying paragraph (a)(4) of this section and under 
section 415 for purposes of satisfying paragraph (a)(9) of this 
section.
    (2) Disaggregation for excess annual additions. In accordance with 
the last sentence of section 415(a)(2), if an excess annual addition is 
made to a contract that otherwise satisfies the requirements of this 
section, then the portion of the contract that includes such excess 
annual addition fails to be a section 403(b) contract (and instead is a 
contract to which section 403(c) applies, as further described in 
paragraph (c)(1) of this section) and the remaining portion of the 
contract is a section 403(b) contract. This paragraph (b)(2) does not 
apply unless, for the year of the excess and each year thereafter, the 
issuer of the contract maintains separate accounts for each such 
portion. Thus, the entire contract fails to be a section 403(b) 
contract if an excess annual addition is made and a separate account is 
not maintained with respect to the excess.
    (3) Plan in form and operation. A contract does not satisfy 
paragraph (a) of this section unless it is maintained pursuant to a 
plan. For this purpose, a plan is a written defined contribution plan, 
which, in both form and operation, satisfies the requirements of this 
section and Sec. Sec.  1.403(b)-4 through 1.403(b)-10. For purposes of 
this section and Sec. Sec.  1.403(b)-4 through 1.403(b)-10, the plan 
must contain all the material terms and conditions for eligibility, 
benefits, applicable limitations, the contracts available under the 
plan, and the time and form under which benefit distributions would be 
made. For purposes of this section and Sec. Sec.  1.403(b)-4 through 
1.403(b)-10, a plan may contain certain optional features not required 
under section 403(b), such as hardship withdrawal distributions, loans, 
plan-to-plan or annuity contract-to-annuity contract transfers, and 
acceptance of rollovers to the plan. However, if a plan contains any 
optional provisions, the optional provisions must meet, in both form 
and operation, the relevant requirements under section 403(b), this 
section, and Sec. Sec.  1.403(b)-4 through 1.403(b)-10. This paragraph 
(b)(3) applies to contributions to an annuity contract by a church only 
if the annuity is part of a retirement income account, as defined in 
Sec.  1.403(b)-9.
    (4) Exclusion limited to former employees--(i) General rule. Except 
as provided in paragraph (b)(4)(ii) of this section and in Sec.  
1.403(b)-4(d), the exclusion from gross income provided by section 
403(b) does not apply to contributions made for former employees. For 
this purpose, a contribution is not made for a former employee if the 
contribution is with respect to compensation that would otherwise be 
paid for a payroll period that begins before severance from employment.
    (ii) Exceptions. [Reserved].
    (c) Effect of failure--(1) General rule. See section 403(c) 
(relating to nonqualified annuities) for the treatment of a 
nonqualified annuity contract issued by an insurance company that is 
not a section 403(b) contract. See section 61, 83, or 402(b) for the 
treatment of a custodial account or retirement income account that 
fails to be treated as a section 403(b) contract.
    (2) Failure to satisfy nonforfeitability requirement. If an annuity 
contract issued by an insurance company would qualify as a section 
403(b) contract but for the failure to satisfy the nonforfeitability 
requirement of paragraph (a)(2) of this section, then the contract is 
treated as a contract to which section 403(c) applies. However, on or 
after the date on which the participant's interest in that contract 
becomes nonforfeitable, the contract may be treated as a section 403(b) 
contract if no election has been made under section 83(b) with respect 
to the contract, the participant's interest in the contract has been 
subject to a substantial risk of forfeiture before becoming 
nonforfeitable, and the contract has at all times satisfied the 
requirements of paragraph (a) of this section other than the 
nonforfeitability requirement of paragraph (a)(2) of this section. 
Thus, for example, for the current year and each prior year, no 
contribution can have been made to the contract that would cause the 
contract to fail to be a section 403(b) contract as a result of 
contributions exceeding the limitations of section 415 (except to the 
extent permitted under paragraph (b)(2) of this section) or to fail to 
satisfy the nondiscrimination rules described in Sec.  1.403(b)-5.
    (3) Treatment of partial vesting and separate accounts. For 
purposes of applying this paragraph (c), if a participant's interest in 
a contract becomes nonforfeitable to any extent in a year but the 
participant's entire interest in the contract is not nonforfeitable, 
then the portion that is nonforfeitable and the portion that fails to 
be nonforfeitable are each treated as separate contracts. In addition, 
for purposes of applying this paragraph (c), if a contribution is made 
to an annuity contract in excess of the limitations of section 415(c) 
and the excess is maintained in a separate account, then

[[Page 67088]]

the portion of the contract that includes the excess contributions 
account and the remainder are each treated as separate contracts. Thus, 
if an annuity contract that includes an excess contributions account 
changes from forfeitable to nonforfeitable during a year, then the 
portion that is not attributable to the excess contributions account 
constitutes a section 403(b) contract (assuming it otherwise satisfies 
the requirements to be a section 403(b) contract) and is not included 
in gross income, and the portion that is attributable to the excess 
contributions account is included in gross income in accordance with 
section 403(c).
    Par. 5a. Sections 1.403(b)-4 through 1.403(b)-11 are added to read 
as follows:


Sec.  1.403(b)-4  Contribution limitations.

    (a) Treatment of contributions in excess of limitations. The 
exclusion provided under Sec.  1.403(b)-3(a) applies to a participant 
only if the amounts contributed by the employer for the purchase of an 
annuity contract for the participant do not exceed the applicable limit 
under sections 415 and 402(g), as described in this section. Under 
Sec.  1.403(b)-3(a)(4), a section 403(b) contract is required to 
include the limits on elective deferrals imposed by section 402(g), as 
described in paragraph (c) of this section. See paragraph (f) of this 
section for special rules concerning correction of excess contributions 
and deferrals. The limits imposed by section 415, Sec.  1.403(b)-
3(a)(9), section 402(g), Sec.  1.403(b)-3(a)(4), and this section do 
not apply with respect to rollover contributions made to a section 
403(b) contract, as described in Sec.  1.403(b)-10(d), but after-tax 
contributions are taken into account under section 415, Sec.  1.403(b)-
3(a)(9), and this section.
    (b) Maximum annual contribution--(1) General rule. In accordance 
with section 415(a)(2) and Sec.  1.403(b)-3(b)(2), the contributions 
for any participant under a section 403(b) contract (i.e., employer 
nonelective contributions (including matching contributions), section 
403(b) elective deferrals, and after-tax contributions) are not 
permitted to exceed the limitations imposed by section 415. For this 
purpose, contributions made for a participant are aggregated to the 
extent applicable under sections 414(b), (c), (m), (n), and (o). For 
purposes of section 415(a)(2) and Sec.  1.403(b)-1 through Sec.  
1.403(b)-11, a contribution means any annual addition, as defined in 
section 415(c).
    (2) Special rules. See section 415(k)(4) for a special rule under 
which contributions to section 403(b) contracts are generally 
aggregated with contributions under other arrangements in applying 
section 415. For purposes of applying section 415(c)(1)(B) with respect 
to a section 403(b) contract, except as provided in section 
415(c)(3)(C), a participant's includible compensation (as defined in 
Sec.  1.403(b)-2) is substituted for the participant's compensation, as 
described in section 415(c)(3)(E). Any age 50 catch-up contributions 
under paragraph (c)(2) of this section are disregarded in applying 
section 415.
    (c) Section 403(b) elective deferrals--(1) Basic limit under 
section 402(g)(1). In accordance with section 402(g)(1)(A), the section 
403(b) elective deferrals for any individual are included in the 
individual's gross income to the extent the amount of such deferrals, 
plus all other elective deferrals for the individual, for the taxable 
year exceeds the applicable dollar amount under section 402(g)(1)(B). 
The applicable annual dollar amount under section 402(g)(1)(B) is: 
$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 section 
402(g)(4). See Sec.  1.403(b)-5(b) for a universal availability rule 
that applies if any employee is permitted to have any section 403(b) 
elective deferrals made on his or her behalf.
    (2) Age 50 catch-up--(i) In general. In accordance with section 
414(v) and the regulations thereunder, a section 403(b) contract may 
provide for additional 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 additional 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 in the manner described in section 
414(v)(2)(C). For additional requirements, see regulations under 
section 414(v).
    (ii) Coordination with special section 403(b) catch-up. In 
accordance with sections 414(v)(6)(A)(ii) and 402(g)(7)(A), the age 50 
catch-up described in this paragraph (c)(2) may apply for any taxable 
year in which a participant also qualifies for the special section 
403(b) catch-up under paragraph (c)(3) of this section.
    (3) Special section 403(b) catch-up for certain organizations--(i) 
Amount of the special section 403(b) catch-up. In the case of a 
qualified employee of a qualified organization for whom the basic 
section 403(b) elective deferrals for any year are not less than the 
applicable dollar amount under section 402(g)(1)(B), the section 403(b) 
elective deferral limitation of section 402(g)(1) for the taxable year 
of the qualified employee is increased by the least of--
    (A) $3,000;
    (B) The excess of--
    (1) $15,000; over
    (2) The total special section 403(b) catch-up elective deferrals 
made for the qualified employee by the qualified organization for prior 
years; or
    (C) The excess of--
    (1) $5,000 multiplied by the number of years of service of the 
employee with the qualified organization; over
    (2) The total elective deferrals (as defined at Sec.  1.403(b)-2) 
made for the qualified employee by the qualified organization for prior 
years.
    (ii) Qualified organization. (A) For purposes of this paragraph 
(c)(3), qualified organization means an eligible employer that is 
either--
    (1) An educational organization described in section 
170(b)(1)(A)(ii);
    (2) A hospital;
    (3) A health and welfare service agency (including a home health 
service agency); or
    (4) A church-related organization. All entities that are in a 
church-related organization are treated as a single qualified 
organization (so that years of service and any special section 403(b) 
catch-up elective deferrals previously made for a qualified employee 
for a church within a church-related organization are taken into 
account for purposes of applying this paragraph (c)(3) to the employee 
with respect to any other entity within the same church-related 
organization).
    (B) For purposes of this paragraph (c)(3)(ii), a health and welfare 
service agency means either an organization whose primary activity is 
to provide services that constitute medical care as defined in section 
213(d)(1) (such as a hospice) or a section 501(c)(3) organization whose 
primary activity is the prevention of cruelty to individuals or 
animals, or which provides substantial personal services to the needy 
as part of its primary activity (such as a section 501(c)(3) 
organization that provides meals to needy individuals).
    (iii) Qualified employee. For purposes of this paragraph (c)(3), 
qualified employee means an employee who has completed at least 15 
years of service (as defined under paragraph (e) of this section) 
taking into account only

