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4.72.2  Cash or Deferred Arrangements

Manual Transmittal

September 05, 2017


(1) This transmits revised IRM 4.72.2, Employee Plans Technical Guidelines, Cash or Deferred Arrangements (CODAs).

Material Changes

(1) This IRM is updated to add sections (Program Scope and Objectives), (Background), (Authority), (Responsibilities), and (Acronyms and Definitions).

(2) This IRM is updated to add sections and to reflect the new substantiation guidelines for safe-harbor hardship distributions from section 401(k) plans as set forth in the Memorandum for Employee Plans Examination Employees on February 23, 2017 (Interim Guidance TE/GE-04-0217-0008).

(3) IRM sections and (8), and were updated to reflect the Notice of Proposed Rulemaking published in the Federal Register on January 18, 2017 that proposes to change the definitions of Qualified Matching Contributions and Qualified Nonelective Contributions.

(4) This IRM is updated to make editorial changes, changes section numbers, and to reflect current versions of revenue procedures and IRM procedures.

Effect on Other Documents

This supersedes IRM 4.72.2, dated September 22, 2016.


Tax Exempt and Government Entities
Employee Plans

Effective Date


Robert S. Choi
Director, Employee Plans
Tax Exempt and Government Entities  (09-05-2017)
Program Scope and Objectives

  1. This IRM section helps EP specialists identify issues related to retirement plans with cash or deferred arrangements (CODAs).

  2. Audience: Tax Exempt and Government Entities, Employee Plans employees.

  3. Policy Owner: Director, Tax Exempt and Government Entities, Employee Plans.

  4. Program Owner: Tax Exempt and Government Entities, Employee Plans.

  5. Program Goal: To ensure continued compliance and qualification of retirement plans with cash or deferred arrangements.  (09-05-2017)

  1. A plan is qualified if it meets the requirements of IRC 401(a) in form and operation. A qualified plan is entitled to favorable tax treatment.

  2. The primary objective of an Employee Plans audit is to determine if the plan is operating in compliance with the Internal Revenue Code and if the terms of the written plan document are being followed.

  3. The technical guidelines in this IRM section summarize the law that agents must consider in determining whether a plan meets the requirements of the Internal Revenue Code for retirement plans with cash or deferred arrangements.  (09-05-2017)

  1. Policy Statement 4-119 states that the primary objective of the Employee Plans audit program is regulatory, with emphasis on continued qualification of employee benefit plans. Plans will be examined to determine whether they meet the applicable qualification requirements in operation. See IRM

  2. Delegation Order 8-3 gives the Director, Tax Exempt and Government Entities, Employee Plans, authority to enter into and approve a written agreement with any person relating to their tax liability. See IRM

  3. A plan is qualified if it meets the requirements of IRC 401(a) in form and operation.

  4. A qualified cash or deferred arrangement (CODA) must meet the requirements of IRC 401 (a) and IRC 401(k).  (09-05-2017)

  1. Agents examine a plan to determine if the plan:

    • Meets the qualification requirements of IRC sections 401(a) and 501(a). See IRM and IRM

    • Filed all required tax and information returns. See IRM

    • Reported information and excise tax liabilities correctly. See IRM

  2. In June 2014, the IRS adopted the Taxpayer Bill of Rights (TBOR). Agents must consider these rights when carrying out EP examinations. See Policy Statement 1-236 and the Taxpayer Bill of Rights (TBOR).  (09-05-2017)
Acronyms and Definitions

  1. This subsection defines some abbreviations we use in this IRM, but the terms are also discussed in IRM 4.72.3, Employee Plans Technical Guidance, Employee Contributions and Matching Contributions.

    Term Acronym Definition
    Elective deferrals or
    Elective contributions
    ED Contributions made to a plan per an employee’s cash or deferred election. EDs are:
    • Included in the IRC 402(g) definition of elective deferrals.

    • Treated as employer contributions for most purposes of the Code, including IRC 401(a), IRC 401(k), IRC 402, IRC 404, IRC 409, IRC 411, IRC 412, IRC 415, IRC 416, and IRC 417.

    • Counted as part of the employee’s wages for FICA withholding, FUTA, and Railroad Retirement tax.

    • Treated as plan assets for the Department of Labor, ERISA Title 1 rules.

    Actual deferral ratio ADR An employee’s EDs (and amounts treated as EDs) for a plan year divided by his/her compensation for the plan year.
    Actual deferral percentage ADP The average of the ADRs for the relevant group of employees. ADP is used in the ADP test, an anti-discrimination test in IRC 401(k)(3)(A)(ii).
    Actual contribution ratio ACR The sum of an employee’s employee contributions and matching contributions (and amounts treated as matching contributions) for a plan year divided by his/her compensation for the plan year.
    Actual contribution percentage ACP The average of the ACRs for the relevant group of employees. It is used in the ACP test, an anti-discrimination test in IRC 401(m)(2)(A)
    Qualified nonelective contributions QNECs (or QNCs) Special employer contributions not subject to a CODA election.
    • Always fully vested

    • Subject to certain distribution restrictions

    • May be treated as elective deferrals or matching contributions in the ADP test or the ACP test respectively.

    Qualified matching contributions QMACs Employer matching contributions:
    • Always fully vested

    • Subject to certain distribution restrictions

    • Counted in the ACP test unless they are treated as elective deferrals, in which case they are counted in the ADP test.

    Automatic contribution arrangement, ACA An arrangement within a CODA under which, if a covered employee doesn't affirmatively elect a different percentage (including 0), the plan sponsor withholds a certain percentage of compensation from the employee’s compensation and contributes it to the plan as an elective contribution.
    Qualified automatic contribution arrangement QACA A type of safe harbor 401(k) plans in IRC 401(k)(13) that includes an ACA and satisfys other requirements. A QACA has minimum contribution requirements and isn't subject to the ADP or ACP test if the plan/plan sponsor satisfies additional requirements in IRC 401(m)(12).
    Eligible automatic contribution arrangement EACA A type of ACA in IRC 414(w). An EACA may permit covered employees to withdraw initial amounts they contribute under a default election. EACAs alone don’t automatically satisfy the nondiscrimination requirements under IRC 401(k)(3).
  2. A "safe harbor 401(k) plan" means a plan that isn’t subject to the:

    1. ADP test because it meets the requirements of IRC 401(k)(12) or 401(k)(13).

    2. ACP test if it meets the safe harbor requirements of IRC 401(m)(11) or 401(m)(12), as applicable.  (09-05-2017)
Overview of CODAs

  1. A CODA is an arrangement that allows eligible employees to make a cash or deferred election (before the taxable benefit is currently available to him/her) for contributions, benefits or accruals in a plan intended to satisfy IRC 401(a). A cash or deferred election is an employee’s direct or indirect election (or modification of an earlier election) to have the employer either:

    1. Give the employee an amount in cash or some other taxable benefit that is not currently available.

    2. Contribute an amount to a trust, or give an accrual or other benefit, to a plan deferring the employee’s receipt of compensation.

  2. A cash or deferred election includes "deemed" elections made under an automatic contribution arrangement (ACA), (also known as "automatic-enrollment" ). In an ACA, if an employee doesn’t affirmatively elect not to contribute, or contribute a different amount, the plan applies a default election, so that, the employer can treat an employee as having made an election to have a specified contribution made on his/her behalf to the plan.

