These proposed regulations reflect the numerous statutory changes to section 415 and related provisions that have been made since 1981. Some of the statutory changes reflected in the proposed regulations are as follows:

The proposed regulations contain new rules for determining the annual benefit under a defined benefit plan where there has been more than one annuity starting date (e.g., where benefits under a plan are aggregated with benefits under another plan under which distributions previously commenced). These rules would resolve the numerous issues that have arisen in determining the annual benefit under a plan where the application of the section 415(b) limitations must take into account prior distributions as well as currently commencing distributions.

The proposed regulations also provide specific rules regarding when amounts received following severance from employment are considered compensation for purposes of section 415, and when such amounts are permitted to be deferred pursuant to section 401(k), section 403(b), or section 457(b). These rules would resolve issues that have arisen with respect to payments made after the end of employment. The proposed regulations generally provide that amounts received following severance from employment are not considered to be compensation for purposes of section 415, but provide exceptions for certain payments made within 2¹/₂ months following severance from employment. These exceptions apply to payments (such as regular compensation, and payments for overtime, commissions, and bonuses) that would have been payable if employment had not terminated, and to payments with respect to leave that would have been available for use if employment had not terminated. This notice of proposed rulemaking includes corresponding changes to the regulations under sections 401(k), 403(b), and 457 that would provide that amounts receivable following severance from employment can only be deferred if those amounts meet these conditions. The rule pursuant to which compensation received after severance from employment is not considered compensation for purposes of section 415 generally does not apply to payments to an individual in qualified military service.

Section 1.415(a)-1 of these proposed regulations sets forth general rules relating to limitations under section 415 and provides an overview of the remaining regulations, including cross-references to special rules that apply to section 403(b) annuities, multiemployer plans, and governmental plans. In addition, this section provides rules for a plan’s incorporation by reference of the rules of section 415 pursuant to section 1106(h) of TRA ’86 (including detailed guidelines regarding incorporation by reference of the annual cost-of-living adjustments to the statutory limits and the application of default rules), rules for plans maintained by more than one employer, and rules that apply in other special situations.

Section 1.415(b)-1 of these proposed regulations sets forth rules for applying the limitations on benefits under a defined benefit plan. Under these limitations, the annual benefit must not be greater than the lesser of $160,000 (as adjusted pursuant to section 415(d)) or 100% of the participant’s average compensation for the participant’s high 3 consecutive years. A retirement benefit payable in a form other than a straight life annuity is adjusted to an actuarially equivalent straight life annuity to determine the annual benefit payable under that form of distribution. In addition, the dollar limitation under section 415(b)(1)(A) is actuarially adjusted for benefit payments that commence before age 62 or after age 65. The proposed regulations clarify that, in addition to applying to benefits payable to participants and beneficiaries, the limitations of section 415(b) apply to accrued benefits and benefits payable from an annuity contract distributed to a participant. Thus, the limitations of section 415(b) apply to a participant’s entire accrued benefit, regardless of whether the benefit is vested. Where a participant’s accrued benefit is computed pursuant to the fractional rule of section 411(b)(1)(C), the limitations of section 415(b) apply to the accrued benefit as of the end of the limitation year and, for ages prior to normal retirement age, are not required to be applied to the projected annual benefit commencing at normal retirement age from which the accrued benefit is computed. In addition, the proposed regulations provide a number of other updates, clarifications, and other changes to the existing regulations, as described below.

The proposed regulations provide rules under which a retirement benefit payable in any form other than a straight life annuity is converted to the straight life annuity that is actuarially equivalent to that other form to determine the annual benefit (which is used to demonstrate compliance with section 415) with respect to that form of distribution. These rules reflect statutory changes that specify the actuarial assumptions that are to be used for these equivalency calculations (including, for plan years beginning in 2004 and 2005, the use of a 5.5% interest rate for benefits that are subject to the present value rules of section 417(e)(3),^[1] as set forth in PFEA), as well as published guidance that has been issued since 1981. In addition to setting forth rules for adjusting forms of benefit other than straight life annuities, the proposed regulations would permit the IRS to issue published guidance setting forth simplified methods for making these adjustments.

Under the proposed regulations, the annual benefit is determined as the greater of the actuarially equivalent straight life annuity determined under the plan’s actuarial assumptions or the actuarially equivalent straight life annuity determined under actuarial assumptions specified by statute. This methodology implements the policy reflected in section 415(b)(2)(E), under which the plan’s determination that a straight life annuity is actuarially equivalent to a particular optional form of benefit is overridden only when the optional form of benefit is more valuable than the corresponding straight life annuity when compared using statutorily specified actuarial assumptions.

