4.72.7 Examination Guidelines for IRC 415(c)

Manual Transmittal

December 06, 2018

Purpose

(1) This transmits revised IRM 4.72.7, Employee Plans Technical Guidelines, Examination Guidelines for IRC 415(c).

Background

This IRM provides guidance for examining defined contribution plans subject to the limitations of IRC 415(c).

Material Changes

(1) IRM 4.72.7.5.1, added the 2018 and 2019 dollar limits for defined contribution plans.

(2) Updated 4.72.7.1 to reflect the Program, Scope and Objectives. Added new sections 4.72.2.1.1, Background; 4.72.7.1.2, Authority; 4.72.7.1.3, Responsibilities; and 4.72.7.1.4, Acronyms.

(3) Made editorial updates throughout.

Effect on Other Documents

This supersedes IRM 4.72.7 dated May 22, 2017.

Audience

Tax Exempt and Government Entities
Employee Plans

Effective Date

(12-06-2018)

Catherine L. Jones
Acting Director, Employee Plans
Tax Exempt and Governmental Entities

Program Scope and Objectives

  1. Purpose: This IRM helps Employee Plans (EP) specialists examining defined contribution (DC) plans subject to the IRC 415(c) limits.

  2. Audience: EP examiners and other specialists

  3. Policy Owner: Director, EP

  4. Program Owner: EP

  5. Program Goal: To ensure continued compliance and qualification of DC plans subject to the IRC 415(c) limits.

Background

  1. The Employee Retirement Income Security Act of 1974, Pub. Law 93-406 (ERISA) added IRC 415 to the Code. A trust is not a qualified trust under IRC 501(a) if the plan of which such trust is a part provides for benefits or contributions that exceed the IRC 415 limits (IRC 401(a)(16)).

    1. IRC 415(c) limits the amount of employer and employee contributions that may be allocated to an individual’s account under a DC plan, while IRC 415(b) limits the annual benefit that can be accrued or paid to a participant under a defined benefit (DB) plan.

    2. For limitation years beginning before 2000, when an individual participated in an employer’s DC and DB plan, the amounts under both plans were subject to the combined plan limit of IRC 415(e). SBJPA repealed IRC 415(e) effective for limitation years beginning after1999.

  2. IRC 415 is generally effective for years beginning after 1975.

    1. Treasury regulations under IRC 415 (T.D. 9319) are generally effective for limitation years beginning on or after July 1, 2007. See 26 CFR 1.415(a)-1(g).

    2. WRERA amendments are generally effective for limitation years beginning after December 31, 2008.

  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 subject to the limits, as amended by:

    1. Title VII of the Uruguay Round Agreements Act, Pub. Law 103-465 (GATT).

    2. The Small Business Job Protection Act of 1996, Pub. Law 104-188 (SBJPA).

    3. The Taxpayer Relief Act of 1997, Pub. Law 105-34 (TRA ‘97).

    4. The Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. Law 107-16 (EGTRRA).

    5. The Job Creation and Worker Assistance Act of 2002, Pub. Law 107-147 (JCWAA).

    6. The Pension Funding Equity Act of 2004, Pub. Law 108-218 (PFEA).

    7. The Working Families Tax Relief Act of 2004, Pub. Law 108-311 (WFTRA).

    8. The Pension Protection Act of 2006, Pub. Law 109-280 (PPA ‘06).

    9. The Worker, Retiree, and Employer Recovery Act of 2008, Pub. Law 110- 458 (WRERA).

    10. The Gulf Opportunity Zone Act of 2005, Pub. Law 109-135 (GOZA).

    11. The Heroes Earnings Assistance and Relief Tax Act of 2008, Pub. Law 110-245 (Heart Act).

  4. In general, applying the IRC 415 limits doesn’t relieve a plan from its obligation to satisfy other plan qualification requirements. See 26 CFR 1.415(a)-1(f)(7).

Authority

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

  2. A trust is not a qualified trust under IRC 501 if the plan of which such trust is a part provides for benefits or contributions that exceed the IRC 415 limits (IRC 401(a)(16)).

  3. IRC 415(c) limits the amount of employer and employee contributions that may be allocated to an individual’s account under a DC plan.

  4. Policy Statement 4-119 states that the primary objective of the Employee Plans examination 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. IRM 1.2.13.1.36.

  5. Delegation Order 8-3 gives the Director, Employee Plans, authority to enter into and approve a written agreement with any person relating to their tax liability. IRM 1.2.47.4.