  3. A CODA that is not qualified is one that doesn’t satisfy the requirements of IRC 401(k). Except where clearly specified, these guidelines assume a CODA is intended to be a qualified CODA, using the term "CODA" to mean a qualified CODA because only qualified CODAs get the benefit of tax deferral. An employee’s contributions made per a cash or deferred election to a qualified CODA aren’t treated as distributed or made available to the employee. So, they are not included in the employee’s gross income until distributed (unless they are designated Roth contributions). See IRC 402(e)(3).  (09-05-2017)
CODA Changes

  1. This IRM reflects statutory changes made by these laws and reflects all current guidance as of this IRM’s effective date:

    • Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)

    • Pension Protection Act of 2006 (PPA)

    • Worker, Retiree, and Employer Recovery Act of 2008 (WRERA)

    • Small Business Jobs Act of 2010 (SBJA)

    • Patient Protection and Affordable Care Act (PPACA)

    • American Taxpayer Relief Act of 2012 (ATRA)

  2. The statutes listed below made the following changes to CODAs:

    2002 EGTRRA 631 414(v) Adds catch-up contributions for individuals age 50 or over.
    2002 EGTRRA 646 401(k)(2)(B)(i)(I) Replaces "separation from service" with "severance from employment" to eliminate the "same desk rule."
    2002 EGTRRA 646 401(k)(10) Removes certain corporate dispositions from the list of distributable events for elective deferrals, because these dispositions are now covered by a "severance from employment."
    2002 EGTRRA 666 401(m)(9) Eliminates the multiple use test.
    2002 EGTRRA 636 401(k)(2) Directs the Secretary of the Treasury to modify deemed hardship rules to reduce the suspension period after a hardship distribution from 12 months to six months,
    2002 EGTRRA 611(d) 402(g) Increases the maximum limit for elective deferrals and changed the method for determining COLAs.
    2002 EGTRRA 611(f) 401(k)(11) Refers to IRC 408(p) for the maximum amount of elective deferrals that can be made to a SIMPLE 401(k) plan.
    2002 EGTRRA 613(b) 416(c)(2)(A) Stated that matching contributions are used to satisfy the top heavy minimum contribution requirement.
    2002 EGTRRA 613(d) 416(g)(4)(H) Exempts certain safe harbor 401(k) plans from the top heavy rules.
    2002 PPA 904(a) 411(a)(2)(B) Changes the minimum vesting requirements for matching contributions to either three-year cliff or six-year graded.
    2006 EGTRRA 617 402A Permits optional treatment of elective deferrals as Roth contributions.
    2006 PPA 826 401(k), 403(b), 409A and 457(b) Directs the Secretary of the Treasury to modify deemed hardship rules so that a participant’s beneficiary is treated the same as the participant’s spouse or dependent when deciding whether the participant has incurred a hardship or unforeseeable financial emergency.
    2006 PPA 861(a)(2) 401(k)(3)(G) States that all governmental plans (per IRC 414(d)) are treated as meeting the participation and nondiscrimination requirements of IRC 401(k)(3). Before this change, only state and local government plans were so treated.
    2007 PPA 904 411(a) Changes the minimum vesting requirements for employer nonelective contributions to defined contribution plans to either 3-year cliff or 6-year graded.
    2008 PPA 902(a) and (b) 401(k)(13) and 401(m)(12) Permits qualified automatic contribution arrangements (QACAs) as alternative ways of satisfying the ADP and ACP tests.
    2008 PPA 902(d) 414(w), 401(k)(8)(E) and 411(a)(3)(G) Allows eligible automatic contribution arrangements (EACA)
    Allows plans to forfeit matching contributions associated with permissible withdrawals under IRC 414(w).
    2008 PPA 902(e)(3)(A) &(B) 401(k)(8)(A)(i), 401(m)(6)(A) and 4979(f)(1) Eliminates the "gap-period earnings" rule for excess and excess aggregate contributions. Gap-period earnings are earnings from the end of the year in which the excess arose to the date of distribution.
    2008 WRERA 109(b)(3) 402(g)(2)(A)(ii) States that a corrective distribution of excess deferrals may not include gap-period earnings.
    2008 PPA827(b) 401(k)(2)(B)(i) States that elective deferrals may be distributed as a "qualified reservist distribution" defined in IRC 72(t)(2)(G), effective for distributions after September 11, 2001.


    HEART section 107(a) extends the applicability of the qualified reservist distribution to individuals ordered or called to active duty after December 31, 2007

    2008 PPA 902(e)(2) 4979(f)(2) States that a distribution of excess contributions or excess aggregate contributions, plus attributable earnings on each, is includible in the recipient’s gross income in the year distributed.
    2010 PPA 903(a) 414(x) Allows "eligible combined plans (" a "DB-K plan)" - a plan that has defined benefit plan that meets certain specified benefit and vesting requirements and a CODA that meets certain specified contribution, vesting, nondiscrimination and notice requirements.
    2010 SBJPA 2112 402A(c)(4) States amounts can be rolled into an employee’s designated Roth account from another account in the same plan if the amount was otherwise eligible for rollover.


    The taxable part of the "in-plan Roth rollover" made in 2010 could have been deferred. Half of the taxable part could've been included in income in 2011 and the other half in 2012.

    2011 SBJPA 2111 402A(e)(1) Stated that a governmental IRC 457(b) plan could include a designated Roth program.
    2013 PPACA 9013 213 Amends the deductible medical expense amount from amounts exceeding 7.5 percent to amounts exceeding 10 percent of adjusted gross income. There is a transition rule for individuals age 65 and older.


    The only effect this has on 401(k) plans is a reference to the old 7.5 percent limit in the Treasury regulations dealing with deemed hardship standards. See IRM, Deemed Hardship Distribution Standards

    2013 ATRA 902 402A(c)(4)(E) Expands amounts eligible for in-plan Roth rollovers. A plan can now permit amounts not otherwise eligible for rollover to be rolled over to an employee’s designated Roth account.
  3. The IRS issued these guidance items on IRC 401(k):

    Guidance IRC Section(s)
    Guidance provided:
    Rev. Rul. 2004-13 , 2004-1 C.B. 485 416(g)(4)(H) Whether certain safe harbor 401(k) plans are subject to the top heavy rules.
    Treasury regulations published on December 29, 2004, 69 CFR 78144 401(k) and 401(m) Sets comprehensive requirements (including the nondiscrimination requirements) for 401(k) and 401(m) plans
    Treasury regulations published on January 3, 2006, 71 CFR 6 401(k) and 401(m) Explains Designated Roth contributions for plan qualification purposes.
    Treasury regulations published on April 5, 2007, 72 CFR 16878 415 and 401(k) Adds paragraph (e)(8) to CFR 1.401(k)-1, requiring deferral elections to be made only from compensation defined in IRC 415(c)(3) and CFR 1.415(c)-2 . Elective deferrals may be made from severance pay if this pay would otherwise be paid by the later of:
    • 2 1/2 months after severance from employment

    • the end of the year that includes the date of severance from employment.

    See 26 26 CFR 1.415(c)-2(e)(3)(ii) or (iii) minimum coverage requirements in IRC 410(b).
    Treasury regulations published on April 30, 2007, 72 CFR 21103 401(k), 402(g), 402A and 408A Addresses Designated Roth contributions.
    Treasury regulations published on July 21, 2006, 71 CFR 41357 401(k), 401(m) and 410(b) Permits the exclusion of certain employees of a tax-exempt organization described in IRC 501(c)(3) for purposes of determining whether an IRC 401(k) plan (or an 401(m) plan) meets the minimum coverage requirements in IRC 410(b).
    Announcement 2007-59, 2007-1 C.B. 1448 401(k) States that a plan will not fail to satisfy the requirements to be a safe harbor 401(k) just because it adds a designated Roth contribution program or the deemed hardship rules for the designated beneficiary of a participant mid-year (under PPA section 826).
    Notice 2007-7, Part III, 2007-1 C.B. 395 401(k) Contains guidance on PPA section 826 for 401(k) plan distributions on account of the hardship of a participant’s beneficiary
    Treasury regulations published on February 24, 2009, 74 CFR 8200 401(k)(13), 401(m)(12) and 414(w) Adds QACAs and EACAs.
    Rev. Rul. 2009-30, 2009-39 IRB 391 401(k) and 414(w) Explains how automatic enrollment in an IRC 401(k) plan can work when it includes an escalator feature.
    Rev. Rul. 2009-31, 2009-39 IRB 395 and Rev. Rul. 2009-32, 2009-39 IRB 398 401(k) States that plan sponsor may contribute the dollar equivalent of any unused paid time off to a profit-sharing plan on either an annual basis or upon termination of employment.
    Notice 2009-65, 2009-39 IRB 413 401(k) and 414(w) Contains two sample amendments 401(k) plan sponsors can use to add automatic enrollment features to their plans.
    Notice 2010-84, 2010-51 IRB 872 402A(c)(4), 401(k), 403(b) and 408A Contains guidance on in-plan Roth rollovers under SBJPA.
    Treasury regulations published on November 15, 2013, 78 CFR 68735 401(k) and 401(m) Expands the reasons for suspending safe harbor contributions in a safe harbor IRC 401(k) (IRC 401(k)(12)) or a QACA (IRC 401(k)(13)).
    Notice 2013-74, 2013-52 IRB 819 402A(c)(4)(E), 401(k), 403(b) and 457(b) Contains guidance on in-plan Roth rollovers under ATRA.
    Notice 2014-19, 2014-17 IRB 979 401(a), 401(k), 417(a)(4) and other related sections Contains guidance on applying the decision in United States v. Windsor, 570 U.S. 12 (2013), and the holdings of Rev. Rul. 2013-17, 2013-38 IRB 201 to retirement plans
    Notice 2014-37, 2014-24 IRB 1100 401(k) and 401(m) Provides guidance on a mid-year amendment to a safe harbor plan under IRC 401(k) and 401(m) to reflect the outcome of United States v. Windsor, per Notice 2014-19.
    Notice 2016-16, 2016-7 IRB 318 401(k) and 401(m) Contains guidance on a mid-year change to a safe harbor plan under IRC 401(k) and 401(m).
    Notice of Proposed Rulemaking REG-131643-15, 2017-6 I.R.B. 865, 401(k) and 401(m) Proposed regulations on the definitions of QNEC and QMAC.  (09-05-2017)
Eligible Employer and Plan