The rules in the proposed regulations under which a retirement benefit payable in any form other than a straight life annuity is converted to a straight life annuity to determine the annual benefit with respect to that form of distribution generally follow the rules set forth in Rev. Rul. 98-1. However, the calculation of the actuarially equivalent straight life annuity determined using the plan’s assumptions for actuarial equivalence has been simplified for a form of benefit that is not subject to the minimum present value rules of section 417(e)(3). Under the simplified calculation, instead of determining the actuarial assumptions used under the plan and applying those assumptions to convert an optional form of benefit to an actuarially equivalent straight life annuity, the regulations use the straight life annuity, if any, that is payable at the same age under the plan. This straight life annuity is then compared to the straight life annuity that is the actuarial equivalent of the optional form of benefit, determined using the standardized assumptions, and the larger of the two straight life annuities is used for purposes of demonstrating compliance with section 415. This simplification has not been extended to forms of benefit that are subject to the minimum present value rules of section 417(e), however, because under the plan those forms of benefit may be determined as the actuarial equivalent of the deferred annuity, rather than as the actuarial equivalent of the immediate straight life annuity.

The proposed regulations clarify that a social security supplement is included in determining the annual benefit. Under section 415(b)(2)(B), the annual benefit does not include ancillary benefits that are not directly related to retirement benefits. However, because a social security supplement is payable upon retirement as a form of retirement income, it is a retirement benefit. Thus, a social security supplement is included in determining the annual benefit without regard to whether it is an ancillary benefit or a QSUPP within the meaning of §1.401(a)(4)-12.

The proposed regulations would make two changes that would have a significant effect on the determination of a participant’s average compensation for the participant’s high 3 consecutive years. Consistent with the provisions of section 415(b)(3), the proposed regulations would restrict compensation used for this purpose to compensation earned in periods during which the participant was an active participant in the plan. In addition, the proposed regulations under §1.415(c)-2 would clarify the interaction of the requirements of section 401(a)(17) and the definition of compensation that must be used for purposes of determining a participant’s average compensation for the participant’s high 3 consecutive years. Because a plan may not base benefit accruals on compensation in excess of the limitation under section 401(a)(17), a plan’s definition of compensation used for purposes of applying the limitations of section 415 is not permitted to reflect compensation in excess of the limitation under section 401(a)(17). Thus, for example, where a participant commences receiving benefits in 2005 at age 75 (so that the adjusted dollar limitation could be as high as $379,783), and the participant had compensation in excess of the applicable section 401(a)(17) limit for 2002, 2003, and 2004, the participant’s benefit under the plan is limited by the average compensation for his highest three years as limited by section 401(a)(17) (i.e., $201,667, or the average of $200,000, $200,000, and $205,000).

The proposed regulations set forth rules for computing the limitation of section 415(b)(1)(B) of 100% of the participant’s compensation for the period of the participant’s high 3 years of service for a participant who is employed with the employer while an active participant for less than 3 consecutive calendar years. For such a participant, the period of a participant’s high 3 years of service is the actual number of consecutive years of employment (including fractions of years) while an active participant in the plan. In such a case, the limitation of section 415(b)(1)(B) of 100% of the participant’s compensation for the period of the participant’s high 3 years of service is computed by averaging the participant’s compensation during the participant’s longest consecutive period of employment while a plan participant over the actual period of service (including fractions of years, but not less than one year).

Under section 415(b)(2)(B), the portion of any joint and survivor annuity that constitutes a qualified joint and survivor annuity (QJSA) as defined in section 417(b) is not taken into account in determining the annual benefit for purposes of applying the limitations of section 415(b). The proposed regulations would clarify how this exception from the limitations of section 415 for the survivor annuity portion of a QJSA applies to benefits paid partially in the form of a QJSA and partially in some other form. Under this clarification, the rule excluding the survivor portion of a QJSA from the annual benefit applies to the survivor annuity payments under the portion of a benefit that is paid in the form of a QJSA, even if another portion of the benefit is paid in some other form.

The determination of the age-adjusted dollar limitation under the proposed regulations reflects the rules enacted in EGTRRA. As provided in Q&A-3 of Rev. Rul. 2001-51, this determination generally follows the same steps and procedures as those used in Rev. Rul. 98-1, except that such determination takes into account the increased defined benefit dollar limitation enacted by EGTRRA and that the adjustments for early or late commencement are no longer based on social security retirement age. Applying rules that are similar to those that are used for determining actuarial equivalence among forms of benefits, the proposed regulations generally use the plan’s determinations for actuarial equivalence of early or late retirement benefits, but override those determinations where the use of the specified statutory assumptions results in a lower limit.

The proposed regulations adopt rules for mortality adjustments used in computing the dollar limitation on a participant’s annual benefit for distributions commencing before age 62 or after age 65. Under these rules, to the extent that a forfeiture does not occur upon the participant’s death, no adjustment is made to reflect the probability of the participant’s death during the relevant time period, and to the extent a forfeiture occurs upon the participant’s death, an adjustment must be applied to reflect the probability of the participant’s death during the relevant time period. These rules generally are consistent with the guidance provided in Notice 83-10.