Responsibilities

  1. Agents examine a plan to determine if the plan

    • Meets the qualification requirements of IRC 401(a) and IRC 501(a). See IRM 4.71.1.3 and IRM 4.71.1.4.

    • Filed all required tax and information returns. See IRM 4.71.1.14.

    • Reported information and excise tax liabilities correctly. See IRM 4.71.1.4.

  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 1-236 and the Taxpayer Bill of Rights (TBOR).

Acronyms

  1. The table lists commonly used acronyms and their definitions.

    Acronym Definition
    COLA Cost-of-living adjustment
    CPI Consumer Price Index
    DB Defined benefit plan
    DC Defined contribution plan
    IRC Internal Revenue Code of 1986, as amended
    IRC 415 limit Benefit or compensation limit in IRC 415
    QDRO Qualified Domestic Relations Order
    QJSA Qualified joint and survivor annuity

Specific Plan Requirements

  1. 26 CFR 1.415(a)-1(d) provides that the terms of a qualified plan must preclude the possibility that an amount contributed to a DC plan will exceed the limitations imposed by IRC 415. If two or more DC plans are aggregated under the rules of IRC 415(f), the provisions in each of the plans must specify how benefits will be limited to prevent a violation of IRC 415(c), without involving employer discretion.

  2. The Tax Reform Act of 1986 (TRA ’86) provided that the limitations of IRC 415 may be incorporated by reference, but such an incorporation by reference must not violate the definitely determinable requirement of 26 CFR 1.401(a)-1(b)(1). The terms of the plan must preclude employer discretion, and any rules that allow optional methods of compliance must be stated in the plan. See 26 CFR 1.415(a)-1(d)(3).

    1. If a provision of IRC 415 may be applied in more than one way including a default rule, and if the plan terms simply incorporate this provision by reference and does not specifically vary from the default rule, the default rule applies.

    2. If a provision of IRC 415 may be applied in more than one way and a default rule does not exist, the plan terms must provide how this provision will be applied, even if the plan otherwise incorporates IRC 415 by reference.

General Definitions and Concepts

  1. The following general definitions and concepts are relevant to IRC 415(c).

Employer

  1. IRC 414(b), (c) and (m) provide that for purposes of IRC 415 all employees of all corporations which are members of a controlled group of corporations (within the meaning of IRC 1563(a), as modified by IRC 1563(f)(5) and determined without regard to IRC 1563(a)(4) and (e)(3)(C)), all employees of trades or businesses (whether or not incorporated) which are under common control, and all employees of the members of an affiliated service group are treated as employed by a single employer. See 26 CFR 1.415(a)-1(f)(1) and (2).

  2. IRC 415(h) and 26 CFR 1.415(a)-1(f)(1) provide that for purposes of applying IRC 414(b) and (c), the phrase “more than 50 percent” shall be substituted for the phrase “at least 80 percent” each place it appears in IRC 1563(a)(1), except for purposes of determining whether two or more organizations are a brother-sister group of trades or businesses under common control.

  3. IRC 414(n) and 26 CFR 1.415(a)-1(f)(3) provide that, for purposes of IRC 415, a leased employee is treated as an employee of the recipient of the leased employee’s services, unless the leased employee is covered by a money purchase plan described in IRC 414(n)(5) maintained by the leasing organization.

    1. Except as provided below, benefits or contributions provided by the leasing organization that are attributable to services performed for the recipient are treated as provided by the recipient.

    2. An exception is provided with respect to a leased employee covered by a money purchase plan described in IRC 414(n)(5) if both of the following conditions are met:

      1. The leased employee is covered by a plan that is maintained by the leasing organization and that meets the requirements of IRC 414(n)(5)(B); and

      2. Leased employees do not constitute more than 20 percent of the recipient’s nonhighly compensated workforce. See 26 CFR 1.415(a)-1(f)(3)(ii).

  4. If a company is a member of a controlled group or affiliated service group that maintains a plan covering its employees, and the company subsequently leaves the group and establishes an unrelated new plan, the plan of the prior group is aggregated with the company’s new plan for purposes of applying the IRC 415 limits to employees covered by both plans. The formerly affiliated plan is treated as if it had terminated immediately prior to the cessation of affiliation with sufficient assets to pay benefit liabilities under the plan, and had purchased annuities to provide plan benefits. See 26 CFR 1.415(f)-1(b)(2).