  1. Employers/entities that can establish a CODA:

    Employer/Entity Delineated Dates Cite
    Sole Proprietors, Partnerships, Corporations and Federal Government Agencies N/A 26 CFR 1.401(k)-1(a)(6)
    Tax-Exempt Organizations Effective January 1, 1997


    between May 6, 1986 and December 31, 1996, tax-exempt organizations (other than rural co-ops) could not establish a CODA

    IRC 401(k)(4)(B)(i)
    Tax Reform Act of 1986, section 1116
    Indian Tribal Governments (and related entities) Effective January 1, 1997 IRC 401(k)(4)(B)(iii)
    State or Local Governments Only those with a CODA on May 6, 1986, may continue or establish a new CODA 26 CFR 1.401(k)-1(e)(4)
  2. An employer who establishes a SIMPLE 401(k) plan under IRC 401(k)(11) must be an "eligible employer" (in addition to meeting the requirements in IRM (1)). That is, the employer must have had no more than 100 employees who received $5,000 or more in compensation from the employer for the preceding calendar year (IRC 408(p)(2)(C)(i)).

  3. A CODA must be part of a profit-sharing plan, a stock bonus plan, a pre-ERISA money purchase plan, or a rural cooperative plan. See IRC 401(k)(1), (2), (6) and (7). If a CODA doesn't satisfy IRC 401(k), it won't always disqualify the plan of which it is a part of.


    A CODA in a profit-sharing plan fails the ADP test. This doesn't automatically disqualify the plan, although the plan will most likely have failed to follow its terms, which is ground for disqualification. But, a CODA that is part of a defined benefit plan would disqualify the entire plan because defined benefit plans are not permitted to contain CODAs.


    An "eligible combined plan" is a combination of a defined benefit plan that meets certain specific benefit and vesting requirements and a separate defined contribution plan containing a CODA that meets certain specific contribution, vesting, nondiscrimination and notice requirements. See IRC 414(x).

  4. Sometimes the term "401(k) plan" is used to refer to a plan that contains a CODA. However, the plan may offer one or more types of other contributions, such as employee (after-tax) contributions, and employer matching and nonelective contributions.  (09-05-2017)
CODA Defined

  1. A CODA is any arrangement under which an eligible employee may elect between receiving a current compensation amount or a deferred compensation benefit in a plan subject to IRC 401(a) plan.

  2. Only certain plans may contain CODAs (see IRM (3)) and only certain employers may maintain plans with CODAs (see IRM (1).)

  3. A CODA doesn’t include arrangements that:

    • Treat amounts contributed at an employee’s election at the time of contribution as after-tax employee contributions. (A designated Roth contribution isn’t treated as an after-tax employee contribution for the CODA rules.)

    • Distribute or invest ESOP dividends under either participants or beneficiaries elections following the rules of IRC 404(k)(2)(A)(iii).  (09-05-2017)
Cash or Deferred Election

  1. A cash or deferred election is any direct or indirect election (or modification of a previous election) an employee makes to have the employer either:

    1. Give an amount to him/her in cash or some other taxable benefit not currently available to the employee at the time of the election.

    2. Contribute an amount to a trust, or give an accrual or other benefit, under a plan deferring the receipt of compensation.

  2. Cash or another taxable benefit is currently available to an employee if either:

    1. It has been paid to the employee.

    2. The employee is able currently to receive the cash or other taxable benefit at his/her discretion.

  3. An amount is not currently available to an employee if either:

    1. There is a significant limitation or restriction on his/her right to receive the amount currently.

    2. He/she may under no circumstances receive the amount before a particular time in the future.


      The determination as to whether an amount is "currently available" for CODA purposes doesn’t depend on whether it is also "constructively received" for purposes of IRC 451.

  4. Participants can elect to defer only compensation they earn that would, but for the election, become currently available after the later of the date the CODA is:

    1. adopted.

    2. effective

  5. A participant’s salary deferral election uses a salary reduction agreement in which an eligible employee agrees to reduce his/her cash compensation, or forgo an increase in cash compensation, in exchange for the employer contributing that amount to the plan. But, the election may also be made under an ACA. Under these "automatic enrollment plans," employees must be given a reasonable opportunity to elect to have a different amount or no amount contributed to the plan. Under 26 CFR 1.401(k)-1(a)(3)(ii) , when you decide if an election is a cash or deferred election, it doesn’t matter whether the plan default (absent an affirmative election) is:

    • The participant receives cash.

    • The plan makes an elective contribution on his behalf.  (09-05-2017)
Certain One-Time Elections

  1. One-time irrevocable non-participation elections are not considered CODA elections.


    A plan permits employees to make an irrevocable election to contribute or not contribute to the plan or any of the other employer’s plans (including plans not yet established) for their employment with that employer on their hire date or when they first becomes eligible under any of the employer’s plans.


    So, if these were the only elections available under a plan, the plan wouldn’t be considered to contain a CODA because employees are given a one-time, irrevocable election. Contributions employees made to a plan by this election wouldn’t be considered EDs.

  2. Plans that use a one-time election can’t permit employees to do a one-time election:

    • If they’ve participated in any of the employer’s plans.

    • When they change jobs with the same employer, such as from associate to partner, or union employee to manager.

  3. Plans that give this one-time irrevocable election must follow the regular, non-CODA nondiscrimination rules. So, they must offer the one-time election to a nondiscriminatory group, and the plan as a whole must satisfy the regular nondiscrimination rules.  (09-05-2017)
CODAs of Self-Employed Individuals

  1. Under the partnership taxation rules, when a partnership plan sponsor makes a contribution on behalf of a partner:

    • The contribution is allocated to that partner.

    • The contribution is deducted on the partner’s individual income tax return.

    • The contribution is deducted from the partner’s distributive share of the partnership income.

    • The remaining portion of the partner’s distributive share of partnership income is payable directly to the partner.

  2. Because a partner can choose to vary the plan contribution the partnership makes for him/her, this is a cash or deferred election. Rev. Proc. 91-47, 1991-2 C.B. 75 gave limited relief for partnership plans that allowed partners to individually vary their plan contributions, but plans had to be amended by the end of the 1992 plan year to become either a qualified CODA or a plan without variable contributions.

  3. For plan years beginning after 1997, matching contributions of self-employed individuals, including partners, are no longer treated as EDs (Taxpayer Relief Act of 1997, Pub. L. 105-34, section 1501, added IRC 402(g)(9) (now IRC 402(g)(8)).

  4. Self-employed participant compensation is deemed currently available for a cash or deferred election for:

    1. A partner - on the last day of the partnership taxable year. So, a partner can make a cash or deferred election for a year’s compensation any time before (but not after) the last day of the year, even though the partner takes drawsagainst his/her expected share of partnership income throughout the year. See 26 CFR 1.401(k)-1(a)(6) .