The proposed regulations would also provide a simplified method for applying this rule. Under this simplified method, a plan is permitted to treat no forfeiture as occurring upon a participant’s death if the plan does not charge participants for providing a qualified preretirement survivor annuity, but only if the plan applies this treatment for adjustments that apply both before age 62 and after age 65.

Consistent with section 415(b)(2)(G) and (H), the proposed regulations would provide that the early retirement reduction does not apply to certain participants in plans of state and local government units who are employees of a police department or fire department, or former members of the Armed Forces of the United States. This rule applies to any participant in a plan maintained by a state or political subdivision of a state who is credited, for benefit accrual purposes, with at least 15 years of service as either (1) a full-time employee of any police department or fire department of the state or political subdivision that provides police protection, firefighting services, or emergency medical services, or (2) a member of the Armed Forces of the United States. The proposed regulations would clarify that the application of this rule depends on whether the employer is a police department or fire department of the state or political subdivision, rather than on the job classification of the individual participant.

Pursuant to section 415(b)(4), the benefits payable with respect to a participant satisfy the limitations of section 415(b) if the retirement benefits payable with respect to such a participant under the plan and all other defined benefit plans of the employer do not exceed $10,000 for the plan year or for any prior plan year, and the employer has not at any time maintained a defined contribution plan in which the participant participated. The proposed regulations would clarify that the section 415(b)(4) alternative $10,000 limitation is applied to actual distributions made during each year. Thus, a distribution for a limitation year that exceeds $10,000 is not within the section 415(b)(4) alternative limitation (and therefore will not be excepted from the otherwise applicable limits of section 415(b)), even if the distribution is a single-sum distribution that is the actuarial equivalent of an accrued benefit with annual payments that are less than $10,000.

The proposed regulations would retain the rules under existing final regulations that the annual benefit does not include the annual benefit attributable to mandatory employee contributions. For this purpose, the term “mandatory employee contributions” means amounts contributed to the plan by the employee that are required as a condition of employment, as a condition of participation in the plan, or as a condition of obtaining benefits (or additional benefits) under the plan attributable to employer contributions. See section 411(c)(2)(C). Employee contributions to a defined benefit plan that are not maintained in a separate account as described in section 414(k) constitute mandatory employee contributions (even if section 411 does not apply to the plan) because, depending upon the investment performance of plan assets, employer contributions may be needed to pay a portion of the participant’s benefit that is conditioned upon these employee contributions. The rules covering mandatory employee contributions do not extend to voluntary contributions because voluntary employee contributions (plus earnings thereon) are treated as a separate defined contribution plan rather than as part of a defined benefit plan.

The proposed regulations would retain the rule under the existing regulations that the annual benefit attributable to mandatory employee contributions is determined using the factors described in section 411(c)(2)(B) and the regulations thereunder, regardless of whether section 411 applies to the plan. The proposed regulations also would clarify that the following are not treated as employee contributions: (1) contributions that are picked up by a governmental employer as provided under section 414(h)(2), (2) repayment of any loan made to a participant from the plan, and (3) repayment of any amount that was previously distributed.

The proposed regulations would clarify that the annual benefit does not include the annual benefit attributable to rollover contributions made to a defined benefit plan (i.e., rollover contributions that are not maintained in a separate account that is treated as a separate defined contribution plan under section 414(k)). In such a case, the annual benefit attributable to rollover contributions is determined by applying the rules of section 411(c) treating the rollover contributions as employee contributions (regardless of whether section 411 applies to the plan). This will occur, for example, if a distribution is rolled over from a defined contribution plan to a defined benefit plan to provide an annuity distribution. Thus, in the case of rollover contributions from a defined contribution plan to a defined benefit plan to provide an annuity distribution, the annual benefit attributable to those rollover contributions for purposes of section 415 is determined by applying the rules of section 411(c), regardless of the assumptions used to compute the annuity distribution under the plan. Accordingly, in such a case, if the plan uses more favorable factors than those specified in section 411(c) to determine the amount of annuity payments arising from a rollover contribution, the annual benefit under the plan would reflect the excess of those annuity payments over the amounts that would be payable using the factors specified in section 411(c)(3).

Rollover contributions to an account that is treated as a separate defined contribution plan under section 414(k) do not give rise to an annual benefit because the separate account is not treated as a defined benefit plan under section 415(b). Furthermore, under the rules relating to defined contribution plans, these rollover contributions to a separate account are excluded from the definition of annual additions to a defined contribution plan.