[[Page 67089]]

employment with the qualified organization.
    (iv) Coordination with age 50 catch-up. In accordance with sections 
402(g)(1)(C) and 402(g)(7), any catch-up amount contributed by an 
employee who is eligible for both an age 50 catch-up and a special 
section 403(b) catch-up is treated first as an amount contributed as a 
special section 403(b) catch-up to the extent a special section 403(b) 
catch-up is permitted, and then as an amount contributed as an age 50 
catch-up (to the extent the catch-up amount exceeds the maximum special 
section 403(b) catch-up after taking into account sections 402(g) and 
415(c), this paragraph (c)(3), and any limitations on the special 
section 403(b) catch-up that are imposed by the terms of the plan).
    (4) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:

    Example 1.  (i) Facts illustrating application of the basic 
dollar limit. Participant B, who is 45, is eligible to participate 
in a State university section 403(b) plan in 2006. B is not a 
qualified employee, as defined in paragraph (c)(3)(iii) of this 
section. The plan permits section 403(b) elective deferrals, but no 
other employer contributions are made under the plan. The plan 
provides limitations on section 403(b) elective deferrals up to the 
maximum permitted under paragraphs (c)(1) and (3) of this section 
and the additional age 50 catch-up amount described in paragraph 
(c)(2) of this section. For 2006, B will receive includible 
compensation of $42,000 from the eligible employer. B desires to 
elect to have the maximum section 403(b) elective deferral possible 
contributed in 2006. For 2006, the basic dollar limit for section 
403(b) elective deferrals under paragraph (c)(1) of this section is 
$15,000 and the additional dollar amount permitted under the age 50 
catch-up is $5,000.
    (ii) Conclusion. B is not eligible for the age 50 catch-up in 
2006 because B is 45 in 2006, or the special section 403(b) catch-up 
under paragraph (c)(3) of this section because B is not a qualified 
employee. Accordingly, the maximum section 403(b) elective deferral 
that B may elect for 2006 is $15,000.
    Example 2.  (i) Facts illustrating application of the includible 
compensation limitation. The facts are the same as in Example 1, 
except B's includible compensation is $14,000.
    (ii) Conclusion. Under section 415(c), contributions may not 
exceed 100 percent of includible compensation. Accordingly, the 
maximum section 403(b) elective deferral that B may elect for 2006 
is $14,000.
    Example 3.  (i) Facts illustrating application of the age 50 
catch-up. Participant C, who is 55, is eligible to participate in a 
State university section 403(b) plan in 2006. The plan permits 
section 403(b) elective deferrals, but no other employer 
contributions are made under the plan. The plan provides limitations 
on section 403(b) elective deferrals up to the maximum permitted 
under paragraphs (c)(1) and (3) of this section and the additional 
age 50 catch-up amount described in paragraph (c)(2) of this 
section. For 2006, C will receive includible compensation of $48,000 
from the eligible employer. C desires to elect to have the maximum 
section 403(b) elective deferral possible contributed in 2006. For 
2006, the basic dollar limit for section 403(b) elective deferrals 
under paragraph (c)(1) of this section is $15,000 and the additional 
dollar amount permitted under the age 50 catch-up is $5,000. C does 
not have 15 years of service and thus is not a qualified employee, 
as defined in paragraph (c)(3)(iii) of this section.
    (ii) Conclusion. C is eligible for the age 50 catch-up in 2006 
because C is 55 in 2006. C is not eligible for the special section 
403(b) catch-up under paragraph (c)(3) of this section because C is 
not a qualified employee (as defined in paragraph (c)(3)(iii) of 
this section). Accordingly, the maximum section 403(b) elective 
deferral that C may elect for 2006 is $20,000 ($15,000 plus $5,000).
    Example 4.  (i) Facts illustrating application of both the age 
50 and the special section 403(b) catch-up. The facts are the same 
as in Example 3, except that C is a qualified employee for purposes 
of the special section 403(b) catch-up provisions in paragraph 
(c)(3) of this section. For 2006, the maximum additional section 
403(b) elective deferral for which C qualifies under the special 
section 403(b) catch-up under paragraph (c)(3) of this section is 
$3,000.
    (ii) Conclusion. The maximum section 403(b) elective deferrals 
that C may elect for 2006 is $23,000. This is the sum of the basic 
limit on section 403(b) elective deferrals under paragraph (c)(1) of 
this section equal to $15,000, plus the $3,000 additional special 
section 403(b) catch-up amount for which C qualifies under paragraph 
(c)(3) of this section, plus the additional age 50 catch-up amount 
of $5,000.
    Example 5.  (i) Facts illustrating calculation of years of 
service with a predecessor organization for purposes of the special 
section 403(b) catch-up. The facts are the same as in Example 4, 
except that C has previously made special section 403(b) catch-up 
deferrals to a section 403(b) plan maintained by a hospital which 
was acquired by C's current eligible employer which is a hospital.
    (ii) Conclusion. The special section 403(b) catch-up amount for 
which C qualifies under paragraph (c)(3) of this section must be 
calculated taking into account C's prior years of service and 
special section 403(b) catch-up deferrals with the predecessor 
hospital if and only if C did not have any severance from service in 
connection with the acquisition.
    Example 6.  (i) Facts illustrating application of the age 50 
catch-up and the section 415(c) dollar limitation. The facts are the 
same as in Example 4, except that the employer makes a nonelective 
contribution for each employee equal to 20 percent of C's 
compensation (which is $48,000). Thus, the employer makes a 
nonelective contribution for C for 2006 equal to $9,600. The plan 
provides that a participant is not permitted to make section 403(b) 
elective deferrals to the extent the section 403(b) elective 
deferrals would result in contributions in excess of the maximum 
permitted under section 415 and provides that contributions are 
reduced in the following order: the special section 403(b) catch-up 
elective deferrals under paragraph (c)(3) of this section are 
reduced first; the age 50 catch-up elective deferrals under 
paragraph (c)(2) of this section are reduced second; and then the 
basic section 403(b) elective deferrals under paragraph (c)(1) of 
this section are reduced. For 2006, it is assumed that the 
applicable dollar limit under section 415(c)(1)(A) is $44,000.
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that C may elect for 2006 is $23,000. This is the sum of the basic 
limit on section 403(b) elective deferrals under paragraph (c)(1) of 
this section equal to $15,000, plus the $3,000 additional special 
section 403(b) catch-up amount for which C qualifies under paragraph 
(c)(3) of this section, plus the additional age 50 catch-up amount 
of $5,000. The limit in paragraph (b) of this section would not be 
exceeded because the sum of the $9,600 nonelective contribution and 
the $23,000 section 403(b) elective deferrals does not exceed the 
lesser of $49,000 (which is the sum of $44,000 plus the $5,000 
additional age 50 catch-up amount) or $53,000 (which is the sum of 
C's includible compensation for 2006 ($48,000) plus the $5,000 
additional age 50 catch-up amount).
    Example 7. (i) Facts further illustrating application of the age 
50 catch-up and the section 415(c) dollar limitation. The facts are 
the same as in Example 6, except that C's includible compensation 
for 2006 is $56,000 and the plan provides for a nonelective 
contribution equal to 50 percent of includible compensation, so that 
the employer nonelective contribution for C for 2006 is $28,000 (50 
percent of $56,000).
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that C may elect for 2006 is $21,000. A section 403(b) elective 
deferral in excess of this amount would exceed the sum of the limit 
in section 415(c)(1)(A) plus the additional age 50 catch-up amount, 
because the sum of the employer's nonelective contribution of 
$28,000 plus a section 403(b) elective deferral in excess of $21,000 
would exceed $49,000 (the sum of the $44,000 limit in section 
415(c)(1)(A) plus the $5,000 additional age 50 catch-up amount).
    Example 8. (i) Facts further illustrating application of the age 
50 catch-up and the section 415(c) dollar limitation. The facts are 
the same as in Example 7, except that the plan provides for a 
nonelective contribution for C equal to $44,000 (which is the limit 
in section 415(c)(1)(A)).
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that C may elect for 2006 is $5,000. A section 403(b) elective 
deferral in excess of this amount would exceed the sum of the limit 
in section 415(c)(1)(A) plus the additional age 50 catch-up amount 
($5,000), because the sum of the employer's nonelective contribution 
of $44,000 plus a section 403(b) elective deferral in excess of 
$5,000 would exceed $49,000 (the sum of the $44,000 limit in section 
415(c)(1)(A) plus the $5,000 additional age 50 catch-up amount).

[[Page 67090]]