    2. A sole proprietor - on the last day of the individual’s taxable year.  (09-05-2017)
Qualified CODAs

  1. To be a qualified CODA under IRC 401(k), the arrangement must meet these requirements:

    1. The CODA must be part of an eligible plan maintained by an eligible employer.

    2. The employee’s election must be between cash (or some other taxable benefit) and deferral.

    3. EDs aren’t distributable before certain events.

    4. EDs are nonforfeitable at all times.

    5. The CODA satisfies the participation requirements of IRC 410(b)(1).

    6. The CODA satisfies either the ADP test in IRC 401(k)(3) or one of the design-based alternatives in IRC 401(k)(11), IRC 401 (k)(12), or IRC 401(k)(13).

    7. Benefits, other than matching contributions, must not be contingent on an employee’s choosing or not choosing to make a deferral.

    8. The plan can’t require more than one year of service before an employee is eligible to make a cash or deferred election.

  2. A governmental plan (under IRC 414(d)) meets requirements (e) and (f), above.  (09-05-2017)
Nonqualified CODAs

  1. A nonqualified CODA is one that fails to meet one or more of the requirements listed in IRM, Qualified CODAs. An employee includes his/her elective deferrals in a nonqualified CODA in gross income at the time they would’ve been included if not for the cash or deferred election.

  2. If the CODA is nonqualified because it is part of an ineligible plan, then the entire plan is not qualified.

  3. But, if the nonqualified CODA is part of a plan permitted to include a CODA (such as, a profit-sharing plan), then the entire plan may still satisfy IRC 401(a). However, a nonqualified CODA invariably violates the terms of the plan document and causes the entire plan to be nonqualified. Treat and test the elective deferrals in a nonqualified CODA as employer nonelective contributions. And, to determine if the plan satisfies the nondiscrimination requirements of IRC 401(a)(4), the plan can’t use the ADP and ACP tests.

  4. Nonelective employer contributions under a nonqualified CODA satisfy IRC 401(a)(4) if the arrangement is part of a collectively bargained plan that automatically satisfies the requirements of IRC 410(b). Also, IRC 401(a)(4) and IRC 410(b) don’t apply to a IRC 414(d) governmental plan.  (09-05-2017)
Examination Steps

  1. Review corporate and other documents to verify that the plan sponsor adopted the CODA and made it effective before any deferral elections took effect.

  2. Verify that the plan allows participants the right to elect to have contributions made to the plan in lieu of cash or some other taxable benefit. Also determine whether there is a pattern of allowing employees (including partners in a partnership plan) to regularly elect in and out of the plan in return for changes in compensation. This is a cash or deferred election unless it fits the one-time irrevocable election exception in IRM

  3. Review Forms W-2 and payroll records to verify that contributions are not designated or treated as after-tax employee contributions.

  4. If a CODA exists, determine whether the plan is eligible to have one (for example, a profit-sharing plan). If the employer isn’t eligible (see IRM (1)), the entire plan is not qualified.

  5. If the plan is eligible to have a CODA, determine if the CODA is qualified or not qualified. If not qualified, verify:

    1. The EDs were reported in participants’ wages in the year they were withheld from compensation. Research IDRS if necessary. See IRM (1).

    2. The plan satisfied the coverage and nondiscrimination rules of IRC 410(b) and IRC 401(a)(4), counting the EDs as employer nonelective contributions. See IRM (3) for further explanation.  (09-05-2017)
Coverage and Participation

  1. The CODA portion of the plan, by itself, must satisfy one of the IRC 410(b) coverage tests:

    • The ratio percentage test

    • The average benefits test

  2. Plans containing CODAs may be permissively aggregated for coverage and can satisfy the ratio percentage test if they have the same plan year and use the same testing method (prior year or current year). CODA plans can’t be aggregated with a non-CODA plan.

  3. Eligible employees are

    • Employees who are eligible to make an ED.

    • Employees who are temporarily prohibited under the plan from making deferrals, such as a suspension following a hardship distribution. See IRM, ADP Test.


      Eligible employees are considered to "benefit" in the plan (in other words, are covered) even if they choose not to make deferrals.

  4. Under 26 CFR 1.401(a)(4)–11(g)(3):

    1. Plan sponsors may retroactively amend their IRC 401(k) and 401(m) plans to meet coverage by extending eligibility to employees for the preceding plan year. They must amend within 10 1/2 months after the plan year.

    2. If a CODA needs to add NHCEs to satisfy IRC 410(b), the employer must make a QNEC contribution to them equal to the NHCE ADR average.


      Plans can’t use the above retroactive correction feature for other defects, such as a failed ADP test.

  5. A CODA can’t have more than one year as its minimum service requirement for participation (IRC 401(k)(2)(D)). The IRC 410(b)(1)(B) eligibility rules (up to two years if immediate vesting) apply for other contributions, such as matching contributions or QNECs.

  6. For the ADP test:

    • Employees covered by a collective bargaining agreement must be disaggregated from employees not covered by a collective bargaining agreement.

    • Separate collective bargaining units within the same plan may be disaggregated, but are not required to be.

    • Combining bargaining units for testing must be reasonable and reasonably consistent from year to year.

    • Equivalent rules apply to multiemployer plans.

  7. CODAs aren’t subject to the rules requiring mandatory disaggregation of ESOP and non-ESOP portions of a plan (26 CFR 1.410(b)-7(c)). So, despite the rule prohibiting permissive aggregation of plans or portions of plans that are mandatorily disaggregated (26 CFR 1.410(b)-7(d)(2 )), an employer may aggregate plans containing ESOP features with those that do not for purposes of CODA testing, even if the ESOP and non-ESOP are in different plans of the employer.  (09-05-2017)

  1. An employer has Division A and B as its workforce. The plan document states that only employees of Division A are eligible to participate in the 401(k) plan. Division A employs 80 employees: five highly compensated employees (HCEs) and 75 NHCEs. All Division A employees satisfy the 401(k) plan’s participation requirements. Division B employs 25 employees and all are NHCEs. The plan benefits at least 70 percent of total NHCEs (75/100 divided by 5/5=75 percent); so, the plan passes coverage without having to use the average benefits test.

  2. Employer C’s plan allows elective deferrals, matching contributions and employer discretionary profit-sharing contributions. Under the plan terms, all employees are eligible to make elective deferrals and to receive matching and discretionary profit sharing contributions. Employer C makes a matching contribution for all employees making elective deferrals. Employer C also made a discretionary profit-sharing contribution of five percent of each employee’s compensation. Under the disaggregation rules, each portion of the plan must be separately tested for and meet coverage.

    Part of plan that must satisfy coverage Conclusion
    401(k) portion Satisfies coverage as 100 percent of non-excludable employees benefit
    401(m) portion Satisfies coverage as 100 percent of non-excludable employees benefit
    Profit sharing portion Satisfies coverage as 100 percent of non-excludable employees benefit  (09-05-2017)
Examination Steps

  1. Inspect the plan document and review all eligibility sections (define eligible employees, age and service requirements and entry dates). A plan can have separate eligibility requirements for EDs, matching contributions and nonelective contributions.


    A plan can’t require an employee to complete more than one year of service to be eligible to make EDs.

  2. Eligibility, participation and coverage - review these records to determine who should or shouldn’t be included in the plan. Review any related entities’ records if the entity is a member of a controlled group or part of an affiliated service group.

    1. Inspect the Form 5500 lines that list the total number of employees, excluded employees and employees benefiting. Compare these numbers with the payroll records to determine if the plan/return considers all employees.

    2. Inspect employer payroll records for the total employees, birth dates, hire dates, hours worked, collective bargaining status and other pertinent information.

    3. Inspect Form(s) W-2 and State Unemployment Tax Returns (compare the employees on these records with the employer’s payroll records) to ensure all employees of the employer are considered for the coverage test.

    4. Inspect participant election forms to verify the names of eligible employees who elected not to participate in the plan (have EDs made to the plan). Include these employees: as eligible employees with a zero percentage in the ADP calculations (and in the ACP calculations but not if they make after- tax employee contributions) and as eligible employees for receiving an allocation of other, non-ED, employer contributions if they are eligible.