The proposed regulations would modify the rules of the existing final regulations for determining the amount of transferred benefits that are excluded from the annual benefit under a defined benefit plan in the event of a transfer from another defined benefit plan. These modifications are designed to ensure that transferred benefits are not counted twice by the same employer toward the limitations of section 415(b) and, similarly, to prevent the circumvention of the limitations of section 415(b) through benefit transfers to plans of unrelated employers. Under the proposed regulations, if the transferee plan’s benefits are required to be taken into account pursuant to section 415(f) and §1.415(f)-1 in determining whether the transferor plan satisfies the limitations of section 415(b), then the transferred benefits are included in determining the annual benefit under the transferee plan and are disregarded in determining the annual benefit under the transferor plan. Accordingly, in such a case, the annual benefit under each plan is determined taking into account the actual benefits provided under that plan after the transfer.

In contrast, if the transferee plan’s benefits are not required to be taken into account pursuant to section 415(f) and §1.415(f)-1 in determining whether the transferor plan satisfies the limitations of section 415(b), then the assets associated with those transferred liabilities (other than surplus assets) are treated by the transferor plan as distributed as a single-sum distribution. This will occur, for example, if the employer sponsoring the transferor plan is a predecessor employer with respect to the participant whose benefits are transferred to the transferee plan, where the transferee plan’s benefits are not required to be taken into account pursuant to section 415(f) and §1.415(f)-1 in determining whether the transferor plan satisfies the limitations of section 415(b). Although such a transfer is treated as a distribution in computing the annual benefit under the transferor plan, no corresponding adjustment to the annual benefit under the transferee plan is made to reflect the fact that some of the benefits provided under the transferee plan are attributable to the transfer. Thus, the actual benefit provided under the transferee plan is used to determine the annual benefit under the transferee plan even though the transferred amount is included as a distribution in determining the annual benefit under the transferor plan. In most such cases, however, a participant whose benefits have been transferred would accrue no additional benefit under the transferor plan that would be required to be tested under the plan (in combination with the transferred benefits).

The proposed regulations would provide rules for applying the 10-year phase-in of the dollar limitation based on years of participation in the plan, as added by TRA ’86, and would modify the rules set forth in final regulations for applying the 10-year phase-in of the compensation limit based on years of service. The proposed regulations follow the guidance set forth in Notice 87-21 for determining years of participation, and apply analogous rules for determining years of service for this purpose.

Section 1.415(b)-2 of the proposed regulations sets forth rules that apply in computing the annual benefit under one or more defined benefit plans in the case of multiple annuity starting dates (i.e., in cases in which a participant has received one or more distributions in limitation years prior to an increase in the accrued benefit occurring during the current limitation year or prior to the annuity starting date for a distribution that commences during the current limitation year). These rules apply, for example, where benefit distributions to a participant have previously commenced under a plan that is aggregated with a plan from which the participant receives current accruals, or where a new distribution election is effective during the current limitation year with respect to a distribution that commenced in a prior limitation year. These rules also apply where benefit payments are increased as a result of plan terms applying a cost-of-living adjustment pursuant to an adjustment of the dollar limit of section 415(b)(1)(A) made pursuant to section 415(d), if the plan does not provide for application of the safe harbor methodology set forth in the proposed regulations for determining the adjusted amount of the benefit.

In the case of multiple annuity starting dates, the annual benefit that is subject to the limits of section 415(b) and §1.415(b)-1(a) is equal to the sum of (1) the annual benefit determined with respect to any accrued benefit with respect to which distribution has not yet commenced as of the current determination date, computed pursuant to the rules of §1.415(b)-1, (2) the annual benefit determined with respect to any distribution with an annuity starting date that occurs within the current limitation year and on or before the current determination date, computed pursuant to the rules of §1.415(b)-1, (3) the annual benefit determined with respect to the remaining amounts payable under any distribution with an annuity starting date that occurred during a prior limitation year, computed pursuant to the rules of §1.415(b)-1, and (4) the annual benefit attributable to prior distributions. For this purpose, the current determination date is the last day of period for which an increase in the participant’s benefit accrues if an increase in the participant’s accrued benefit occurs during the limitation year, and if there is no such increase, the current determination date is the annuity starting date for the distribution that commences during the limitation year. The annual benefit determined using this formula is tested for compliance with section 415(b) as of the current determination date, applying the dollar limitation (which is adjusted under section 415(d) to the current determination date and is also adjusted for the participant’s age as of the current determination date) and the compensation limitation applicable as of that date (which is adjusted under section 415(d) to the current determination date but is not adjusted based on the participant’s age).

