Guest Article

(From the April 9, 2007 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Treasury and IRS Issue Final IRC § 415 Regulations

The Treasury Department and Internal Revenue Service have issued final updates to the regulations under IRC § 415, which establishes maximum benefits and contributions for qualified plans. 72 FR 16878 (April 5, 2007). The final regulations incorporate numerous changes Congress has made to IRC § 415 since 1981, the last time IRS and Treasury issued comprehensive IRC § 415 regulations. But the final regulations, which are effective April 5, 2007 and generally apply to limitation years beginning on or after July 1, 2007, are about more than just catching up with the statutory changes.

Following is a brief overview of the final regulations. A more in-depth analysis will be published in future editions of Washington Bulletin in two parts, with one part focusing on issues relevant to defined benefit plans and another focusing on issues relevant to defined contribution plans.

Background

In order to be an IRC § 401(a) qualified plan, defined benefit and defined contribution plans must comply with the IRC § 415 benefit and contribution limits. A participant's annual benefit under a qualified defined benefit plan generally may not exceed the lesser of $180,000 or 100 percent of the participant's average compensation for his or her high three years. (The dollar limit is lower for participants who retire before age 62 and higher for those who retire after age 65.) Annual additions to a participant's qualified defined contribution plan account may not exceed the lesser of $45,000 or 100 percent of the participant's compensation. These dollar limits are adjusted annually for inflation.

Congress has made changes to IRC § 415 on at least 14 separate occasions during the last 26 years, yet the section 415 regulations have not kept pace. (For example, the current section 415 regulations state the dollar limit on annual additions to defined contribution plans is $25,000. Congress raised that limit to $30,000 in 1982, and again to $40,000 in 2001!) Except for two minor amendments to the regulations, IRS and Treasury have addressed most of these changes with a series of notices and revenue rulings.

The IRS and Treasury issued proposed rules to update the IRC § 415 regulations in 2005. These final rules are based on the proposed rules, but with changes.

Updates

In addition to updating the IRC § 415 regulations to reflect the current statutory limits, the final regulations address many other statutory changes, including the following.

Change to Compensation Definition

Among the significant provisions not related to statutory changes is guidance on determining whether amounts employees receive following severance from employment are "compensation" for purposes of applying the IRC § 415 limits. This guidance is significant because the IRC § 415 definition of "compensation" is used for a variety of other purposes throughout the qualified plan rules, including the IRC § 404 deduction limits.

The guidance generally provides that "compensation" does not include amounts received following severance from employment, subject to exceptions for certain payments made by the later of 2½ months following severance or the end of the year in which the severance occurs. (Note, the proposed regulations only would have made the exceptions available for 2½ months following severance.) Basically, the exception applies to payments of regular compensation, or overtime, commissions, and bonuses that would have been payable if employment had not terminated. It also applies to payments attributable to unused bona fide accrued sick, vacation, and other leave that could have been used if the employment relationship had continued. Another change from the proposed regulations makes the exception applicable to payments from a nonqualified deferred compensation plan if the payment would have been made to the employee at the same time if employment had continued and the payment is includible in the employee's gross income. All other post-severance payments are not compensation, regardless of when made.

In order to put to rest questions about individuals using their former employers' 401(k) plans to defer severance payments, the IRS and Treasury also are amending the section 401(k) regulations to specifically incorporate the IRC § 415 "compensation" definition. This clarifies that 401(k) cash or deferred elections may not be made with respect to true severance benefits regardless of when paid, but may be made with respect to certain post-severance payments that fall within the exception.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Laura Morrison 202.879.5653, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2007, Deloitte.