    5. Inspect payroll records and extract the names of those employees who terminated employment during the year. Many plans require an employee to be employed on the last day of the plan year to receive an allocation of an employer nonelective contribution. Many small plans have a last-day requirement and could fail coverage if this condition prevents a necessary allocation. Include any terminated employee with more than 500 hours of service in the coverage test.

    6. Inspect Form 1125-E, Compensation of Officers, to gather names of officers and ownership percentages to help identify related entities.

    7. Inspect any Form 851, Affiliations Schedule, attached to the corporate tax return to determine if there are any related entities.

    8. Inspect a self-employed individual’s Form 1040 income tax return to determine whether he/she owns and operates any other entities. The self- employed individual should file separate Schedules Cs, Profit or Loss from Business, for each business.

    9. Inspect the plan document to determine whether the plan covers leased employees. Obtain contracts the employer has with any leasing organization and information/records for the leased employee’s benefits in the leasing organization’s retirement plans. If the employer has leased employees, the plan may state that these employees are excluded, however, the employer will generally have to include leased employees in the test when the leased employee is performing services on a substantially full-time basis and when the total number of leased employees is more than 20 percent of the employer’s NHCE workforce. If this is the case, consider the leased employees for the code sections noted under IRC 414(n) . If leased employees are eligible to participate per plan terms, ensure the plan includes them. Determine if the plan passes coverage when it’s required to include them in the coverage test. An employer may include the leased employee’s benefits from the leasing organization as though the employer provided them when testing for coverage.

  3. Ensure the plan passes one of the IRC 410(b) tests:

    1. The ratio percentage test

    2. The average benefits test

  4. Include all employees of the employer, including controlled group or affiliated service group member employees in the coverage test. See IRC 414(b), IRC 414(c) and the Treasury regulations for controlled group rules. See IRC 414(m) for affiliated service group rules. The three common forms of controlled groups are:

    • Parent-subsidiary

    • Brother-sister

    • Combined groups  (09-05-2017)
Contribution Limitation

  1. IRC 402(g)(1)(A) and (B) sets the maximum elective deferrals (other than catch-up contributions) an employee can make for a tax year. The amount may be increased, in $500 increments, in future years for cost-of-living increases. See annual dollar limits.

  2. Deferrals in excess of the 402(g) limit are called excess deferrals.

    1. Employees include elective deferrals they make in excess of the annual limit in their gross income for the year and again, when they receive their account as a plan distribution. See IRC 402(g) .

    2. To avoid double income inclusion of excess deferrals, an employee may inform an employer of the amount of excess deferrals in their plan and request them to distribute it with attributable earnings through the end of the year. See 26 CFR 1.402(g)-1.

    3. If the plan returns excess deferrals by April 15 after the year of the excess, they won’t be included in the participant’s gross income when distributed. The employer is not required to honor a request, although most plans do.

    4. Conversely, the employee can’t refuse a distribution if the excess deferrals arose under plans of one employer. (See IRM (5) and IRM (6) below.) However, If a plan has undistributed excess deferrals that aren’t disqualifying (i.e., they are made to plans of unrelated employers) they must remain in the plan until there is a permitted distributable event.

  3. IRC 402(g) is applied to each employee, rather than to a plan, and for the employee’s taxable year, which is nearly always the calendar year. So, it’s possible that an employee can have deferrals to a plan equal to two times the 402(g) limit if the plan year is not the calendar year, although most are.

  4. The maximum elective deferral amount is increased by the permitted amount of catch-up contributions. See IRC 402(g)(1)(C) and IRC 414(v) . Participants age 50 or older can make catch-up contributions. See IRM, Catch-Up Contributions.

  5. A plan can’t accept elective deferrals from an employee in excess of the 402(g) limit, counting only plans of that employer. So, if an employee defers more than the 402(g) limit, in the aggregate, in one or more plans maintained by the employer group, all of these plans could be disqualified (IRC 401(a)(30)).


    An employee works for Company Y from January to June, then transfers to related Company Z for the next six months. His deferrals into Company Y’s plan and into Company Z’s plan for the calendar year are aggregated to determine if the 402(g) limit has been exceeded. Both plans will fail qualification requirements if they accept excess deferrals and don’t correct the problem.

  6. A plan must distribute excess deferrals and their earnings (calculated through the end of the year) by April 15 following the year of the excess to avoid failing IRC 401(a)(30). If a participant has excess deferrals, she is deemed to request a distribution and the plan isn’t required to secure employee or spousal consent.

  7. Unless they can be recharacterized as catch-up contributions, HCE elective deferrals in excess of the 402(g) limit are still counted for ADP testing purposes, even if they are timely distributed. Conversely, timely distributed NHCE excess deferrals over the 402(g) limit are not counted. See 26 CFR 1.402(g)-1(e)(1)(ii).

  8. If an excess deferral is distributed before April 15, the distributing plan counts that distribution as an offset against any distribution of excess contributions it must make to that employee to correct the ADP test.

  9. The IRC 402(g) limit:

    1. Applies only to elective deferrals.

    2. Doesn’t affect other contributions included in the ADP test.

    3. Must be stated in plan but may be incorporated by reference.  (09-05-2017)

  1. Employer A maintains a 401(k) plan that allows participants to elect to defer up to a maximum of 15 percent of their compensation for the year. The plan year is the calendar year. For calendar year 2017, Participant B elects to defer 15 percent of his compensation. Participant B, a HCE, age 40, receives $140,000 of compensation during the year. The total elective deferrals made on behalf of Participant B for calendar year 2017 was $21,000. The IRC 402(g) limit for a person under age 50 for 2017 is $18,000. So, Participant B had an excess deferral of $3,000. The employer must distribute the excess, plus attributable earnings through the end of 2017, by April 15, 2018, for the plan to remain qualified.


    If Participant B was age 50 or older in 2017 and the plan permitted catch-up contributions, he wouldn’t have excess deferrals because the total elective deferral limit for 2017, including catch-ups, is $24,000 ($18,000 + $6,000).  (09-05-2017)
Examination Steps

  1. Inspect the plan document to determine the maximum elective deferrals an employee can defer.

  2. Inspect records to ensure each participant complies with the IRC 402(g) limit in effect for the year.

    1. Inspect the Form W-2, Wage and Tax Statement for all employees.

    2. Compare Form W-2 (Box #12 - code "D" for elective deferrals or "AA" for designated Roth contributions) with payroll records and account statements to reconcile the reported amounts and ensure they are accurate.

    3. Inspect all Forms W-2 of a controlled group to ensure participants haven’t exceeded the limit if they participate in more than one of the controlled group’s 401(k) plans during the year. IRC 402(g) follows the individual and all his/her deferrals must be aggregated to ensure compliance with IRC 402(g) and IRC 401(a)(30).


      It’s common for an employee in a mid-size or a large company to split time between different companies in a controlled group of corporations having separate 401(k) plans. The individual can’t defer more than the IRC 402(g) limit to the employer’s plans. The employee’s deferrals must be aggregated to determine whether he/she exceeded the limit. Ask your contact person if employees work for more than one company in the controlled group.

    4. Ask a Computer Audit Specialist (CAS) for help to download the data to an Excel spreadsheet or Access Database if a large employer gives you payroll data on electronic media. The CAS can also help you test or query data for different limits such as IRC 402(g).

    5. Ensure that the plan sponsor properly and timely corrected any excesses by April 15th of the following year if you find excesses when you test the plan for IRC 402(g) and IRC 401(a)(30). Inspect Forms 1099-R for distributions and cancelled checks to determine when the distribution was actually made.  (09-05-2017)
Restricted Distributions

  1. Contributions that a plan may distribute:

    1. Elective contributions on death, disability, severance from employment, an event described in IRC 401(k)(10) (plan termination) or as a qualified reservist distribution described in IRC 72(t)(2)(G) (IRC 401(k)(2)(B)).


      The one event described in IRC 401(k)(10) is termination of the plan without the establishing or maintaining another defined contribution plan other than an ESOP.

    2. Contributions made to a CODA that is part of a profit-sharing, stock bonus or rural cooperative plan, when the participant is age 59 1/2 or older.

    3. Elective contributions (and grandfathered earnings, QNECs, QMACs and earnings on these QNECs and QMACs) to a profit-sharing, stock bonus or rural cooperative plan may be distributed on account of hardship.