Under the proposed regulations, the annual benefit attributable to prior distributions is determined by adjusting the amounts of prior distributions to an actuarially equivalent straight life annuity commencing at the current determination date. The proposed regulations apply rules that are analogous to the rules for adjusting other benefits to determine the amount of the actuarially equivalent straight life annuity for purposes of determining the annual benefit attributable to prior distributions. Under these rules, the amount and time of prior distributions made to the participant is taken into account, and the prior distributions are adjusted to the actuarially equivalent straight life annuity commencing at the current determination date using interest and mortality assumptions that apply generally for purposes of applying the limitations of section 415(b) to a benefit in a form other than a straight life annuity. For this purpose, the actuarially equivalent straight life annuity commencing at the current determination date must reflect an actuarial increase to the present value of payments to reflect that the participant has survived during the interim period.

The actuarial assumptions used to calculate the annual benefit attributable to a prior distribution are determined as of the current determination date, and are based on the form of the prior distribution. For a prior distribution to which section 417(e)(3) did not apply, the annual benefit attributable to the prior distribution is the greater of the annual amount of a straight life annuity commencing at the current determination date that is the actuarial equivalent of that prior distribution, computed using the actuarial factors specified under the plan that provides for the current distribution or current accrual that are used to determine offsets, if any, for prior distributions, or the annual amount of a straight life annuity commencing at the current determination date that is the actuarial equivalent of that prior distribution, computed using the currently applicable statutory actuarial factors under section 415(b)(2)(E)(i) and (v). Similarly, for a prior distribution to which section 417(e)(3) applied, the annual benefit attributable to the prior distribution is the greater of the annual amount of a straight life annuity commencing at the current determination date that is the actuarial equivalent of that prior distribution, computed using the actuarial factors specified under the plan that provides for the current distribution or current accrual that are used to determine offsets, if any, for prior distributions, or the annual amount of a straight life annuity commencing at the current determination date that is the actuarial equivalent of that prior distribution, computed using the currently applicable statutory actuarial factors under section 415(b)(2)(E)(ii) and (v).

Apart from determining the actuarial factors applicable to calculating the annual benefit attributable to prior distributions, the form of the prior distribution does not otherwise affect the determination of the annual benefit attributable to prior distributions. Thus, for example, if a participant has received $50,000 per year for the past four years, the determination of the annual benefit attributable to prior distributions will be the same if those distributions are part of a 10-year certain and life annuity or are part of a straight life annuity because both of those distribution forms are subject to the same actuarial factors for determining the annual benefit attributable to prior distributions. In either case, the determination of the annual benefit attributable to prior distributions will be determined by applying the interest and mortality assumptions used under the plan to determine offsets, if any, for prior distributions to determine a straight life annuity that is actuarially equivalent to the four prior payments of $50,000, applying the statutory actuarial assumptions to determine a straight life annuity that is actuarially equivalent to the four prior payments of $50,000, and then taking the greater of the two straight life annuity amounts. Determining the annual benefit attributable to prior distributions on the basis of the amount of distributions made rather than on the form of those distributions (or on the basis of the accrued benefit that underlies those distributions) is designed to simplify the application of the multiple annuity starting date rules.

The proposed regulations provide that a prior distribution is not reflected in the annual benefit attributable to prior distributions to the extent the prior distribution has been repaid to the plan with interest (because the amounts attributable to such a prior distribution are reflected in the annual benefit in other ways). Thus, a prior distribution that has been entirely repaid to the plan (with interest) does not give rise to an annual benefit attributable to prior distributions. Similarly, if a prior distribution was made, and a repayment was subsequently made that was less than the amount of the prior distribution (including reasonable interest), the annual benefit attributable to prior distributions is determined by multiplying the annual benefit attributable to the prior distribution by one minus a fraction, the numerator of which is the amount of the repayment and the denominator of which is the amount of the prior distribution plus reasonable interest.

The proposed regulations provide an additional requirement that applies where a stream of annuity payments is modified by a new distribution election. This additional requirement is also imposed in §1.401(a)(9)-6, Q&A-13(c)(3). Under this additional requirement, which is intended to limit the extent to which benefits can increase as a result of a change in market interest rates, if a stream of annuity payments is modified by a new distribution election, the payments under the annuity that are paid before the modification plus the modified payments must satisfy the requirements of §1.415(b)-1 determined as of the original annuity starting date, using the interest rates and mortality table applicable to such date. Following the issuance of the regulations under section 401(a)(9), commentators suggested that the rule should be modified to permit a plan to reflect cost-of-living adjustments under section 415(d) that occur between the original annuity starting date and the date of modification in applying the additional test. These proposed regulations adopt this suggestion, and provide that a plan will not fail to satisfy the additional requirement merely because payments reflect cost-of-living adjustments pursuant to section 415(d) for payments no earlier than the time those adjustments are effective and in amounts no greater than amounts determined under §1.415(d)-1(a)(5). In addition, the proposed regulations include an amendment to §1.401(a)(9)-6, Q&A-13(c)(3), to reflect this change.