    Example 9. (i) Facts illustrating application of the age 50 
catch-up and the section 415(c) includible compensation limitation. 
The facts are the same as in Example 7, except that C's includible 
compensation for 2006 is $28,000, so that the employer nonelective 
contribution for C for 2006 is $14,000 (50 percent of $28,000).
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that C may elect for 2006 is $19,000. A section 403(b) elective 
deferral in excess of this amount would exceed the sum of the limit 
in section 415(c)(1)(B) plus the additional age 50 catch-up amount, 
because C's includible compensation is $28,000 and the sum of the 
employer's nonelective contribution of $14,000 plus a section 403(b) 
elective deferral in excess of $19,000 would exceed $33,000 (which 
is the sum of 100 percent of C's includible compensation plus the 
$5,000 additional age 50 catch-up amount).
    Example 10. (i) Facts illustrating that section 403(b) elective 
deferrals cannot exceed compensation otherwise payable. Employee D 
is age 60, has includible compensation of $14,000, and wishes to 
contribute section 403(b) elective deferrals of $20,000 for the 
year. No nonelective contributions are made for Employee D.
    (ii) Conclusion. The maximum limit on section 403(b) elective 
deferrals for a participant with compensation less than the maximum 
dollar limit in section 415(c) is 100 percent of includible 
compensation, plus the $5,000 additional age 50 catch-up amount. 
However, because a contribution is a section 403(b) elective 
deferral only if it is a result of a compensation reduction, D 
cannot make section 403(b) elective deferrals in excess of D's 
actual compensation.
    Example 11. (i) Facts illustrating calculation of the special 
section 403(b) catch-up. For 2006, employee E, who is age 50, is 
eligible to participate in a section 403(b) plan of hospital H, 
which is a section 501(c)(3) organization. H's plan permits section 
403(b) elective deferrals and provides for an employer contribution 
of 10 percent of a participant's compensation with that employer for 
the taxable year. The plan provides limitations on section 403(b) 
elective deferrals up to the maximum permitted under paragraphs 
(c)(1), (2), and (3) of this section. For 2006, E's includible 
compensation is $50,000. E wishes to elect to have the maximum 
section 403(b) elective deferral possible contributed in 2006. E has 
previously made $62,000 of section 403(b) elective deferrals under 
the plan, but has never made an election for a special section 
403(b) catch-up elective deferral. For 2006, the basic dollar limit 
for section 403(b) elective deferrals under paragraph (c)(1) of this 
section is $15,000, the additional dollar amount permitted under the 
age 50 catch-up is $5,000, E's employer will make a nonelective 
contribution of $5,000 (10% of $50,000 compensation), and E is a 
qualified employee of a qualified employer as defined in paragraph 
(c)(3) of this section.
    (ii) Conclusion. The maximum section 403(b) elective deferrals 
that E may elect for 2006 is $23,000. This is the sum of the basic 
limit on section 403(b) elective deferrals for 2006 under paragraph 
(c)(1) of this section equal to $15,000, plus the $3,000 maximum 
additional special section 403(b) catch-up amount for which D 
qualifies in 2006 under paragraph (c)(3) of this section, plus the 
additional age 50 catch-up amount of $5,000. The limitation on the 
additional special section 403(b) catch-up amount is not less than 
$3,000 because the limitation at paragraph (c)(3)(i)(B) of this 
section is $15,000 ($15,000 minus zero) and the limitation at 
paragraph (c)(3)(i)(C) of this section is $13,000 ($5,000 times 15, 
minus $62,000 of total deferrals in prior years).
    Example 12. (i) Facts illustrating calculation of the special 
section 403(b) catch-up in the next calendar year. The facts are the 
same as in Example 11, except that, for 2007, E has includible 
compensation of $60,000. For 2007, E now has previously made $85,000 
of section 403(b) elective deferrals ($62,000 deferred before 2006, 
plus the $15,000 in basic section 403(b) elective deferrals in 2006, 
the $3,000 maximum additional special section 403(b) catch-up amount 
in 2006, plus the $5,000 age 50 catch-up amount in 2006). However, 
the $5,000 age 50 catch-up amount deferred in 2006 is disregarded 
for purposes of applying the limitation at paragraph (c)(3)(i)(B) of 
this section to determine the special section 403(b) catch-up 
amount. Thus, for 2007, only $80,000 of section 403(b) elective 
deferrals are taken into account in applying the limitation at 
paragraph (c)(3)(i)(B) of this section. For 2007, the basic dollar 
limit for section 403(b) elective deferrals under paragraph (c)(1) 
of this section is assumed to be $16,000, the additional dollar 
amount permitted under the age 50 catch-up is assumed to be $5,000, 
and E's employer contributes $6,000 (10% of $60,000 compensation) as 
a non-elective contribution.
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that D may elect for 2007 is $21,000. This is the sum of the basic 
limit on section 403(b) elective deferrals under paragraph (c)(1) of 
this section equal to $16,000, plus the additional age 50 catch-up 
amount of $5,000. E is not entitled to any additional special 
section 403(b) catch-up amount for 2007 under paragraph (c)(3) due 
to the limitation at paragraph (c)(3)(i)(C) of this section (16 
times $5,000 equals $80,000, minus D's total prior section 403(b) 
elective deferrals of $80,000 equals zero).

    (d) Employer contributions for former employees--(1) Includible 
compensation deemed to continue for nonelective contributions. For 
purposes of applying paragraph (b) of this section, a former employee 
is deemed to have monthly includible compensation for the period 
through the end of the taxable year of the employee in which he or she 
ceases to be an employee and through the end of each of the next five 
taxable years. The amount of the monthly includible compensation is 
equal to one twelfth of the former employee's includible compensation 
during the former employee's most recent year of service. Accordingly, 
nonelective employer contributions for a former employee must not 
exceed the limitation of section 415(c)(1) up to the lesser of the 
dollar amount in section 415(c)(1)(A) or the former employee's annual 
includible compensation based on the former employee's average monthly 
compensation during his or her most recent year of service.
    (2) Examples. The provisions of paragraph (d)(1) of this section 
are illustrated by the following examples:

    Example 1. (i) Facts. College M is a section 501(c)(3) 
organization operated on the basis of a June 30 fiscal year that 
maintains a section 403(b) plan for its employees. In 2004, M amends 
the plan to provide for a temporary early retirement incentive under 
which the college will make a nonelective contribution for any 
participant who satisfies certain minimum age and service conditions 
and who retires before June 30, 2006. The contribution will equal 
110 percent of the participant's rate of pay for one year and will 
be payable over a period ending no later than the end of the fifth 
fiscal year that begins after retirement. It is assumed for purposes 
of this Example 1 that, in accordance with Sec.  1.401(a)(4)-10(b) 
and under the facts and circumstances, the post-retirement 
contributions made for participants who satisfy the minimum age and 
service conditions and retire before June 30, 2006 do not 
discriminate in favor of former employees who are highly compensated 
employees. Employee A retires under the early retirement incentive 
on March 12, 2006, and A's annual includible compensation for the 
period from March 1, 2005 through February 28, 2006 (which is A's 
most recent one year of service) is $30,000. The applicable dollar 
limit under section 415(c)(1)(A) is assumed to be $44,000 for 2006 
and $45,000 for 2007. The college contributes $30,000 for A for 2006 
and $3,000 for A for 2007 (totaling $33,000 or 110 percent of 
$30,000). No other contributions are made to a section 403(b) 
contract for A for those years.
    (ii) Conclusion. The contributions made for A do not exceed A's 
includible compensation for 2006 or 2007.
    Example 2. (i) Facts. College N is a section 501(c)(3) 
organization that maintains a section 403(b) plan for its employees. 
The plan provides for N to make monthly nonelective contributions 
equal to 20 percent of the monthly includible compensation for each 
eligible employee. In addition, the plan provides for contributions 
to continue for 5 years following the retirement of any employee 
after age 64 and completion of at least 20 years of service (based 
on the employee's average annual rate of base salary in the 
preceding 3 calendar years ended before the date of retirement). It 
is assumed for purposes of this Example 2 that, in accordance with 
Sec.  1.401(a)(4)-10(b) and under the facts and circumstances, the 
post-retirement contributions made for participants who satisfy the 
minimum age and service conditions do not discriminate in favor of 
former employees who are highly compensated employees. Employee B 
retires on July 1, 2006, at age 64 after completion of 20 or more 
years of service. At that date, B's annual includible compensation 
for the

[[Page 67091]]

most recently ended fiscal year of N is $72,000 and B's average 
monthly rate of base salary for 2003 through 2005 is $5,000. N 
contributes $1,200 per month (20 percent of 1/12th of $72,000) from 
January of 2006 through June of 2006 and contributes $1,000 (20 
percent of $5,000) per month for B from July of 2006 through June of 
2011. The applicable dollar limit under section 415(c)(1)(A) is 
assumed to be at least $44,000 for 2006 through 2011. No other 
contributions are made to a section 403(b) contract for B for those 
years.
    (ii) Conclusion. The contributions made for B do not exceed B's 
includible compensation for any of the years from 2006 through 2010.

    (3) Disabled employees. See also section 415(c)(3)(C) which sets 
forth a special rule under which compensation may be treated as 
continuing for purposes of section 415 for certain former employees who 
are disabled.
    (e) Special rules for determining years of service--(1) In general. 
For purposes of determining a participant's includible compensation 
under paragraph (b)(2) of this section and a participant's years of 
service under paragraphs (c)(3) (special section 403(b) catch-up for 
qualified employees of certain organizations) and (d) (employer 
contributions for former employees) of this section, an employee's 
number of years of service depend on whether the employee has a full 
year during which the individual is a full-time employee of the 
eligible employer, and any fraction of a year for each part of a year 
during which the individual is a full-time or part-time employee of the 
eligible employer. An individual's number of years of service equals 
the aggregate of the annual work periods during which the individual is 
employed by the eligible employer.
    (2) Work period. A year of service is based on the employer's 
annual work period, not the employee's taxable year. For example, in 
determining whether a university professor is employed full time, the 
annual work period is the school's academic year. However, in no case 
may an employee accumulate more than one year of service in a twelve-
month period.
    (3) Service with more than one eligible employer--(i) General rule. 
With respect to any section 403(b) contract of an eligible employer, 
except as provided in paragraph (e)(3)(ii) of this section, any period 
during which an individual is not an employee of that eligible employer 
is disregarded for purposes of this paragraph (e).
    (ii) Special rule for church employees. With respect to any section 
403(b) contract of an eligible employer that is a church-related 
organization, any period during which an individual is an employee of 
that eligible employer and any other eligible employer that is a 
church-related organization that has an association (as defined in 
section 414(e)(3)(D)) with that eligible employer is taken into account 
on an aggregated basis, but any period during which an individual is 
not an employee of a church-related organization or is an employee of a 
church-related organization that does not have an association with that 
eligible employer is disregarded for purposes of this paragraph (e).
    (4) Full-time employee for full year. Each annual work period 
during which an individual is employed full time by the eligible 
employer constitutes one year of service. In determining whether an 
individual is employed full-time, the amount of work which he or she 
actually performs is compared with the amount of work that is normally 
required of individuals performing similar services from which 
substantially all of their annual compensation is derived.
    (5) Other employees. (i) An individual is treated as performing a 
fraction of a year of service for each annual work period during which 
he or she is a full-time employee for part of the annual work period 
and for each annual work period during which he or she is a part-time 
employee either for the entire annual work period or for a part of the 
annual work period.
    (ii) In determining the fraction that represents the fractional 
year of service for an individual employed full time for part of an 
annual work period, the numerator is the period of time (e.g., weeks or 
months) during which the individual is a full-time employee during that 
annual work period, and the denominator is the period of time that is 
the annual work period.
    (iii) In determining the fraction that represents the fractional 
year of service of an individual who is employed part time for the 
entire annual work period, the numerator is the amount of work 
performed by the individual, and the denominator is the amount of work 
normally required of individuals who perform similar services and who 
are employed full time for the entire annual work period.
    (iv) In determining the fraction representing the fractional year 
of service of an individual who is employed part time for part of an 
annual work period, the fractional year of service that would apply if 
the individual were a part-time employee for a full annual work period 
is multiplied times the fractional year of service that would apply if 
the individual were a full-time employee for the part of an annual work 
period.
    (6) Work performed. For purposes of this paragraph (e), in 
measuring the amount of work of an individual performing particular 
services, the work performed is determined based on the individual's 
hours of service (as defined under section 410(a)(3)(C)), except that a 
plan may use a different measure of work if appropriate under the facts 
and circumstances. For example, a plan may provide for a university 
professor's work to be measured by the number of courses taught during 
an annual work period in any case in which that individual's work 
assignment is generally based on a specified number of courses to be 
taught.
    (7) Most recent one-year period of service. For purposes of 
paragraph (d) of this section, in the case of a part-time employee or a 
full-time employee who is employed for only part of the year determined 
on the basis of the employer's annual work period, the employee's most 
recent periods of service are aggregated to determine his or her most 
recent one-year period of service. In such a case, there is first taken 
into account his or her service during the annual work period for which 
the last year of service's includible compensation is being determined; 
then there is taken into account his or her service during his next 
preceding annual work period based on whole months; and so forth, until 
the employee's service equals, in the aggregate, one year of service.
    (8) Less than one year of service considered as one year. If, at 
the close of a taxable year, an employee has, after application of all 
of the other rules in this paragraph (e), some portion of one year of 
service (but has accumulated less than one year of service), the 
employee is deemed to have one year of service. Except as provided in 
this paragraph (e)(8), fractional years of service are not rounded up.
    (9) Examples. The provisions of this paragraph (e) are illustrated 
by the following examples:

    Example 1. (i) Facts. Individual C is employed half-time in 2004 
and 2005 as a clerk by H, a hospital which is a section 501(c)(3) 
organization. C earns $20,000 from H in each of those years, and 
retires on December 31, 2005.
    (ii) Conclusion. For purposes of determining C's includible 
compensation during C's last year of service under paragraph (d) of 
this section, C's most recent periods of service are aggregated to 
determine C's most recent one-year period of service. In this case, 
since C worked half-time in 2004 and 2005, the compensation C earned 
in those two years are aggregated to produce C's includible 
compensation for C's last full year in service. Thus, in this case, 
the $20,000 that C earned in 2004 and 2005 for C's half-time

[[Page 67092]]

work are aggregated, so that C has $40,000 of includible 
compensation for C's most recent one-year of service for purposes of 
applying paragraphs (b)(2), (c)(3), and (d) of this section.
    Example 2. (i) Facts. Individual A is employed as a part-time 
professor by public University U during the first semester of its 
two-semester 2004-2005 academic year. While A teaches one course 
generally for 3 hours a week during the first semester of the 
academic year, U's full-time faculty members generally teach for 9 
hours a week during the full academic year.
    (ii) Conclusion. For purposes of calculating how much of a year 
of service A performs in the 2004-05 academic year (before 
application of the special rules of paragraphs (e)(7) and (8) of 
this section concerning less than one year of service), paragraph 
(e)(5)(iv) of this section is applied as follows: since A teaches 
one course at U for 3 hours per week for 1 semester and other 
faculty members at U teach 9 hours per week for 2 semesters, A is 
considered to have completed \3/18\ or \1/6\ of a year of service 
during the 2004-05 academic year, determined as follows:
    (A) The fractional year of service if A were a part-time 
employee for a full year is \3/9\ (number of hours employed divided 
by the usual number of hours of work required for that position).
    (B) The fractional year of service if A were a full-time 
employee for half of a year is \1/2\ (one semester, divided by the 
usual 2-semester annual work period).
    (C) These fractions are multiplied to obtain the fractional year 
of service: \3/9\ times \1/2\, or \3/18\, equals \1/6\ of a year of 
service.

    (f) Excess contributions or deferrals--(1) In general. Any 
contribution made for a participant to a section 403(b) contract for 
the taxable year that exceeds either the maximum annual contribution 
limit set forth in paragraph (b) of this section or the maximum annual 
section 403(b) elective deferral limit set forth in paragraph (c) of 
this section constitutes an excess contribution that is included in 
gross income for that taxable year. A contract does not fail to satisfy 
the requirements of Sec.  1.403(b)-3, the distribution rules of 
Sec. Sec.  1.403(b)-6 or 1.403(b)-9, or the funding rules of Sec.  
1.403(b)-8 solely by reason of a distribution made under this paragraph 
(f). See also section 4973 for an excise tax applicable with respect to 
excess contributions to a custodial account.
    (2) Excess section 403(b) elective deferrals. A section 403(b) 
contract may provide that any excess deferral as a result of a failure 
to comply with the limitation under paragraph (c) of this section for a 
taxable year with respect to any section 403(b) elective deferral made 
for a participant by the employer will be distributed to the 
participant, with allocable net income, no later than April 15 of the 
following taxable year or otherwise in accordance with section 402(g). 
See section 402(g)(2)(A) for rules permitting the participant to 
allocate excess deferrals among the plans in which the participant has 
made elective deferrals, and see section 402(g)(2)(C) for special rules 
to determine the tax treatment of such a distribution.
    (3) Special rule for small excess amount. See section 4979(f)(2)(B) 
for a special rule applicable if excess matching contributions, excess 
after-tax contributions, and excess section 403(b) elective deferrals 
do not exceed $100.
    (4) Example. The provisions of this paragraph (f) are illustrated 
by the following example:

    Example. (i) Facts. Individual D makes section 403(b) elective 
deferrals totaling $15,500 for 2006, when D is age 45 and the 
applicable limit on section 403(b) elective deferrals is $15,000. On 
April 14, 2007, the plan refunds the $500 excess along with 
applicable earnings of $65.
    (ii) Conclusion. The $565 payment constitutes a distribution of 
an excess deferral under paragraph (f)(2) of this section. Under 
section 402(g), the $500 excess deferral is included in D's gross 
income for 2006. The additional $65 is included in D's gross income 
for 2007 and, because the distribution is made by April 15, 2007 (as 
provided in section 402(g)(2)), the $65 is not subject to the 
additional 10 percent income tax on early distributions under 
section 72(t).


Sec.  1.403(b)-5  Nondiscrimination rules.

    (a) Nondiscrimination rules for contributions other than section 
403(b) elective deferrals--(1) General rule. Under section 
403(b)(12)(A)(i), employer contributions and employee after-tax 
contributions must satisfy all of the following requirements (the 
nondiscrimination requirements) in the same manner as a qualified plan 
under section 401(a):
    (i) Section 401(a)(4) (relating to nondiscrimination in 
contributions and benefits), taking section 401(a)(5) into account.
    (ii) Section 401(a)(17) (limiting the amount of compensation that 
can be taken into account).
    (iii) Section 401(m) (relating to matching and after-tax 
contributions).
    (iv) Section 410(b) (relating to minimum coverage).
    (2) Nonapplication to section 403(b) elective deferrals. The 
requirements of this paragraph (a) do not apply to section 403(b) 
elective deferrals.
    (3) Compensation for testing. Except as may otherwise be 
specifically permitted under the sections referenced in paragraph 
(a)(1) of this section, compliance with those provisions is tested 
using compensation as defined in section 414(s) (and without regard to 
section 415(c)(3)(E)).
    (4) Employer aggregation rules. See regulations under section 414 
for rules treating entities as a single employer for purposes of the 
nondiscrimination requirements.
    (5) Special rules for governmental plans. Paragraphs (a)(1)(i), 
(iii), and (iv) of this section do not apply to a governmental plan as 
defined in section 414(d) (but contributions to a governmental plan 
must comply with paragraphs (a)(1)(ii) and (b) of this section).
    (b) Universal availability required for section 403(b) elective 
deferrals--(1) General rule. Under section 403(b)(12)(A)(ii), all 
employees of the eligible employer must be permitted to have section 
403(b) elective deferrals contributed on their behalf if any employee 
of the eligible employer may elect to have the organization make 
section 403(b) elective deferrals. The employee's right to have section 
403(b) elective deferrals made on his or her behalf includes the right 
to section 403(b) elective deferrals up to the lesser of the applicable 
limits in Sec.  1.403(b)-4(c) (including any permissible catch-up 
elective deferrals under Sec.  1.403(b)-4(c)(2) and (3)) or the 
applicable limits under the contract with the largest limitation, and 
applies to part-time employees as well as full-time employees.
    (2) Effective opportunity required. A section 403(b) plan satisfies 
this paragraph (b) only if the plan provides an employee with an 
effective opportunity to make (or change) a cash or deferred election 
(as defined at Sec.  1.401(k)-1(a)(3)) at least once during each plan 
year. Whether an employee has an effective opportunity is determined 
based on all the relevant facts and circumstances, including notice of 
the availability of the election, the period of time during which an 
election may be made, and any other conditions on elections. An 
effective opportunity is not considered to exist if there are any other 
rights or benefits that are conditioned (directly or indirectly) upon a 
participant making or failing to make a cash or deferred election with 
respect to a contribution to a section 403(b) contract.
    (3) Special rules. (i) In the case of a section 403(b) plan that 
covers the employees of more than one section 501(c)(3) organization, 
the universal availability requirement of this paragraph (b) applies 
separately to each common law entity, i.e., to each section 501(c)(3) 
organization. In the case of a section 403(b) plan that covers the 
employees of more than one State entity, this requirement applies 
separately to each entity that is not part of a common payroll. An 
employer may condition the employee's right to have

[[Page 67093]]

section 403(b) elective deferrals made on his or her behalf on the 
employee electing a section 403(b) elective deferral of more than $200 
for a year.
    (ii) For purposes of this paragraph (b)(3), an employer that 
historically has treated one or more of its various geographically 
distinct units as separate for employee benefit purposes may treat each 
unit as a separate organization if the unit is operated independently 
on a day-to-day basis. Units are not geographically distinct if such 
units are located within the same Standard Metropolitan Statistical 
Area (SMSA).
    (4) Special exclusions--(i) Exclusions for special types of 
employees. A plan does not fail to satisfy the universal availability 
requirement of this paragraph (b) merely because it excludes one or 
more of the types of employees listed in paragraph (b)(4)(ii) of this 
section. If any employee listed in paragraph (b)(4)(ii)(A) through (E) 
of this section has the right to have section 403(b) elective deferrals 
made on his or her behalf, then no employees listed in that 
subparagraph may be excluded under this paragraph (b)(4).
    (ii) List of special types of excludible employees. The following 
types of employees are listed in this paragraph (b)(4)(ii):
    (A) Employees who are eligible under a section 457(b) eligible 
governmental plan of the employer which permits an amount to be 
contributed or deferred at the election of the employee.
    (B) Employees who are eligible to make a cash or deferred election 
(as defined at Sec.  1.401(k)-1(a)(3)) under a section 401(k) plan of 
the employer.
    (C) Employees who are non-resident aliens described in section 
410(b)(3)(C).
    (D) Subject to the conditions applicable under section 410(b)(4) 
(including section 410(b)(4)(B) permitting separate testing for 
employees not meeting minimum age and service requirements), employees 
who are students performing services described in section 3121(b)(10).
    (E) Subject to the conditions applicable under section 410(b)(4), 
employees who normally work fewer than 20 hours per week. For this 
purpose, an employee normally works fewer than 20 hours per week if and 
only if--
    (1) For the 12-month period beginning on the date the employee's 
employment commenced, the employer reasonably expects the employee to 
work fewer than 1,000 hours of service (as defined in section 
410(a)(3)(C)) in such period; and
    (2) For each plan year ending after the close of the 12-month 
period beginning on the date the employee's employment commenced (or, 
if the plan so provides, each subsequent 12-month period), the employee 
worked fewer than 1,000 hours of service in the preceding 12-month 
period. (See, however, section 202(a)(1) of the Employee Retirement 
Income Security Act of 1974 (ERISA) (88 Stat. 829) Public Law 93-406, 
and regulations under section 410(a) of the Internal Revenue Code 
applicable with respect to plans that are subject to Title I of ERISA.)
    (c) Plan required. Contributions to an annuity contract do not 
satisfy the requirements of this section unless the contributions are 
made pursuant to a plan, as defined in Sec.  1.403(b)-3(b)(3), and the 
terms of the plan satisfy this section.
    (d) Certain requirements not applicable to a church plan. This 
section does not apply to a section 403(b) contract purchased by a 
church (as defined in Sec.  1.403(b)-2).
    (e) Other rules. This section only reflects requirements of the 
Internal Revenue Code applicable for purposes of section 403(b) and 
does not include other requirements. Specifically, this section does 
not reflect the requirements of the ERISA that may apply with respect 
to section 403(b), such as the vesting requirements at 29 U.S.C. 1053.