      Because the "grandfathered" amounts referred to in the preceding sentence were accrued, in most cases, before 1988 or 1989, most plans will only have elective deferrals available for hardship distribution.

  2. Contributions that a plan can’t distribute in a hardship distribution:

    1. QNECs and QMACs, unless grandfathered.

    2. Safe harbor contributions in 401(k)(12) and 401(k)(13) plans.

  3. An employee has a severance from employment when the employee ceases to be an employee of the employer maintaining the plan. An employee doesn’t have a severance from employment if the new employer either:

    • Continues the prior employer’s plan.

    • Accepts a transfer of plan assets or liabilities (within the meaning of IRC 414(l)) for that employee.

  4. Plans may also make distributions, when legislation is enacted to respond to natural disasters, in the amounts and during the periods specified in the legislation.  (09-05-2017)
Plan Termination

  1. Under IRC 401(k)(10)(A), a 401(k) plan can make a distribution to employees if:

    1. The plan is being terminated.

    2. The employer doesn’t maintain another defined contribution plan (other than an ESOP) from the date of termination to 12 months after all assets have been distributed from the terminating plan.

    3. It distributes in a lump sum.

  2. A plan can make a termination distribution even if the employer maintains or establishes any of these plans:

    • SEP


    • 403 (b)

    • 457 (b) or (f)

  3. Generally, if any employer who is in the employer group at the effective date of the termination has a defined contribution plan (other than one listed above), the 401(k) plan assets must be transferred to that plan rather than distributed to the employees.


    See 26 CFR 1.401(k)-1(d)(4) for special rules on how to determine whether the employer (or employer group) maintains another defined contribution plan.

  4. The terminating plan, can however, distribute to participants if less than 2 percent of its employees have been or will become eligible for the other plan in the 24-month period that begins 12 months before the date of termination.

  5. A plan subject to the joint and survivor annuity rules can satisfy the lump-sum distribution requirement by distributing an immediate annuity that satisfies the qualified joint and survivor annuity requirements in IRC 401(a)(11) and IRC 417.  (09-05-2017)
Hardship Distribution

  1. The following plans may distribute elective deferrals on account of hardship:

    1. Profit-sharing

    2. Stock bonus

    3. Rural cooperative plan

  2. A hardship distribution must be limited to the maximum distributable amount. The maximum distributable amount is the employee’s total elective deferrals as of the distribution date less previous distributions of elective deferrals. So, unless grandfathered, the maximum distributable amount doesn’t include:

    1. Earnings

    2. QNECs

    3. QMACs


      The regulations permit a plan to provide a grandfather rule to include earnings, QNECs and QMACs accrued no later than December 31, 1988 (or, if later, the end of the last plan year ending before July 1, 1989) in a hardship distribution. Determine an employee’s elective deferrals, QNECs and QMACs on the applicable date and use it as a frozen amount. Don’t reduce this amount by losses after that date.

  3. Other employer contributions, outside the CODA, are not subject to these restrictions. Therefore, a profit-sharing plan could have one set of rules for hardship distributions from the CODA and another, less restrictive, set of rules for other non-CODA contributions. Although most do, a CODA is not required to allow hardship distributions.

  4. Under 26 CFR 1.401(k)-1(d)(3), hardship distributions must meet two requirements:

    1. They must be made on account of an employee’s immediate and heavy financial need.

    2. The hardship amount must be necessary to satisfy the financial need.

  5. Plan sponsors can use either general hardship distribution standards or deemed hardship distribution standards, in the IRC 401(k) Treasury regulations to determine if the hardship distribution meets the requirements in IRM (4). They must follow nondiscriminatory and objective standards in the plan to determine if the participant meets the hardship requirements. Most 401(k) plans, including all 401(k) pre-approved plans (i.e., Volume Submitter or Master and Prototype), use the deemed standards.

  6. An employee’s hardship amount can be increased for any taxes or penalties that may result from the distribution.

  7. A 401(k) plan may not have a "catch-all" hardship category (26 CFR 1.411(d)-4 ).


    The plan can’t use words such as "and other events which the plan administrator deems to be hardships." This would be impermissible employer discretion.

  8. The plan sponsor may amend a plan to add or eliminate a hardship category or change the conditions for receiving a hardship distribution and this will not violate IRC 411(d)(6). Hardship categories (general or deemed) must be both currently and effectively available to a group of participants that satisfies 26 CFR 1.401(a)(4)-4 .  (09-05-2017)
General Hardship Distribution Standards

  1. Under the general hardship distribution standards, a plan/plan sponsor must determine:

    1. Whether an employee has an immediate and heavy financial need based on all the relevant facts and circumstances.


      Funeral expenses of a family member would qualify, but the need for a television would not generally qualify.

    2. What other assets the employee has, such as vacation homes, insurance policies, availability of plan or bank loans (at reasonable rates), etc. because a distribution is not considered necessary to satisfy an immediate and heavy financial need of the employee if the participant can obtain other reasonably available resources.


      The plan sponsor is permitted to rely on an employee’s written statement that a hardship can’t be satisfied by the employee’s other reasonably available means.


      The plan sponsor can’t rely on the employee’s written statement if they have actual knowledge that the need can be reasonably relieved through reimbursement from insurance, by liquidation of the employee’s assets, by cessation of elective deferrals, or by other distributions or nontaxable loans under plans of the employer or other employers of the employee.


      A participant need not consider commercial loans unless he can reasonably obtain the full amount from the lender. A participant must obtain a plan loan (if available) to offset his/her need for a hardship distribution unless taking a loan would disqualify the employee from obtaining other funds necessary to alleviate the hardship.  (09-05-2017)
Deemed Hardship Distribution Standards

  1. Under the deemed hardship distribution standards, a distribution is considered made on account of "an immediate and heavy financial need" if it’s made for any of the following reasons:

    1. Medical care expenses deductible under IRC 213(d) (determined without considering whether the expenses exceed 10 percent of adjusted gross income) for the employee or the employee’s spouse, children or dependent (as defined in IRC 152) or primary beneficiary under the plan.

    2. Costs directly related to the purchase of an employee’s principal residence. (This does not include making mortgage payments.)

    3. Payments of tuition, related educational fees, and room and board expenses, for up to the next 12 months of post-secondary education for the employee, or the employee’s spouse, children, or dependents (as defined in IRC 152).

    4. Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure of the mortgage on that residence.

    5. Payment for burial or funeral expenses for the employee’s deceased parents, spouse, children or dependents (as defined in IRC 152), or primary beneficiary under the plan.

    6. Repair expenses for damage to the employee’s principal residence that qualify for the casualty deduction under IRC 165 (don’t consider whether the loss exceeds 10 percent of adjusted gross income).

  2. Under the deemed hardship distribution standards, a distribution is deemed "necessary to satisfy an immediate and heavy financial need" if it meets all of the following:

    1. The distribution amount doesn’t exceed the amount needed.

    2. No alternative means available, such as the employee has obtained all distributions and nontaxable loans currently available in all of his employer’s plans.

    3. The plan prohibits the employee from making elective deferrals and employee contributions to any of the employer’s plans for at least six months after receiving the distribution.  (09-05-2017)

  1. Employer A maintains a 401(k) plan that permits hardship distributions under the deemed standards. The plan permits participant loans. In 2017, Participant B submits an application requesting a $20,000 hardship distribution to make a down payment on a principal residence. At the time of the hardship distribution request, Participant B had an account balance of $50,000. The total amount of elective contributions Participant B made is $30,000, and no outstanding plan loans. The plan administrator approved the hardship distribution request and distributed $20,000.


    The plan administrator should not have approved this hardship distribution because participant B may be relieved from other resources that are reasonably available ( IRM (2)(b)), such as a nontaxable loan from the plan. The plan should make nontaxable loans to the participant before making any hardship distributions.  (09-05-2017)
Examination Steps for General Hardship

  1. Inspect the plan language to determine if the plan permits hardship (and distributions in general) and, if so, under what circumstances (general or deemed standards).

  2. Review the plan document sections for allowable distributions. If the plan has QNECs and QMACs, then it must apply the same restrictions to them as elective deferrals. See IRM (2). Unlike elective deferrals, plans can’t distribute QNECs and QMACs on account of hardship, unless grandfathered.