Section 1.415(c)-1 of these proposed regulations sets forth rules that apply to limitations on annual additions under a defined contribution plan. Under these limitations, annual additions must not be greater than the lesser of $40,000 (as adjusted pursuant to section 415(d)) or 100% of the participant’s compensation for the limitation year. The term “annual additions” generally means the sum for any year of employer contributions, employee contributions, and forfeitures. In addition to applying to qualified defined contribution plans, the limitations on defined contribution plans apply to section 403(b) annuity contracts, simplified employee pensions described in section 408(k), mandatory employee contributions to qualified defined benefit plans, and contributions to certain medical accounts.

The proposed regulations reflect a number of statutory changes to section 415(c) that were made after the issuance of existing final regulations. Among these changes are the revised limitation amounts under section 415(c), the revised rules applicable to employee stock ownership plans, and the rules applying the limitations of section 415(c) to certain medical benefit plans. The proposed regulations also would make some other changes to existing regulations, as discussed below.

If annual additions under an annuity contract that otherwise satisfies the requirements of section 403(b) exceed the limitations of section 415(c), then the portion of the contract that includes that excess annual addition fails to be a section 403(b) annuity contract (and instead is a contract to which section 403(c) applies), and the remaining portion of the contract is a section 403(b) annuity contract. As under regulations recently proposed under section 403(b) (REG-155608-02, 2004-49 I.R.B. 924) (69 FR 67075, November 16, 2004), the proposed regulations include a provision under which the status of the remaining portion of the contract as a section 403(b) contract is not retained unless, for the year of the excess and each year thereafter, the issuer of the contract maintains separate accounts for each such portion. In addition, consistent with the change to section 403(b)(1) made in JCWAA, the proposed regulations provide that the limitations under section 415(c) apply to any section 403(b) annuity contract, regardless of whether the contract satisfies the requirements of section 414(i) to be a defined contribution plan. Thus, the limitations under section 415(c) apply to a section 403(b) annuity contract even if the limitations of section 415(b) also apply to the contract (i.e., if the contract is a church plan that is covered by the grandfather rule of section 251(e)(5) of TEFRA).

The proposed regulations clarify that the IRS will treat a sale or exchange by the employee or the employer that transfers assets to a plan where the consideration paid by the plan is less than the fair market value of the assets transferred to the plan as giving rise to an annual addition in the amount of the difference between the value of the assets transferred and the consideration.

Consistent with Rev. Rul. 2002-45, the proposed regulations provide that a restorative payment that is allocated to a participant’s account does not give rise to an annual addition for any limitation year. For this purpose, restorative payments are payments made to restore losses to a plan resulting from actions by a fiduciary for which there is reasonable risk of liability for breach of a fiduciary duty under Title I of ERISA, where plan participants who are similarly situated are treated similarly with respect to the payments. Generally, payments to a defined contribution plan are restorative payments only if the payments are made in order to restore some or all of the plan’s losses due to an action (or a failure to act) that creates a reasonable risk of liability for such a breach of fiduciary duty. The proposed regulations provide that, in addition to payments to a plan made pursuant to Department of Labor order or court-approved settlement to restore losses to a qualified defined contribution plan on account of the breach of fiduciary duty, restorative payments include payments made pursuant to the Department of Labor’s Voluntary Fiduciary Correction Program to restore losses to a qualified defined contribution plan on account of the breach of fiduciary duty. However, payments made to a plan to make up for losses due merely to market fluctuations and other payments that are not made on account of a reasonable risk of liability for breach of a fiduciary duty under Title I of ERISA are contributions that give rise to annual additions and are not restorative payments.

The proposed regulations would retain the rule for taxable employers under existing regulations that the deadline for making a contribution to the plan that is credited to a participant’s account for a limitation year for purposes of section 415(c). Under this rule, employer contributions are not treated as credited to a participant’s account for a particular limitation year unless the contributions are actually made to the plan no later than 30 days after the end of the period described in section 404(a)(6) applicable to the taxable year with or within which the particular limitation year ends. The proposed regulations would modify the corresponding rule for tax-exempt employers. Under the proposed regulations, the deadline for a tax-exempt employer to make a contribution to the plan that is credited to a participant’s account for a limitation year for purposes of section 415(c) is the 15^th day of the tenth calendar month following the close of the taxable year with or within which the particular limitation year ends. This date corresponds to the due date for Form 5500 (with extensions) in cases in which the taxable year coincides with the plan year, and generally corresponds to the contribution due date for taxable employers who request filing extensions. The deadline for contributions for tax-exempt employers under the proposed regulations would be an extension from the earlier deadline now applicable under existing regulations (i.e., the 15^th day of the sixth calendar month following the close of the taxable year with or within which the particular limitation year ends). The extent to which elective contributions constitute plan assets for purposes of the prohibited transaction provisions of section 4975 and Title I of ERISA is determined in accordance with regulations and rulings issued by the Department of Labor. See 29 CFR 2510.3-102.