Sec.  1.403(b)-6  Timing of distributions and benefits.

    (a) Distributions generally. This section includes special rules 
regarding the timing of distributions from, and the benefits that may 
be provided under, a section 403(b) contract, including limitations on 
when early distributions can be made (in paragraphs (b) through (d) of 
this section), required minimum distributions (in paragraph (e) of this 
section), and special rules relating to loans (in paragraph (f) of this 
section) and incidental benefits (in paragraph (g) of this section).
    (b) Distributions from contracts other than custodial accounts or 
amounts attributable to section 403(b) elective deferrals. Except as 
provided in paragraph (c) of this section relating to distributions 
from custodial accounts, paragraph (d) of this section relating to 
distributions attributable to section 403(b) elective deferrals, Sec.  
1.403(b)-4(f) (relating to correction of excess deferrals), or Sec.  
1.403(b)-10(a) (relating to plan termination), a section 403(b) 
contract is permitted to distribute retirement benefits to the 
participant no earlier than upon the earliest of the participant's 
severance from employment or upon the prior occurrence of some event, 
such as after a fixed number of years, the attainment of a stated age, 
or disability. See Sec.  1.401-1(b)(1)(ii) for additional guidance.
    (c) Distributions from custodial accounts that are not attributable 
to section 403(b) elective deferrals. Except as provided in Sec.  
1.403(b)-4(f) (relating to correction of excess deferrals) or Sec.  
1.403(b)-10(a) (relating to plan termination), distributions from a 
custodial account, as defined in Sec.  1.403(b)-8(d)(2), may not be 
paid to a participant before the participant has a severance from 
employment, dies, becomes disabled (within the meaning of section 
72(m)(7)), or attains age 59\1/2\. Any amounts transferred out of a 
custodial account to an annuity contract or retirement income account, 
including earnings thereon, continue to be subject to this paragraph 
(c). This paragraph (c) does not apply to distributions that are 
attributable to section 403(b) elective deferrals.
    (d) Distribution of section 403(b) elective deferrals--(1) 
Limitation on distributions--(i) General rule. Except as provided in 
paragraph (d)(2) of this section (relating to distributions on account 
of hardship), Sec.  1.403(b)-4(f) (relating to correction of excess 
deferrals), or Sec.  1.403(b)-10(a) (relating to plan termination), 
distributions of amounts attributable to section 403(b) elective 
deferrals may not be paid to a participant earlier than the earliest of 
the date on which the participant has a severance from employment, 
dies, has a hardship, becomes disabled (within the meaning of section 
72(m)(7)), or attains age 59\1/2\.
    (ii) Special rule for pre-1989 section 403(b) elective deferrals. 
For special rules relating to amounts held as of the close of the 
taxable year beginning before January 1, 1989 (which does not apply to 
earnings thereon), see section 1123(e)(3) of the Tax Reform Act of 1986 
(100 Stat. 2085, 2475) Public Law 99-514, and section 1011A(c)(11) of 
the Technical and Miscellaneous Revenue Act of 1988 (102 Stat. 3342, 
3476) Public Law 100-647.
    (2) Hardship rules. A hardship distribution under this paragraph 
(d) is defined as, and is subject to the rules in, Sec.  1.401(k)-
1(d)(3) (including limiting the amount of a distribution in the case of 
hardship to the amount necessary to satisfy the hardship). In addition, 
a hardship distribution is limited to the aggregate dollar amount of 
the participant's section 403(b) elective deferrals under the contract 
(and may not include any income thereon), reduced by the aggregate 
dollar amount of the distributions previously made to the participant 
from the contract.
    (3) Failure to keep separate accounts. If a section 403(b) contract 
includes

[[Page 67094]]

both section 403(b) elective deferrals and other contributions and the 
section 403(b) elective deferrals are not maintained in a separate 
account, then distributions may not be made earlier than the later of:
    (i) Any date permitted under this paragraph (d) with respect to 
403(b) elective deferrals; and
    (ii) Any date permitted under paragraph (b) or (c) of this section 
with respect to contributions that are not section 403(b) elective 
deferrals (whichever applies to the contributions that are not section 
403(b) elective deferrals).
    (e) Minimum required distributions for eligible plans--(1) In 
general. Under section 403(b)(10), a section 403(b) contract must meet 
the minimum distribution requirements of section 401(a)(9) (in both 
form and operation). See section 401(a)(9) and the regulations 
thereunder for these requirements.
    (2) Treatment as IRAs. For purposes of applying the distribution 
rules of section 401(a)(9) to section 403(b) contracts, section 403(b) 
contracts are treated as individual retirement annuities described in 
section 408(b) and individual retirement accounts described in section 
408(a) (IRAs). Consequently, except as otherwise provided in paragraphs 
(e)(3) through (e)(5) of this section, the distribution rules in 
section 401(a)(9) are applied to section 403(b) contracts in accordance 
with the provisions in Sec.  1.408-8 for purposes of determining 
required minimum distributions.
    (3) Required beginning date. The required beginning date for 
purposes of section 403(b)(10) is April 1 of the calendar year 
following the later of the calendar year in which the employee attains 
70\1/2\ or the calendar year in which the employee retires from 
employment with the employer maintaining the plan. However, for any 
section 403(b) contract that is not part of a government plan or church 
plan, the required beginning date for a 5-percent owner is April 1 of 
the calendar year following the earlier of the calendar year in which 
the employee attains 70\1/2\ or the calendar year in which the employee 
retires from employment with the employer maintaining the plan.
    (4) Surviving spouse rule does not apply. The special rule in Sec.  
1.408-8, A-5 (relating to spousal beneficiaries), does not apply to a 
section 403(b) contract. Thus, the surviving spouse of a participant is 
not permitted to treat a section 403(b) contract as the spouse's own 
section 403(b) contract, even if the spouse is the sole beneficiary.
    (5) Retirement income accounts. For purposes of Sec.  1.401(a)(9)-
6, A-4 (relating to annuity contracts), annuity payments provided with 
respect to retirement income accounts do not fail to satisfy the 
requirements of section 401(a)(9) merely because the payments are not 
made under an annuity contract purchased from an insurance company, 
provided that the relationship between the annuity payments and the 
retirement income accounts is not inconsistent with any rules 
prescribed by the Commissioner in revenue rulings, notices, or other 
guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter). See Sec.  1.403(b)-9(a)(5).
    (6) Special rules for benefits accruing before December 31, 1986. 
(i) The distribution rules provided in section 401(a)(9) do not apply 
to the undistributed portion of the account balance under the section 
403(b) contract valued as of December 31, 1986, exclusive of subsequent 
earnings (pre-'87 account balance). The distribution rules provided in 
section 401(a)(9) apply to all benefits under section 403(b) contracts 
accruing after December 31, 1986 (post-'86 account balance), including 
earnings after December 31, 1986. Consequently, the post-'86 account 
balance includes earnings after December 31, 1986, on contributions 
made before January 1, 1987, in addition to the contributions made 
after December 31, 1986, and earnings thereon.
    (ii) The issuer or custodian of the section 403(b) contract must 
keep records that enable it to identify the pre-'87 account balance and 
subsequent changes as set forth in paragraph (d)(6)(iii) of this 
section and provide such information upon request to the relevant 
employee or beneficiaries with respect to the contract. If the issuer 
or custodian does not keep such records, the entire account balance is 
treated as subject to section 401(a)(9).
    (iii) In applying the distribution rules in section 401(a)(9), only 
the post-'86 account balance is used to calculate the required minimum 
distribution for a calendar year. The amount of any distribution from a 
contract is treated as being paid from the post-'86 account balance to 
the extent the distribution is required to satisfy the minimum 
distribution requirement with respect to that contract for a calendar 
year. Any amount distributed in a calendar year from a contract in 
excess of the required minimum distribution for a calendar year with 
respect to that contract is treated as paid from the pre-'87 account 
balance, if any, of that contract.
    (iv) If an amount is distributed from the pre-'87 account balance 
and rolled over to another section 403(b) contract, the amount is 
treated as part of the post-'86 account balance in that second 
contract. However, if the pre-'87 account balance under a section 
403(b) contract is directly transferred to another section 403(b) 
contract (as permitted under Sec.  1.403(b)-10(b)), the amount 
transferred retains its character as a pre-'87 account balance, 
provided the issuer of the transferee contract satisfies the 
recordkeeping requirements of paragraph (e)(6)(ii) of this section.
    (v) The distinction between the pre-'87 account balance and the 
post-'86 account balance provided for under this paragraph (e)(6) of 
this section has no relevance for purposes of determining the portion 
of a distribution that is includible in income under section 72.
    (vi) The pre-'87 account balance must be distributed in accordance 
with the incidental benefit requirement of Sec.  1.401-1(b)(1)(i). 
Distributions attributable to the pre-'87 account balance are treated 
as satisfying this requirement if all distributions from the section 
403(b) contract (including distributions attributable to the post-'86 
account balance) satisfy the requirements of Sec.  1.401-1(b)(1)(i) 
without regard to this section, and distributions attributable to the 
post-'86 account balance satisfy the rules of this paragraph (e). 
Distributions attributable to the pre-'87 account balance are treated 
as satisfying the incidental benefit requirement if all distributions 
from the section 403(b) contract (including distributions attributable 
to both the pre-'87 account balance and the post-'86 account balance) 
satisfy the rules of this paragraph (e).
    (7) Application to multiple contracts for an employee. The required 
minimum distribution must be separately determined for each section 
403(b) contract of an employee. However, because, as provided in 
paragraph (e)(2) of this section, the distribution rules in section 
401(a)(9) apply to section 403(b) contracts in accordance with the 
provisions in Sec.  1.408-8, the required minimum distribution from one 
section 403(b) contract of an employee is permitted to be distributed 
from another section 403(b) contract in order to satisfy section 
401(a)(9). Thus, as provided in Sec.  1.408-8, A-9, with respect to 
IRAs, the required minimum distribution amount from each contract is 
then totaled and the total minimum distribution taken from any one or 
more of the individual section 403(b) contracts. However, consistent 
with the rules in Sec.  1.408-8, A-9, only amounts in section 403(b) 
contracts that an individual holds as an employee may be aggregated. 
Amounts in section 403(b) contracts that an