  5. If, as of the first day of a limitation year, two or more DC plans were not required to be aggregated and were not aggregated, but are aggregated later in that year, the plans would not fail to satisfy IRC 415 merely because the aggregation later in the year causes the plans to exceed the limits under IRC 415(c) with respect to a participant, but only if no annual additions are credited to the participant’s account after the date on which the plans are required to be aggregated. See 26 CFR 1.415(f)-1(e)(2).

  6. A multiemployer plan, as described in IRC 414(f), is not combined with other multiemployer plans for purposes of applying the IRC 415(c) limits, even if some or all of the same employers contribute to both plans. See IRC 415(f)(2)(B) and 26 CFR 1.415(f)-1(g)(1).

Plan

  1. IRC 414(i) defines a DC plan as a plan which provides an individual account for each participant and benefits based solely on the amount contributed to the participant’s account, plus any income, expenses, gains, losses and any forfeitures of accounts of other participants which may be allocated to such participant’s account.

    1. DC plans subject to the IRC 415(c) limitation include the portion of a DB plan treated as a DC plan under the rules of IRC 414(k).

    2. Individual retirement accounts or annuities (IRAs) under IRC 408(a) and (b) are not included as plans subject to IRC 415. IRC 408A(a) provides that, except as provided in that section, Roth IRAs are treated in the same manner as individual retirement plans.

  2. DC plans subject to the IRC 415(c) limitation include:

    1. A DC plan described in IRC 401(a) which includes a trust which is exempt from tax under IRC 501(a), including money purchase plans, stock bonus plans, profit-sharing plans, target benefit plans, employee stock ownership plans (ESOPs) and payroll stock ownership plans.

    2. An annuity plan described in IRC 403(a).

    3. A simplified employee pension described in IRC 408(k). See 26 CFR 1.415(c)-1(a)(2)(i).

    4. An annuity contract described in IRC 403(b). IRC 403(b) plans are treated as maintained by the employee, except in limited circumstances where the participant on whose behalf an IRC 403(b) annuity contract is purchased is in control of any employer. See 26 CFR 1.415(f)-1(f).

    Note:

    If the employer also makes contributions to a qualified plan, the IRC 403(b) plan and the qualified plan are generally not aggregated under the IRC 415 Limit.

    See 26 CFR 1.415(f)-1(f)(1) and 26 CFR 1.415(c)-1(a)(2)(i) and (iii).

  3. Contributions to the following types of arrangements are treated as DC plans subject to the IRC 415(c) limitation:

    1. Mandatory employee contributions to a DB plan (unless contributions are picked up by the employer as described in IRC 414(h)(2)). See 26 CFR 1.415(c)-1(a)(2)(ii)(B).

    2. Contributions allocated to any individual medical benefit account which is part of a pension or annuity plan established pursuant to IRC 401(h), and amounts attributable to medical benefits allocated to an account established for a key employee pursuant to IRC 419A(d). See 26 CFR 1.415(c)-1(a)(2)(ii)(C) and (D).

  4. IRC 415(f) and 26 CFR 1.415(f)-1(a)(2) provide that for purposes of applying the IRC 415(c) limitations, all DC plans maintained by an employer (or a predecessor employer) are to be treated as one DC plan.

    Example 1:
    Company A maintains a money purchase pension plan and a profit sharing plan covering the same group of employees. For purposes of IRC 415(c), these two plans are treated as one plan, and the combined annual additions for each participant under both plans cannot exceed the IRC 415(c) limitation.

Limitation Year

  1. The IRC 415 limits apply to amounts for or with respect to a limitation year. The limitation year for a plan is the calendar year unless the terms of the plan provide for a different consecutive 12-month period. See 26 CFR 1.415(j)-1 for the definition of limitation year and special rules.

    1. A plan may only provide for one limitation year regardless of the number or identity of the employers maintaining the plan.

    2. A plan may provide that the limitation year is a fiscal year with an annual period varying from 52 to 53 weeks, so long as the fiscal year satisfies the requirements of IRC 441(f).

    3. Once established, the limitation year may be changed only by amending the plan.

  2. If a change in the limitation year is made (including specification of a limitation year other than the default of the calendar year), the new limitation year must be a consecutive 12-month period (or fiscal year) which begins on any day within the current limitation year. See 26 CFR 1.415(j)-1(d)(1).