The proposed regulations clarify the operation of the special increased limitation applicable to church plans under section 415(c)(7). Under this rule, notwithstanding the generally applicable limitations, annual additions for a section 403(b) annuity contract for a year with respect to an individual who is a church employee are treated as not exceeding the limitation of section 415(c) if such annual additions for the year are not in excess of $10,000. However, the total amount of additions with respect to any participant that are permitted to be taken into account for purposes of this rule for all years may not exceed $40,000. In addition, for any individual who is a church employee performing any services for the church outside the United States, additions for a section 403(b) annuity contract for any year are not treated as exceeding the limitations of section 415(c) if those annual additions for the year do not exceed the greater of $3,000 or the employee’s includible compensation. The proposed regulations would clarify that the $40,000 cumulative total only applies to excesses over what would have been permitted to be contributed without regard to this special rule, and clarifies the interaction between the generally applicable church employee rule and the rule for church employees performing services outside the United States. In addition, the proposed regulations would clarify that the special rule that applies to services for a church performed abroad applies to the employee’s includible compensation only with respect to services for the church outside the United States.

The correction mechanism in current §1.415-6(b)(6) for handling excess annual additions is not included in the proposed regulations. It is anticipated that this correction mechanism will be included in the Employee Plans Compliance Resolution System (see Rev. Proc. 2003-44, 2003-1 C.B. 1051) in the future.

The proposed regulations generally would retain the rules under existing regulations providing that a contribution to reduce accumulated funding deficiencies or a contribution made pursuant to a funding waiver relates to the limitation year of the initial funding obligation. However, the proposed regulations would provide that any interest paid by the employer with respect to such a contribution that is in excess of a reasonable amount is taken into account as an annual addition for the limitation year when the contribution is made (in contrast to existing regulations, which require interest in excess of a reasonable amount to be taken into account as an annual addition for the limitation year for which the contribution was originally required). Rev. Rul. 78-223, 1978-1 C.B. 125, provides a method for determining contributions required to amortize waived contributions under a defined contribution plan. The application of any of the methods described in Rev. Rul. 78-223 will result in reasonable interest payments for purposes of applying the rules of section 415 (provided that, if a fixed interest rate in excess of 5% is used to amortize waived contributions, the interest rate is reasonable). Thus, for example, the actual yield method (under which the adjusted account balance is increased or decreased periodically at the actual rate of investment return experienced by the plan for such period) can be used for this purpose.

Section 1.415(c)-2 of these proposed regulations defines the term compensation, which is defined in section 415(c)(3) and used for purposes of applying the limitations of section 415 as well as for various other purposes specified under the Internal Revenue Code. The proposed regulations reflect a number of statutory changes to section 415(c)(3) that were made after the issuance of existing final regulations. Among these changes are the inclusion in compensation of certain deemed amounts for disabled participants and nontaxable elective amounts for deferrals under sections 401(k), 403(b), and 457, cafeteria plan elections under section 125, and qualified transportation fringe elections under section 132(f)(4). In addition to these changes, the proposed regulations would make some other changes to existing regulations, as discussed below.

The proposed regulations provide specific guidelines regarding when amounts received following severance from employment are considered compensation for purposes of section 415. The following are types of post-severance payments that are not excluded from compensation because of timing if they are paid within 2¹/₂ months following severance from employment: (1) payments that, absent a severance from employment, would have been paid to the employee while the employee continued in employment with the employer and are regular compensation for services during the employee’s regular working hours, compensation for services outside the employee’s regular working hours (such as overtime or shift differential), commissions, bonuses, or other similar compensation; and (2) payments for accrued bona fide sick, vacation, or other leave, but only if the employee would have been able to use the leave if employment had continued. Under the proposed regulations, the rule generally excluding payments after severance from employment from compensation does not apply to payments to an individual who does not currently perform services for the employer by reason of qualified military service (as that term is used in section 414(u)(1)) to the extent those payments do not exceed the amounts the individual would have received if the individual had continued to perform services for the employer rather than entering qualified military service. This notice of proposed rulemaking also contains corresponding proposed amendments to the regulations under sections 401(k), 403(b), and 457 that would provide that amounts received following severance from employment can be deferred only if they are considered compensation under the rules of section 415.

Section 1.415(d)-1 of these proposed regulations sets forth rules that apply to cost-of-living adjustments to the various limitations of section 415 pursuant to section 415(d). Section 415(d) provides for the dollar and compensation limitations on annual benefits and the dollar limitation on annual additions to be adjusted annually for increases in the cost of living based on adjustment procedures similar to the procedures used to adjust social security benefit amounts. These adjustments also apply for other purposes as specified in the Internal Revenue Code. The proposed regulations specify the manner in which these adjustments are determined each year, and reflect statutory changes to the adjustment methodology made after the 1981 regulations were issued. In addition, the proposed regulations make several other changes to existing final regulations, as discussed below.