[[Page 67095]]

individual holds as a beneficiary of the same decedent may be 
aggregated, but such amounts may not be aggregated with amounts held in 
section 403(b) contracts that the individual holds as the employee or 
as the beneficiary of another decedent. Distributions from section 
403(b) contracts do not satisfy the minimum distribution requirements 
for IRAs, nor do distributions from IRAs satisfy the minimum 
distribution requirements for section 403(b) contracts.
    (f) Loans. The determination of whether the availability of a loan, 
the making of a loan, or a failure to repay a loan made from an issuer 
of a section 403(b) contract 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 403(b) and these 
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 be 
treated as not being a distribution. However, a plan loan offset is a 
distribution for purposes of this section. See Sec.  1.72(p)-1, Q&A-13. 
See also Sec.  1.403(b)-7(d) relating to the application of section 
72(p) with respect to the taxation of a loan made under a section 
403(b) contract. (Further, see 29 CFR 2550.408b-1 of the Department of 
Labor regulations concerning additional requirements applicable with 
respect to plans that are subject to Title I of ERISA.)
    (g) Death benefits and other incidental benefits. An annuity is not 
a section 403(b) contract if it fails to satisfy the incidental benefit 
requirement of Sec.  1.401-1(b)(1)(i). For this purpose, to the extent 
the incidental benefit requirement of Sec.  1.401-1(b)(1)(i) requires a 
distribution of the participant's or beneficiary's accumulated benefit, 
that requirement is deemed to be satisfied if distributions satisfy the 
minimum distribution requirements of section 401(a)(9).
    (h) Special rule regarding severance from employment. For purposes 
of this section, severance from employment occurs on any date on which 
an employee ceases to be an employee of an eligible employer (e.g., by 
the section 501(c)(3) organization that maintains the plan, assuming 
that only one section 501(c)(3) organization maintains the plan), even 
though the employee may continue to be employed either by another 
entity that is treated as the same employer where either that other 
entity is not an entity that can be an eligible employer (such as 
transferring from a section 501(c)(3) organization to a for-profit 
subsidiary of the section 501(c)(3) organization) or in a capacity that 
is not employment with an eligible employer (e.g., ceasing to be an 
employee performing services for a public school but continuing to work 
for the same State employer).
    (i) Certain limitations do not apply to rollover contributions. The 
limitations on distributions in paragraphs (b) through (d) of this 
section do not apply to amounts held in a separate account for eligible 
rollover distributions as described in Sec.  1.403(b)-10(d).


Sec.  1.403(b)-7  Taxation of distributions and benefits.

    (a) General rules for when amounts are included in gross income. 
Except as provided in this section (or in Sec.  1.403(b)-10(c) relating 
to payments pursuant to a qualified domestic relations order), amounts 
actually distributed from a section 403(b) contract are includible in 
the gross income of the recipient participant or beneficiary (in the 
year in which so distributed) under section 72 (relating to annuities). 
For an additional income tax that may apply to certain early 
distributions that are includible in gross income, see section 72(t).
    (b) Rollovers to individual retirement arrangements and other 
eligible retirement plans--(1) Timing of taxation of rollovers. In 
accordance with sections 402(c), 403(b)(8), and 403(b)(10), a direct 
transfer in accordance with section 401(a)(31) (generally referred to 
as a direct rollover) is not includible in the gross income of a 
participant or beneficiary in the year transferred. In addition, any 
payment made 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. For this purpose, the rules of section 402(c)(2) through 
(7) and (c)(9) apply. Any direct rollover under this paragraph (b)(1) 
is a distribution that is subject to the distribution requirements of 
Sec.  1.403(b)-6.
    (2) Requirement that contract provide rollover options for eligible 
rollover distributions. As required in Sec.  1.403(b)-3(a)(7), an 
annuity contract is not a section 403(b) contract unless the contract 
provides that if the distributee of an eligible rollover distribution 
elects to have the distribution paid directly to an eligible retirement 
plan (as defined in section 402(c)(8)(B)) and specifies the eligible 
retirement plan to which the distribution is to be paid, then the 
distribution will be paid to that eligible retirement plan in a direct 
rollover. For purposes of determining whether a contract satisfies this 
requirement, the provisions of section 401(a)(31) apply to the annuity 
as though it were a plan qualified under section 401(a) unless 
otherwise provided in section 401(a)(31). In applying the provisions of 
this paragraph (b)(2), the payor of the eligible rollover distribution 
from the contract is treated as the plan administrator.
    (3) Requirement that contract payor provide notice of rollover 
option to distributees. To ensure that the distributee of an eligible 
rollover distribution from a section 403(b) contract has a meaningful 
right to elect a direct rollover, section 402(f) requires that the 
distributee be informed of the option. Thus, within a reasonable time 
period before making the initial eligible rollover distribution, the 
payor must provide an explanation to the distributee of his or her 
right to elect a direct rollover and the income tax withholding 
consequences of not electing a direct rollover. For purposes of 
satisfying the reasonable time period requirement, the plan timing rule 
provided in section 402(f)(1) and the regulations thereunder applies to 
section 403(b) contracts.
    (4) Mandatory withholding upon certain eligible rollover 
distributions from contracts. If a distributee of an eligible rollover 
distribution from a section 403(b) contract does not elect to have the 
eligible rollover distribution paid directly to an eligible retirement 
plan in a direct rollover, the eligible rollover distribution is 
subject to 20-percent income tax withholding imposed under section 
3405(c). See section 3405(c) and the regulations thereunder for 
provisions regarding the withholding requirements relating to eligible 
rollover distributions.
    (5) Automatic rollover for certain mandatory distributions under 
section 401(a)(31)(B). [Reserved].
    (c) Special rules for certain corrective distributions. See section 
402(g)(2)(C) for special rules to determine the tax treatment of a 
distribution of excess deferrals, and see Sec.  1.401(m)-1(e)(3)(v) for 
the tax treatment of corrective distributions of after-tax and matching 
contributions to comply with section 401(m).

[[Page 67096]]

    (d) Amounts taxable under section 72(p)(1). In accordance with 
section 72(p), the amount of any loan from a section 403(b) contract 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 contract 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 Sec.  1.72(p)-1. Thus, except to the 
extent a loan satisfies section 72(p)(2), any amount loaned from a 
section 403(b) contract 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 Sec.  
1.72(p)-1.


Sec.  1.403(b)-8  Funding.

    (a) Investments permitted. Section 403(b) and Sec.  1.403(b)-3 only 
apply to amounts held in an annuity contract (as defined in Sec.  
1.403(b)-2), including a custodial account that is treated as an 
annuity contract under this section or a retirement income account that 
is treated as an annuity contract under Sec.  1.403(b)-9.
    (b) Contributions to the plan. Contributions to a section 403(b) 
plan must be transferred to the insurance company issuing the annuity 
contract (or the entity holding assets of any custodial or retirement 
income account that is treated as an annuity contract) within a period 
that is not longer than is reasonable for the proper administration of 
the plan. For purposes of this requirement, the plan may provide for 
section 403(b) elective deferrals for a participant under the plan to 
be transferred to the annuity contract within a specified period after 
the date the amounts would otherwise have been paid to the participant. 
For example, the plan could provide for section 403(b) elective 
deferrals under the plan to be contributed within 15 business days 
following the month in which these amounts would otherwise have been 
paid to the participant.
    (c) Annuity contracts--(1) Generally. As defined in Sec.  1.403(b)-
2, and except as otherwise permitted under this section, an annuity 
contract means a contract that is issued by an insurance company 
qualified to issue annuities in a State and that includes payment in 
the form of an annuity. This paragraph (c) sets forth additional rules 
regarding annuity contracts.
    (2) Certain insurance contracts. Neither a life insurance contract, 
as defined in section 7702, an endowment contract, a health or accident 
insurance contract, nor a property, casualty, or liability insurance 
contract meets the definition of an annuity contract. See Sec.  
1.401(f)-4(e). Also see Sec.  1.403(b)-11(d) for a transition rule.
    (3) Special rule for certain contracts. This paragraph (c)(3) 
applies in the case of a contract issued under a State section 403(b) 
plan established on or before May 17, 1982, or for an employee who 
becomes covered for the first time under the plan after May 17, 1982, 
unless the Commissioner had before that date issued any written 
communication (either to the employer or financial institution) to the 
effect that the arrangement under which the contract was issued did not 
meet the requirements of section 403(b). The requirement that the 
contract be issued by an insurance company qualified to issue annuities 
in a State does not apply to that contract if one of the following two 
conditions is satisfied and that condition has been satisfied 
continuously since May 17, 1982--
    (i) Benefits under the contract are provided from a separately 
funded retirement reserve that is subject to supervision of the State 
insurance department; or
    (ii) Benefits under the contract are provided from a fund that is 
separate from the fund used to provide statutory benefits payable under 
a State retirement system and that is part of a State teachers 
retirement system to purchase benefits that are unrelated to the basic 
benefits provided under the retirement system, and the death benefit 
provided under the contract does not at any time exceed the larger of 
the reserve or the contribution made for the employee.
    (d) Custodial accounts--(1) Treatment as a section 403(b) contract. 
Under section 403(b)(7), a custodial account is treated as an annuity 
contract for purposes of Sec. Sec.  1.403(b)-1 through 1.403(b)-11. See 
section 403(b)(7)(B) for special rules regarding the tax treatment of 
custodial accounts and section 4973(c) for an excise tax that applies 
to excess contributions to a custodial account.
    (2) Custodial account defined. A custodial account means a plan, or 
a separate account under a plan, in which an amount attributable to 
section 403(b) contributions (or amounts rolled over to a section 
403(b) contract, as described in Sec.  1.403(b)-10(d)) is held by a 
bank or a person who satisfies the conditions in section 401(f)(2), 
if--
    (i) All of the amounts held in the account are invested in stock of 
a regulated investment company (as defined in section 851(a) relating 
to mutual funds);
    (ii) The requirements of Sec.  1.403(b)-6(c) (imposing restrictions 
on distributions with respect to a custodial account) Sec.  1.403(b)-
6(d) are satisfied with respect to the amounts held in the account;
    (iii) The assets held in the account cannot be used for, or 
diverted to, purposes other than for the exclusive benefit of plan 
participants or their beneficiaries (for which purpose, assets are 
treated as diverted to the employer if the employer borrows assets from 
the account); and
    (iv) The account is not part of a retirement income account.
    (3) Effect of definition. The requirement in paragraph (d)(2)(i) of 
this section is not satisfied if the account includes any assets that 
other than stock of a regulated investment company.
    (e) Retirement income accounts. See Sec.  1.403(b)-9 for special 
rules under which a retirement income account for employees of a 
church-related organization is treated as a section 403(b) contract for 
purposes of Sec. Sec.  1.403(b)-1 through 1.403(b)-11.
    (f) Combining assets. To the extent permitted by the Commissioner 
in revenue rulings, notices, or other guidance published in the 
Internal Revenue Bulletin (see Sec.  601.601(d)(2)(ii)(b) of this 
chapter), trust assets held under a custodial account and trust assets 
held under a retirement income account, as described in Sec.  1.403(b)-
9(a)(6), may be invested in a group trust with trust assets held under 
a qualified plan or individual retirement plan. For this purpose, a 
trust includes a custodial account that is treated as a trust under 
section 401(f).