    1. Adjustment of the IRC 415(c) DC dollar limit is required to reflect the short limitation period created by a change in the limitation year. See 26 CFR 1.415(j)-1(d)(2).

      Example 2: Short Limitation Year
      Under Plan X, a profit-sharing plan, the calendar year is the limitation year. On June 30, 2018, the plan is amended to change the limitation year to a July 1 to June 30 year. Therefore, the new limitation year begins July 1, 2018, and a short limitation period is created (January 1, 2018 to June 30, 2018).
      Since the short limitation period ends in 2018, a calendar year for which the dollar limitation is $55,000, the dollar limitation for the short limitation period is: $55,000 x (6/12) = $27,500.
      Therefore, annual additions allocated in the short limitation period cannot exceed the lesser of (1) $27,500; or (2) 100 percent of IRC 415 compensation earned (or accrued where applicable) during the short limitation period.
    2. There is a deemed change in limitation year due to plan termination. If a DC plan is terminated effective as of a date other than the last day of the plan’s limitation year, the plan is treated as if an amendment has been adopted to change the limitation year to a period ending on the termination date. This results in prorating of the applicable dollar limit with respect to the allocation of annual additions for the final year in which the plan is an active plan. See 26 CFR 1.415(j)-1(d)(3).

      Example 3: Deemed Change of Limitation Year Due to Plan Termination
      Under Plan Y, a 401(k) plan, the calendar year is the limitation year. On August 31, 2018 the plan is terminated. Both elective deferrals and matching contributions have been allocated to participants’ accounts as of August 31, 2018. Since the termination date is August 31 rather than the last day of the limitation year (December 31), the plan is deemed to have been amended to create a short limitation year from January 1, 2018 through August 31, 2018. Since the short limitation period ends in 2018, a calendar year for which the dollar limitation is $55,000, the dollar limitation for the short limitation period is $55,000 x (8/12) = $36,667. Thus, the total annual additions credited for this deemed short year may not exceed the lesser of (1) $36,667; or (2) 100 percent of IRC 415 compensation earned during the short limitation period.
  3. If an employer maintains more than one qualified plan, those plans may provide for different limitation years. See 26 CFR 1.415(j)-1(c)(2) for testing rules that apply to an individual who has participated in more than one DC plan of the employer, where different limitation years are used by those plans.

Examination Steps

  1. Determine whether the employer is a member of a controlled group of corporations, a member of trades or businesses (whether or not incorporated) which are under common control, or a member of an affiliated service group. Taking IRC 415(h) into account, determine whether the employer is treated with other members of these groups as a single employer for purposes of applying the IRC 415 limits. If other members are to be taken into account, determine the same information for their DC plans, as described in the following examination steps, as determined for the employer.

  2. Identify all DC plans and arrangements treated as DC plans maintained by the employer and its controlled group.

  3. Identify the limitation years used by each DC plan or arrangement treated as a DC plan.

  4. If the limitation year has been changed and a short limitation period is created, has a prorated dollar limitation been used for the short limitation period? For purposes of determining the compensation limitation that applies for the short limitation period, has compensation earned (or accrued as applicable) during the short limitation period been used?

  5. If an individual participates in two or more plans that have different limitation years, have the allocations under each of the plans been taken into account in accordance with the rules of 26 CFR 1.415(j)-1(c)?

Annual Additions

  1. "Annual additions" means the sum, allocated to a participant’s account for any limitation year, of:

    1. Employer contributions. For this purpose, employer contributions include elective deferrals under IRC 401(k) plan (other than catch-up contributions).

    2. Employee contributions. Employee contributions refers to after-tax contributions made by the employees to the plan (whether voluntary or mandatory) other than designated Roth contributions. Designated Roth contributions are included in employer contributions.

    3. Forfeitures.

    4. Employee contributions to a DB plan.

    5. Contributions allocated to any individual medical account which is part of a pension or annuity plan established pursuant to IRC 401(h).

    6. Amounts derived from contributions paid or accrued after December 31, 1985, in taxable years ending after such date that are attributable to post-retirement medical benefits allocated to the separate account of a key employee (as defined in IRC 419A(d)(3)) under a welfare benefit fund.

      See IRC 415(c)(2), IRC 401(h), 26 CFR 1.415(c)-1(a)(2) and 26 CFR 1.415(c)-1(b).