The proposed regulations would specify the circumstances under which an adjusted limit is permitted to be applied to participants who have previously commenced receiving benefits under a defined benefit plan. Under the proposed regulations, the adjusted dollar limitation is applicable to current employees who are participants in a defined benefit plan and to former employees who have retired or otherwise terminated their service under the plan and have a nonforfeitable right to accrued benefits, regardless of whether they have actually begun to receive such benefits. A plan is permitted to provide that the annual increase applies for a participant who has previously commenced receiving benefits only to the extent that benefits have not been paid. Thus, for example, a plan cannot provide that this annual increase applies to a participant who has previously received the entire plan benefit in a single-sum distribution. However, a plan is permitted to provide for an increase in benefits to a participant who accrues additional benefits under the plan that could have been accrued without regard to the adjustment of the dollar limitation (including benefits that accrue as a result of a plan amendment) on or after the effective date of the adjusted limitation.

The proposed regulations provide for a safe harbor under which the annual benefit will satisfy the limitations of section 415(b) for the current limitation year following an adjustment to benefit payments that is made to reflect the cost-of-living adjustment made pursuant to section 415(d). If such adjustments are made in accordance with this safe harbor, the multiple annuity starting date rules of §1.415(b)-2 do not apply on account of such adjustments. Under this safe harbor, if a participant has received one or more distributions under an annuity stream that satisfies the requirements of section 415(b) before the adjustment, the plan’s benefits will satisfy the limitations of section 415(b) if the amounts payable to the employee for the limitation year and subsequent limitation years are not greater than the amounts that would otherwise be payable under the annuity stream without regard to the adjustment, multiplied by a fraction. The numerator of this fraction is the limitation under section 415(b) (i.e., the lesser of the applicable dollar limitation under section 415(b)(1)(A), as adjusted for age at commencement, and the applicable compensation-based limitation under section 415(b)(1)(B)) in effect for the distribution following the adjustment, and the denominator of this fraction is such limitation under section 415(b) in effect for the distribution immediately before the adjustment.

Section 1.415(f)-1 of these proposed regulations sets forth rules for combining and aggregating plans pursuant to section 415(f). Under section 415(f) and these proposed regulations, for purposes of applying the limitations of section 415(b) and (c), all defined benefit plans of an employer are treated as one defined benefit plan, and all defined contribution plans of an employer are treated as one defined contribution plan. The controlled group rules of section 414(b) and (c) (as modified by section 415(h)), the affiliated service group rules of section 414(m), and the leased employee rules of section 415(n) apply for purposes of determining whether a plan that is maintained by an entity other than the employer is considered maintained by the employer for purposes of applying the aggregation rules of section 415(f).

The proposed regulations would also make various changes and clarifications to the existing regulations. The proposed regulations would clarify that an employer’s plan must be aggregated with all plans maintained by a predecessor employer (see section 414(a)), regardless of whether any such plan is assumed by the employer. Pursuant to section 414(a)(1), the proposed regulations would provide that, for purposes of section 415, a former employer is a predecessor employer with respect to a participant in a plan maintained by an employer if the employer maintains a plan under which the participant had accrued a benefit while performing services for the former employer, but only if that benefit is provided under the plan maintained by the employer. In addition, the proposed regulations would provide pursuant to section 414(a)(2) that, with respect to an employer of a participant, a former entity that antedates the employer is a predecessor employer with respect to the participant if, under the facts and circumstances, the employer constitutes a continuation of all or a portion of the trade or business of the former entity. This will occur, for example, where formation of the employer constitutes a mere formal or technical change in the employment relationship and continuity otherwise exists in the substance and administration of the business operations of the former entity and the employer. See Lear Eye Clinic, Ltd. v. Commissioner, 106 T.C. 418, 425-429 (1996).

The proposed regulations provide rules for aggregating participation and service for purposes of the 10-year phase-in of the limitations on defined benefit plans. Under these rules, years of participation in all aggregated plans and years of service for employers maintaining all aggregated plans are counted for purposes of applying the 10-year phase-in rules.

The proposed regulations clarify the aggregation rules that apply to section 403(b) annuity contracts, other plans of the employer, and plans of related employers, in light of changes made in EGTRRA. Generally a section 403(b) annuity contract is not aggregated with plans that are maintained by the participant’s employer because the section 403(b) annuity contract is deemed maintained by the participant and not the employer for purposes of section 415. However, if a participant on whose behalf a section 403(b) annuity contract is purchased is in control of any employer for a limitation year, the annuity contract for the benefit of the participant is treated as a defined contribution plan maintained by both the controlled employer and