Sec.  1.403(b)-9  Special rules for church plans.

    (a) Retirement income accounts--(1) Treatment as a section 403(b) 
contract. Under section 403(b)(9), a retirement income account for 
employees of a church-related organization (as defined in Sec.  
1.403(b)-2) is treated as an annuity contract for purposes of 
Sec. Sec.  1.403(b)-1 through 1.403(b)-11.
    (2) Retirement income account defined--(i) In general. A retirement 
income account means a defined contribution program established or 
maintained by a church-related organization under which--
    (A) There is separate accounting for the retirement income 
account's interest in the underlying assets (i.e., there must be 
sufficient separate accounting for it

[[Page 67097]]

to be possible at all times to determine the retirement income 
account's interest in the underlying assets and to distinguish that 
interest from any interest that is not part of the retirement income 
account);
    (B) Investment performance is based on gains and losses on those 
assets; and
    (C) The assets held in the account cannot be used for, or diverted 
to, purposes other than for the exclusive benefit of plan participants 
or their beneficiaries. For this purpose, assets are treated as 
diverted to the employer if the employer borrows assets from the 
account.
    (ii) Plan required. A retirement income account must be maintained 
pursuant to a program which is a plan (as defined in Sec.  1.403(b)-
3(b)(3)) and the plan document must state (or otherwise evidence in a 
similarly clear manner) the intent to constitute a retirement income 
account.
    (3) Ownership or use constitutes distribution. Any asset of a 
retirement income account that is owned or used by a participant or 
beneficiary is treated as having been distributed to that participant 
or beneficiary. See Sec. Sec.  1.403(b)-6 and 1.403(b)-7 for rules 
relating to distributions.
    (4) Coordination of retirement income account with custodial 
account rules. A retirement income account that is treated as an 
annuity contract is not a custodial account (defined in Sec.  1.403(b)-
8(d)(2)), even if it is invested solely in stock of a regulated 
investment company.
    (5) Life annuities. A retirement income account may distribute 
benefits in a form that includes a life annuity only if--
    (i) The amount of the distribution form has an actuarial present 
value, at the annuity starting date, equal to the participant's or 
beneficiary's accumulated benefit, based on reasonable actuarial 
assumptions, including regarding interest and mortality; and
    (ii) The plan sponsor guarantees benefits in the event that a 
payment is due that exceeds the participant's or beneficiary's 
accumulated benefit.
    (6) Combining retirement income account assets with other assets. 
For purposes of Sec.  1.403(b)-8(f) relating to combining assets, 
retirement income account assets held in trust (including a custodial 
account that is treated as a trust under section 401(f)) are subject to 
the same rules regarding combining of assets as custodial account 
assets. In addition, retirement income account assets are permitted to 
be commingled in a common fund with amounts devoted exclusively to 
church purposes (such as a fund from which unfunded pension payments 
are made to former employees of the church). However, unless otherwise 
permitted by the Commissioner, no assets of the plan sponsor, other 
than retirement income account assets, may be combined with custodial 
account assets or any other assets permitted to be combined under Sec.  
1.403(b)-8(f). This paragraph (a)(6) is subject to any additional rules 
issued by the Commissioner in revenue rulings, notices, or other 
guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter).
    (7) Trust treated as tax exempt. A trust (including a custodial 
account that is treated as a trust under section 401(f)) that includes 
no assets other than assets of a retirement income account is treated 
as an organization that is exempt from taxation under section 501(a).
    (b) No compensation limitation up to $10,000. See section 415(c)(7) 
for special rules regarding certain employer contributions not 
exceeding $10,000.
    (c) Special deduction rule for self-employed ministers. See section 
404(a)(10) for a special rule regarding the deductibility of a 
contribution made by a self-employed minister.


Sec.  1.403(b)-10  Miscellaneous provisions.

    (a) Plan terminations and frozen plans--(1) In general. An employer 
may amend its section 403(b) plan to eliminate future contributions for 
existing participants. Alternatively, an employer may amend its section 
403(b) plan to limit participation to existing participants and 
employees (to the extent consistent with Sec.  1.403(b)-5). A section 
403(b) plan may contain provisions that permit plan termination and 
permit accumulated benefits to be distributed on termination. However, 
in the case of a section 403(b) contract that is subject to the 
distribution restrictions in Sec.  1.403(b)-6(c) or (d) (relating to 
custodial accounts and section 403(b) elective deferrals), termination 
of the plan and the distribution of accumulated benefits is permitted 
only if the employer (taking into account all entities that are treated 
as the employer under section 414 on the date of the termination) does 
not make contributions to an alternative section 403(b) contract that 
is not part of the plan. For purposes of this rule, contributions are 
made to an alternative section 403(b) contract if and only if 
contributions are made to a section 403(b) contract during the period 
beginning on the date of plan termination and ending 12 months after 
distribution of all assets from the terminated plan. However, if at all 
times during the period beginning 12 months before the termination and 
ending 12 months after distribution of all assets from the terminated 
plan, fewer than 2 percent of the employees who were eligible under the 
section 403(b) plan as of the date of plan termination are eligible 
under the alternative section 403(b) contract, the alternative section 
403(b) contract is disregarded. In order for a section 403(b) plan to 
be considered terminated, all accumulated benefits under the plan must 
be distributed to all participants and beneficiaries as soon as 
administratively practicable after termination of the plan. A 
distribution includes delivery of a fully paid individual insurance 
annuity contract. The mere provision for, and making of, distributions 
to participants or beneficiaries upon plan termination does not cause a 
contract to cease to be a section 403(b) contract. See Sec.  1.403(b)-7 
for rules regarding the tax treatment of distributions.
    (2) Employers that cease to be eligible employers. An employer that 
ceases to be an eligible employer may no longer contribute to a section 
403(b) contract for any subsequent period, and the contract will fail 
to satisfy Sec.  1.403(b)-3(a) if any further contributions are made 
with respect to a period after the employer ceases to be an eligible 
employer.
    (b) Contract exchanges and plan-to-plan transfers--(1) Contract 
exchanges and transfers--(i) General rule. If the conditions in 
paragraph (b)(2) of this section are met, a section 403(b) contract 
held under a section 403(b) plan may be exchanged for another section 
403(b) contract held under that section 403(b) plan. Further, if the 
conditions in paragraph (b)(3) of this section are met, a section 
403(b) plan may provide for the transfer of its assets (i.e., the 
section 403(b) contracts held thereunder, including any assets held in 
a custodial account or retirement income account that are treated as 
section 403(b) contracts) to another section 403(b) plan. In addition, 
if the conditions in paragraph (b)(4) of this section (relating to 
permissive service credit and repayments under section 415) are met, a 
section 403(b) plan may provide for the transfer of its assets to a 
qualified plan under section 401(a). However, neither a qualified plan 
nor an eligible plan under section 457(b) may transfer assets to a 
section 403(b) plan, and a section 403(b) plan may not accept such a 
transfer. In addition, a section 403(b) contract may not be exchanged 
for an annuity contract that is not a section 403(b) contract. Neither 
a plan-to-plan transfer nor a contract exchange permitted under this 
paragraph (b) is treated as a distribution

[[Page 67098]]