  3. Compare the amount distributed as a hardship to the participant’s total elective deferrals to ensure the distribution doesn’t exceed total elective deferrals.


    See participant account statements for a breakdown of the types of contributions.

  4. Inspect copies of hardship application documents to determine if the reason the distribution was made meets the hardship distribution standards.

  5. Inspect the plan document to determine whether loans are available. If so, the plan should make nontaxable loans to the participant before making any hardship distributions, unless that would have the effect of increasing the amount of the need.

  6. Interview the plan administrator to determine the facts and circumstances for questionable distributions.

  7. Request copies of Forms 1099-R for all distributions including hardship distributions.  (09-05-2017)
Examination Steps For Deemed Hardship

  1. If the plan uses the deemed hardship distribution standards, follow these steps to determine whether distributions are made on account of a deemed immediate and heavy financial need.

  2. Step 1:

    1. Determine whether the employer or third-party administrator, before making a distribution, obtains either:

      1. source documents (such as estimates, contracts, bills and statements from third parties)

      2. a summary (in paper, electronic format, or telephone records) of the information contained in source documents.

    2. If the employer/third party uses a summary of information on source documents, determine whether they provides the employee notifications required on Attachment One, in Exhibit 4.72.2-2, before making a hardship distribution.

  3. Step 2:

    1. If the employer/ third-party obtains source documents under Step 1(1)(a), review the documents to determine if they substantiate the hardship distribution.

    2. If the employer/ third-party administrator obtains a summary of information on source documents under Step 1(1)(b), review the summary to determine whether it contains the relevant items listed in Exhibit 4.72.2-2

    3. If the notification provided to employees in Step 1(2) or the information reviewed in Step 2(2) is incomplete or inconsistent on its face, you may ask for source documents from the employer/ third-party administrator to substantiate that a hardship distribution is deemed to be on account of an immediate and heavy financial need.

    4. If the summary of information reviewed in Step 2(2) is complete and consistent but you find employees who have received more than 2 hardship distributions in a plan year, then, in the absence of an adequate explanation for the multiple distributions and with managerial approval, you may ask for source documents from the employer or third-party administrator to substantiate the distributions.


      Examples of an adequate explanation include follow-up medical or funeral expenses or tuition on a quarterly school calendar.

    5. If a third-party administrator obtains a summary of information contained in source documents under Step 1(1)(b), determine whether the third-party administrator provides a report or other access to data to the employer, at least annually, describing the hardship distributions made during the plan year.

  4. If you determine that all applicable requirements in Step 1 and Step 2 are satisfied, treat the plan as satisfying the substantiation requirement for making hardship distributions deemed to be on account of an immediate and heavy financial need. You may also inspect the employee’s individual account statement for the six months following the hardship distribution to make sure the employee didn’t make elective deferrals (and after-tax employee contributions).  (09-05-2017)

  1. All employee elective deferrals, QNECs, and QMACs are 100 percent vested at all times, So, an employer can’t:

    1. Redesignate a contribution as a nonforfeitable contribution and call it a QNEC to satisfy the ADP test for a year.

    2. Use forfeitures as QNECs or QMACs, because they aren’t nonforfeitable when made to the plan


      On January 18, 2017, IRS and Treasury issued proposed regulations that changed the definitions of QMACs and QNECs (26 CFR 1.401(k)-(6) and 26 CFR 1.401(m)-(5)). Under the current regulations, employer contributions that qualify as QMACs and QNECs must be nonforfeitable when contributed to the plan. Under the proposed regulations, employer contributions to a plan will qualify as QMACs and QNECs if they satisfy applicable nonforfeitability and distribution requirements when they are allocated to participants’ accounts, but need not be when contributed to the plan. The proposed regulations apply to taxable years beginning on or after they are finalized. Taxpayers may however, rely on the proposed regulations before the effective date, but not earlier than January 18, 2017.

  2. However, a plan may forfeit any of the following vested or non-vested matching contribution made on account of an elective or employee contribution (IRC 401(k)(8)(E) and IRC 411(a)(3)(G)):

    1. An excess deferral under IRC 402(g)(2)(A)

    2. An excess contribution (amounts in excess of what is permitted under the ADP test)

    3. An excess aggregate contribution (amounts in excess of what is permitted under the ACP test)

    4. A permissible withdrawal under IRC 414(w)

  3. Plans that keep matching contributions in HCEs’ accounts for their distributed excess contributions (or excess aggregate contributions) (sometimes called "orphan matches" ) will cause the HCEs to have a higher rate of match than NHCEs, resulting in discrimination (26 CFR 1.401(a)(4)-4) . If the plan isn’t required to distribute this matching contribution as an excess aggregate contribution under the ACP test, the plan should forfeit it because there is no mechanism for distributing amounts that fail the 26 CFR 1.401(a)(4)-4 availability test. Of course, the plan can only forfeit the matching contribution if the plan document allows the forfeiture. See 26 CFR 1.401(m)- 2(b)(3)(v)(B) .  (09-05-2017)
Examination Steps

  1. Verify that any amounts used to satisfy the ADP test (EDs, QNECs, and QMACs) are 100 percent vested at all times.

  2. Check that the plan forfeits or distributes matching contributions that relate to corrective distributions of elective or employee contributions to satisfy the ADP or ACP test.  (09-05-2017)
CODA Nondiscrimination

  1. A 401(k) plan must satisfy the ADP test annually. See IRC 401(k)(3). The test compares eligible HCEs elective deferrals to those made by eligible NHCEs. The ADP test is the exclusive nondiscrimination test for amounts contributed to a CODA. That is, this test is used instead of any amounts test of IRC 401(a)(4). Count QNECs and QMACs that the plan treats as elective deferrals in the ADP test.

  2. Annually computing the ADP test and correcting it when it fails can be costly for employers, so Congress enacted three alternatives to the ADP test:

    • SIMPLE 401(k) plans, modeled after SIMPLE IRA plans in IRC 408(p) (for plan years beginning in 1997 and later). See IRC 401(k)(11), IRC 401(m)(10) and IRM, SIMPLE 401(k) Plans.

    • Safe harbor 401(k) plans in IRC 401(k)(12) and IRC 401(m)(11) (for plan years beginning in 1999 and later). See IRM, Safe Harbor 401(k) Plans.

    • Qualified automatic contribution arrangement (QACA) in IRC 401(k)(13) and IRC 401(m)(12) (for plan years beginning in 2008 and later). See IRM, Automatic Contribution Arrangements (ACAs).

  3. Although a CODA must satisfy the ADP test (or be deemed to satisfy the ADP test because it’s part of a SIMPLE 401(k) plan, a safe harbor 401(k) plan or a QACA) for the amount of elective deferrals, the plan must satisfy the nondiscriminatory availability requirement of 26 CFR 1.401(a)(4)-4(e)(3) because the right to make each level of elective deferrals under a CODA is a benefit, right or feature.

  4. A governmental plan under IRC 414(d) is treated as meeting the ADP test (IRC 401(k)(3)(G)).  (09-05-2017)
ADP Test

  1. Under IRC 401(k)(3)(A)(ii) ADP test, the ADP of the eligible HCEs can’t exceed the greater of:

    1. 1.25 x the eligible NHCEs ADP.

    2. The lesser of: i) 2 + the eligible NHCEs ADP or ii) 2 x the eligible NHCEs ADP.


      If the only eligible employees under the CODA are HCEs, the plan automatically passes the ADP test.

  2. The ADP for a group (either HCE or NHCE) is the average of the individual ADRs of that group. An eligible employee’s ADR is:

    1. His/her allocated elective deferrals and QNECs and QMACs treated as elective deferrals

    2. Divided by his/her compensation


      ADRs and ADPs, expressed as a percentage, must be rounded to the nearest one-hundredth of a percent.

  3. Include only "eligible employees" in the ADP test. ("Eligible employees" are also counted as "benefiting" for the IRC 410(b) coverage requirements.) An "eligible employee" is one who is eligible under the plan to make an elective contribution, whether or not they make them. If an eligible employee chooses not to make elective deferrals, and doesn’t receive QNECs or QMACs the employee must be included in the ADP test with an ADR of zero. The term also includes an employee who:

    1. Must perform purely ministerial or mechanical acts in order to make an elective contribution.

    2. Chooses not to make a mandatory after-tax employee contribution in a plan requiring after-tax contributions as a prerequisite to CODA.

    3. Has been suspended from making elective deferrals under the plan (for example, for having taken a hardship distribution).

    4. May not receive additional contributions because of IRC 415(c) limits.

  4. Employees who can’t make elective deferrals because they were given a one- time election when they commenced employment or upon first becoming eligible under any of the employer’s CODAs and elected not to be eligible to make elective deferrals for the duration of employment with the employer is not an eligible employee.

  5. First identify the plan because the ADP test is performed on the plan level. See IRM, Coverage and Participation. If a plan contains more than one CODA, the CODAs must be aggregated for the ADP test.

  6. If a plan is disaggregated into separate plans for IRC 410(b), the CODA must also be disaggregated.


    If a plan covers all employees, but, for testing purposes the plan is disaggregated into two plans, one covering employees who have less than one year of service or are less than age 21, and one covering all other employees, the employer would run two ADP tests. One test for the employees with less than one year of service or less than age 21, and the other test for all other employees.

  7. An employer may exclude all eligible employees (other than HCEs) who have not met the minimum age and service requirements of IRC 410(a)(1)(A) from the ADP test (IRC 401(k)(3)(F)).

  8. If an HCE is eligible to participate in more than one of an employer’s CODAs, his/her elective deferrals under all the employer’s CODAs are combined to determine the HCE’s ADR. Then, use this ADR in the ADP test under each CODA.

  9. Participant compensation used to calculate ADRs:

    • Is limited to the IRC 401(a)(17) amount.

    • Must satisfy IRC 414(s).

    • May include or exclude elective deferrals.

  10. Elective deferrals for HCEs that exceed the ADP test limits are "excess contributions." A plan must dispose of excess contributions by one or more of the following:

    1. Distribute them to certain HCEs

    2. Recharacterize them as employee after-tax contributions

    3. Recharacterize them as catch-up contributions, if applicable

  11. Plans can contribute QNECs and QMACs to NHCEs to raise the NHCE ADP. By contributing to NHCEs, the plan can reduce or eliminate excess contributions.

  12. A plan can choose, by specifying in the plan document, whether it will perform the ADP test by comparing the HCE ADP for a plan year with the NHCE ADP:

    • For the same plan year (current year testing).

    • For the prior plan year (prior year testing).  (09-05-2017)
Current Year Testing

  1. For the current year testing method, use the same plan year as the one for which the ADP test is being performed to determine the eligible NHCEs ADP. But, the employer may not know for certain how much HCEs can defer for a particular plan year until the plan year is over, and by then, it may be too late to have prevented the plan from having excess contributions. In calendar-year 401(k) plans, the ADP test is usually performed around the end of January when the plan administrator receives all the necessary demographic and financial information.

  2. Plans take employees’ elective deferrals into account for the ADP test for a plan year only if

    1. They are allocated to the employee’s account as of a date that plan year and paid to the trust no later than 12 months after the end of the plan year to which the contributions relate.


      Department of Labor regulations require elective deferrals to be paid into the trust by the earliest date such contributions can reasonably be segregated from the employer’s general assets, with a safe harbor for small plans. See DOL Reg. section 2510.3-102.

    2. The contributions must relate to compensation that, if the employee hadn’t elected to defer it, would’ve been received either in the plan year or, if the plan so provides and the compensation is for services performed in the plan year, within 2 1/2 months after the plan year.

  3. Plans don’t take employee elective deferrals into account for the ADP test for a plan year if they:

    1. Don’t satisfy the requirements above in IRM (2).

    2. Are excess deferrals of NHCEs that are prohibited by IRC 401(a)(30) (i.e., an NHCE is deferring more than the IRC 402(g) limit under one employer’s plan or plans).

    3. Are treated as catch-up contributions under IRC 414(v).

    4. Are used in the ACP test (although, before they can be used in an ACP test, they must satisfy the ADP test).

    5. Are made per IRC 414(u) because of an eligible employee’s qualified military service.

  4. Employers may take into account QNECs and QMACs to calculate the ADP (IRC 401(k)(3)(D)) if the contributions satisfy the:

    1. Nonforfeitability requirement

    2. Distribution limitations

    3. 12-month contribution-to-the-trust rule that applies to elective deferrals in IRM (2)(a).


      QNECs must satisfy IRC 401(a)(4) both before and after the plan uses them in the ADP test.

  5. The plan can’t use QNECs and QMACs in the ADP test for a plan year:

    • If they’re used in the ACP test

    • For a NHCE in amounts exceeding that NHCE’s compensation x the greater of: i) five percent or 2 x the plan’s representative contribution rate.


      This is to prevent the abuses arising from "targeted QNECs and QMACs" (also called "bottom-up leveling" ) when the plan sponsor targets certain NHCEs with the lowest compensation and contributes corrective QNECs to them, and limits the total corrective contributions necessary to correct the ADP failure. This method causes the lowest paid employees to have the highest ADRs (up to 100 percent), and when averaged with the ADRs of the remaining NHCEs, permits the plan to pass the ADP test.  (09-05-2017)
Prior Year Testing

  1. Generally, the rules to calculate ADRs and ADPs in current year testing also apply to prior year testing. Prior year testing simplifies plan administration because an employer can determine the NHCEs’ ADP early in the plan year, allowing time to avoid a failed ADP test.”


    Employer X’s plan calendar-year 401(k) plan states distributing excess contributions is the only method the plan uses to correct ADP test failures. In January 2017, Employer X determines that the plan fails the ADP test for 2016 and that the plan must make corrective distributions of excess contributions to appropriate HCEs by March 15, 2017 to avoid all penalties.


    Same facts as above, except that the testing year is 2017 and the plan is using the prior year testing method. Employer X can determine the NHCEs ADP for 2016 early in 2017 because it has the necessary data on prior year NHCE status, contributions and compensation by January 2017. This simplifies plan administration for Employer X.

  2. Consider the eligible employees who were NHCEs during the preceding year, without considering their status in the testing year, to determine the prior year’s NHCEs ADP.


    Employee A was employed by Employer X and was an NHCE in Year One. Employee A no longer works for Employer X in Year Two. To determine the prior year’s ADP for Employer X’s 401(k) plan for the Year Two testing year, Employee A is taken into account. Employee A would also be taken into account if still employed by Employer X but became an HCE in Year Two.

  3. Plan language must specify whether the plan is using current year or prior year testing. The first plan year rule requires plans that incorporates these provisions by reference to specify whether the ADP/ACP for NHCEs is three percent or the first year’s ADP/ACP. See 26 CFR 1.401(k)-1(e)(7) .  (09-05-2017)
Use of QNECs and QMACs in Prior Year Testing

  1. Plans that take into account QNEC or QMACs for the NHCE ADP for the prior year must:

    • Allocate them as of a date within that prior year.

    • Pay them to the trust by 12-months after the end of that prior year. In other words, the plan sponsor must actually pay them to the trust by the end of the testing year.


      Therefore, if a plan is using prior year testing and QNECs/QMACs for ADP correction, it will probably miss the deadline to make QNECs or QMACs. So, an employer must use other methods to correct a failed ADP test. However, if the employer pays the QNECs and QMACs by the 12 months, it can use them to satisfy a failed ADP test.


      A plan uses the prior year testing method for the 2017 testing year. In February 2018, it discovered the plan failed the ADP test. The applicable year for the NHCE ADP is 2016. As a result, the deadline to allocate QMACs to NHCEs’ accounts is the last day of 2017. The deadline for allocating QNECs has passed because the plan didn’t complete the ADP test until February 2018. If the employer contributed QMACs by the last day of 2017, they could have been allocated to NHCEs’ accounts and considered when calculating the NHCE ADP.


      This 12-month rule does not change the rule under IRC 415: employer contributions are not treated as credited to a participant’s account for a particular limitation year unless actually made by 30 days after the end of the IRC 404(a)(6) period for the tax year with or within which the particular limitation year ends. See 26 CFR 1.415(c)-1(b)(6)(i)(B) .

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