for purposes of the distribution restrictions at Sec.  1.403(b)-6. 
Therefore, such a transfer or exchange may be made before severance 
from employment or another distribution event. Further, no amount is 
includible in gross income by reason of such a transfer or exchange.
    (ii) ERISA rules. See Sec.  1.414(l)-1 for other rules that are 
applicable to section 403(b) plans that are subject to section 208 of 
the Employee Retirement Income Security Act of 1974 (88 Stat. 829, 
865).
    (2) Requirements for contract exchange within the same plan. A 
section 403(b) contract of a participant or beneficiary may be 
exchanged under paragraph (b)(1) of this section for another section 
403(b) contract of that participant or beneficiary under the same 
section 403(b) plan if the following conditions are met--
    (i) The plan under which the contract is issued provides for the 
exchange;
    (ii) The participant or beneficiary has an accumulated benefit 
immediately after the transfer at least equal to the accumulated 
benefit of that participant or beneficiary immediately before the 
exchange (taking into account the accumulated benefit of that 
participant or beneficiary under both section 403(b) contracts 
immediately before the exchange); and
    (iii) The other contract provides that, to the extent a contract 
that is exchanged is subject to any distribution restrictions under 
Sec.  1.403(b)-6, the other contract imposes restrictions on 
distributions to the participant or beneficiary that are not less 
stringent than those imposed on the contract being exchanged.
    (3) Requirements for plan-to-plan transfers. A plan-to-plan 
transfer under paragraph (b)(1) of this section from a section 403(b) 
plan to another section 403(b) plan is permitted if the following 
conditions are met--
    (i) The participant or beneficiary whose assets are being 
transferred is an employee of the employer providing the receiving 
plan;
    (ii) The transferor plan provides for transfers;
    (iii) The receiving plan provides for the receipt of transfers;
    (iv) The participant or beneficiary whose assets are being 
transferred has an accumulated benefit immediately after the transfer 
at least equal to the accumulated benefit with respect to that 
participant or beneficiary immediately before the transfer.
    (v) The receiving plan provides that, to the extent any amount 
transferred is subject to any distribution restrictions under Sec.  
1.403(b)-6, the receiving plan imposes restrictions on distributions to 
the participant or beneficiary whose assets are being transferred that 
are not less stringent than those imposed on the transferor plan.
    (vi) If a plan-to-plan transfer does not constitute a complete 
transfer of the participant's or beneficiary's interest in the section 
403(b) plan, the transferee plan treats the amount transferred as a 
continuation of a pro rata portion of the participant's or 
beneficiary's interest in the section 403(b) plan (e.g., a pro rata 
portion of the participant's or beneficiary's interest in any after-tax 
employee contributions).
    (4) Purchase of permissive service credit by contract-to-plan 
transfers from a section 403(b) contract to a qualified plan--(i) 
General rule. If the conditions in paragraph (b)(4)(ii) of this section 
are met, a section 403(b) plan may provide for the transfer of assets 
held thereunder to a qualified defined benefit governmental plan (as 
defined in section 414(d)).
    (ii) Conditions for plan-to-plan transfers. A transfer may be made 
under this paragraph (b)(4) only if the transfer is either--
    (A) For the purchase of permissive 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).
    (c) Qualified domestic relations orders. In accordance with the 
second sentence of section 414(p)(9), any distribution from an annuity 
contract under section 403(b) (including a distribution from a 
custodial account or retirement income account that, under section 
403(b)(7) or (9), is treated as a section 403(b) contract) pursuant to 
a qualified domestic relations order is treated in the same manner as a 
distribution from a plan to which section 401(a)(13) applies. Thus, for 
example, a section 403(b) plan does not fail to satisfy the 
distribution restrictions set forth in Sec.  1.403(b)-6(b), (c), or (d) 
merely as a result of distribution made pursuant to a qualified 
domestic relations order under section 414(p), so that such a 
distribution is permitted without regard to whether the employee from 
whose contract the distribution is made has had a severance from 
employment or other event permitting a distribution to be made under 
section 403(b).
    (d) Rollovers to a section 403(b) contract. A section 403(b) 
contract 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)).
    Amounts contributed to a section 403(b) contract as eligible 
rollover distributions are not taken into account for purposes of the 
limits in Sec.  1.403(b)-4, but, except as otherwise specifically 
provided (for example, at Sec.  1.403(b)-6(i)), are otherwise treated 
in the same manner as amounts held under a section 403(b) contract for 
purposes of Sec. Sec.  1.403(b)-3 through 1.403(b)-9 and this section.
    (e) Deemed IRAs. See regulations under section 408(q) for special 
rules relating to deemed IRAs.
    (f) Defined benefit plans--(1) TEFRA church defined benefit plans. 
See section 251(e)(5) of the Tax Equity and Fiscal Responsibility Act 
of 1982, Public Law 97-248, for a provision permitting certain 
arrangements established by a church-related organization and in effect 
on September 3, 1982 (a TEFRA church defined benefit plan) to be 
treated as section 403(b) contract even though it is a defined benefit 
arrangement. In accordance with section 403(b)(1), for purposes of 
applying section 415 to a TEFRA church defined benefit plan, the 
accruals under the plan are limited to the maximum amount permitted 
under section 415(c) when expressed as an annual addition, and, for 
this purpose, the rules at Sec.  1.402(b)-1(a)(2) for determining the 
present value of an accrual under a nonqualified defined benefit plan 
also apply for purposes of converting the accrual under a TEFRA church 
defined benefit plan to an annual addition. See section 415(b) for 
additional limits for TEFRA church defined benefit plans.
    (2) Other defined benefit plans. Except for a TEFRA church defined 
benefit plan, section 403(b) does not apply to any contributions or 
accrual under a defined benefit plan.
    (g) Other rules relating to section 501(c)(3) organizations. See 
section 501(c)(3) and regulations thereunder for the substantive 
standards for tax-exemption under that section, including the 
requirement that no part of the organization's net earnings inure to 
the benefit of any private shareholder or individual. See also sections 
4941 (self dealing), 4945 (taxable expenditures), and 4958 (excess 
benefit transactions), and the regulations thereunder, for rules 
relating to excise taxes imposed on certain transactions involving 
organizations described in section 501(c)(3).


Sec.  1.403(b)-11  Effective dates.

    (a) Except as otherwise provided in this section, Sec. Sec.  
1.403(b)-1 through 1.403(b)-10 apply for taxable years beginning after 
December 31, 2005.

[[Page 67099]]

    (b) In the case of a section 403(b) contract maintained pursuant to 
a collective bargaining agreement that is ratified and in effect on the 
date of publication of final regulations in the Federal Register, 
Sec. Sec.  1.403(b)-1 through 1.403(b)-10 do not apply before the date 
on which the collective bargaining agreement terminates (determined 
without regard to any extension thereof after the date of publication 
of final regulations in the Federal Register).
    (c) In the case of a section 403(b) contract maintained by a 
church-related organization for which the authority to amend the 
contract is held by a church convention (within the meaning of section 
414(e)), Sec. Sec.  1.403(b)-1 through 1.403(b)-10 do not apply before 
the earlier of--
    (1) January 1, 2007; or
    (2) 60 days following the earliest church convention that occurs 
after the date of publication of final regulations in the Federal 
Register.
    (d) Section 1.403(b)-8(c)(2) does not apply to a contract issued 
before February 14, 2005.
    Par. 6. Section 1.414(c)-5 is redesignated as Sec.  1.414(c)-6 and 
new Sec.  1.414(c)-5 is added to read as follows:


Sec.  1.414(c)-5  Certain tax-exempt organizations.

    (a) Application. This section applies to an organization that is 
exempt from tax under section 501(a). The rules of this section are in 
addition to the rules otherwise applicable under section 414(b) and 
414(c). Except to the extent set forth in paragraphs (d), (e), and (f) 
of this section, this section does not apply to any church, as defined 
in section 3121(w)(3)(A), or any qualified church-controlled 
organization, as defined in section 3121(w)(3)(B).
    (b) General rule. In the case of an organization that is exempt 
from tax under section 501(a) (an exempt organization) whose employees 
participate in a plan, the employer with respect to that plan includes 
the exempt organization and any other organization that is under common 
control with the exempt organization whose employees participate in the 
plan. For this purpose, common control exists between exempt 
organizations if at least 80 percent of the directors or trustees of 
one organization are either representatives of, or directly or 
indirectly controlled by, the other organization. A trustee or director 
is treated as a representative of another exempt organization if he or 
she also is a trustee, director, agent, or employee of the other exempt 
organization. Existence of control is determined based on the facts and 
circumstances. A trustee or director is controlled by another 
organization if the other organization has the power to remove such 
trustee or director and designate a new trustee or director. For 
example, if exempt organization A appoints at least 80 percent of the 
trustees of exempt organization B (which is the owner of the 
outstanding shares of corporation C, which is not an exempt 
organization) and has the power to control at least 80 percent of the 
directors of exempt organization D, then, under this paragraph (b) and 
Sec.  1.414(b)-1, entities A, B, C, and D are treated as the same 
employer with respect to any plan maintained by A, B, C, or D for 
purposes of the sections referenced in sections 414(b), 414(c), and 
414(t).
    (c) Permissive aggregation with entities having a common exempt 
purpose. For purposes of this section, exempt organizations that 
maintain a single plan covering one or more employees from each 
organization may treat themselves as under common control for purposes 
of section 414(c) if each of the organizations regularly coordinate 
their day-to-day exempt activities. For example, an entity that 
provides a type of emergency relief within one geographic region and 
another exempt organization that provides that type of emergency relief 
within another geographic region may treat themselves as under common 
control if they have a single plan covering employees of both entities 
and regularly coordinate their day-to-day exempt activities. Similarly, 
a hospital that is an exempt organization and another exempt 
organization with which it coordinates the delivery of medical services 
or medical research may treat themselves as under common control if 
there is a single plan covering employees of the hospital and employees 
of the other exempt organization and the coordination is a regular part 
of their day-to-day exempt activities.
    (d) Permissive disaggregation between qualified church controlled 
organizations and other entities. In the case of a church plan (as 
defined in section 414(e)) to which contributions are made by more than 
one common law entity, any employer may apply paragraphs (b) and (c) of 
this section to those entities that are not a church (as defined in 
section 403(b)(12)(B) and Sec.  1.403(b)-2) separately from those 
entities that are churches. For example, in the case of a group of 
entities consisting of a church (as defined in section 3121(w)(3)(A)), 
a secondary school (that is treated as a church under Sec.  1.403(b)-
2), and a nursing home that receives more than 25 percent of its 
support from fees paid by residents (so that it is not treated as a 
qualified church-controlled organization under Sec.  1.403(b)-2 and 
section 3121(w)(3)(B)), the nursing home may treat itself as not being 
under common control with the church and the school, even though under 
the nursing home may be under common control with the school and the 
church under paragraph (b) of this section.
    (e) Application to certain church entities. [Reserved].
    (f) Anti-abuse rule. In any case in which the Commissioner 
determines that the structure of one or more exempt organizations 
(including an exempt organization and an entity that is not exempt from 
income tax) or the positions taken by those organizations has the 
effect of avoiding or evading Sec.  1.403(b)-5(a) or another 
requirement imposed under section 401(a), 403(b), or 457(b), or any 
applicable section (as defined in section 414(t)), the Commissioner may 
treat an entity as under common control with the exempt organization.
    (g) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. (i) Facts. Organization A is a tax-exempt 
organization under section 501(c)(3) which owns 80% or more of the 
total value of all classes of stock of corporation B, which is a for 
profit organization.
    (ii) Conclusion. Under paragraph (a) of this section, this 
section does not alter the rules of section 414(b) and (c), so that 
organization A and corporation B are under common control under 
Sec.  1.414(c)-2(b).
    Example 2. (i) Facts. Organization M is a hospital which is a 
tax-exempt organization under section 501(c)(3) and organization N 
is a medical clinic which is also a tax-exempt organization under 
section 501(c)(3). N is located in a city and M is located in a 
nearby suburb. There is a history of regular coordination of day-to-
day activities between M and N, including periodic transfers of 
staff, coordination of staff training, common sources of income, and 
coordination of budget and operational goals. A single section 
403(b) plan covers professional and staff employees of both the 
hospital and the medical clinic. While a number of members of the 
board of directors of M are also on the board of directors of N, 
there is less than 80% overlap in board membership. Both 
organizations have approximately the same percentage of employees 
who are highly compensated and have appropriate business reasons for 
being maintained in separate entities.
    (ii) Conclusion. M and N are not under common control under this 
section, but, under paragraph (c) of this section, may choose to 
treat themselves as under common control, assuming both of them act 
in a manner that is consistent with that choice for purposes of 
Sec.  1.403(b)-5(a), sections 401(a), 403(b), and 457(b), and any 
other applicable section (as defined in section 414(t)).


[[Page 67100]]


    (h) Effective date. This section applies for taxable years 
beginning after December 31, 2005.

PART 31--EMPLOYMENT TAXES

    Par. 7. The authority citation for part 31 continues to read in 
part as follows:

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

    Par. 8. Section 31.3121(a)(5)-2 is added to read as follows:


Sec.  31.3121(a)(5)-2  Payments under or to an annuity contract 
described in section 403(b).

    [The text of proposed Sec.  31.3121(a)(5)-2 is the same as the text 
of Sec.  31.3121(a)(5)-2T published elsewhere in this issue of the 
Federal Register].

Nancy Jardini,
Acting Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-25237 Filed 11-15-04; 8:45 am]
BILLING CODE 4830-01-P