  2. Contributions do not fail to be annual additions merely because they are excess deferrals, excess contributions, excess aggregate contributions or merely because excess contributions are corrected through distribution or recharacterization. See 26 CFR 1.415(c)-1(b)(1)(ii). However, excess deferrals distributed in accordance with 26 CFR 1.402(g)-1(e)(2) or (3) are not annual additions. See 26 CFR 1.415(c)-1(b)(2)(ii)(D).

  3. Not included as an annual addition subject to the IRC 415(c) limitation are the following:

    1. Catch-up contributions made in accordance with IRC 414(v). See 26 CFR 1.415(c)-1(b)(2)(ii)(B). However, any matching contributions associated with the catch-up contributions are annual additions.

    2. Direct transfer of a benefit or employee contributions from a qualified plan to a DC plan. See 26 CFR 1.415(c)-1(b)(1)(iii).

    3. Rollover contributions. See 26 CFR 1.415(c)-1(b)(3)(i).

    4. Repayments of loans made to a participant from the plan. See 26 CFR 1.415(c)-1(b)(3)(ii). However, if the loan bears an above-market interest rate, the excess interest might be characterized as an annual addition allocated to the employee. See 26 CFR 1.415(c) -1(b)(4).

    5. Employee contributions to a qualified cost-of-living arrangement under IRC 415(k)(2)(B). See 26 CFR 1.415(c)-1(b)(3)(v).

    6. Reinvestment of dividends on employer securities under an ESOP. See 26 CFR 1.415(c)-1(b)(1)(iv).

    7. Restoration of an employee’s accrued benefit by the employer resulting from the repayment of cash-outs (generally under a governmental plan). See 26 CFR 1.415(c)-1(b)(2)(ii).

    8. Certain repayments described in 26 CFR 1.415(c)-1(b)(3)(iii) (generally repayment of contributions to a governmental plan).

    9. Restorative payments described in 26 CFR 1.415(c)-1(b)(2)(ii)(C) (generally due to breach of fiduciary duty).

    10. Certain contributions to a deferred retirement option plan (DROP) in a governmental defined benefit plan. See IRM 4.72.7.4.4, DROP Design, and IRM 4.72.7.4.5, Detailed Explanation of the Three Criteria Used for Determining Whether IRC 415(c) Limits Apply to Additional Contributions in a DROP.

  4. A contribution by the employer or employee of property other than cash is considered to be a contribution in an amount equal to the fair market value of the property on the date the contribution is made. See 26 CFR 1.415(c)-1(b)(5).

General Rules Applicable to Annual Additions

  1. An amount is an annual addition if it is credited to a participant for a limitation year. An amount is credited if it is allocated to the account of a participant under the terms of a plan as of any date within that limitation year. See 26 CFR 1.415(c)-1(b)(6)(i)(A).

  2. In general, employer contributions are not deemed credited to a participant’s account for a particular limitation year unless they are actually made no later than 30 days after the period described in IRC 404(a)(6) for the tax year with or within which the limitation year ends. See 26 CFR 1.415(c)-1(b)(6)(i)(B). IRC 404(a)(6) provides that a payment made not later than the time prescribed by law for filing the return for a taxable year (including extensions) and is on account of such taxable year, is deemed to have been made as of the end of that taxable year.

    Note:

    If the employer is a tax exempt or government organization, the extra 30 day period does not apply because the employer does not file a tax return, so the IRC 404 (a)(6) reference point for calculating the 30 day period does not apply. Instead, for the contribution to be treated as an annual addition for the prior year, the IRC 415 crediting deadline is 91/1 months after the close of the taxable year in which the limitation year ends.

  3. Forfeitures are annual additions for a limitation year if they are allocated to the account of a participant as of any date within the limitation year. See 26 CFR 1.415(c)-1(b)(6)(i)(D).

  4. There are four special timing rules where an employer contribution made to the plan in a limitation year is not considered an annual addition for that limitation year but for the limitation year to which it relates. See 26 CFR 1.415(c)-1(b)(6)(ii).

    1. Corrective contributions made because of an erroneous forfeiture in a prior limitation year or an erroneous failure to allocate amounts in a prior limitation year.

    2. Contributions to reduce an accumulated funding deficiency or to repay a waived funding deficiency.

    3. Contributions to a simplified employee pension described in IRC 408(k).

    4. Certain contributions made pursuant to a veteran’s reemployment rights in accordance with IRC 414(u)(1)(B).

  5. Employee contributions (voluntary and mandatory) are not deemed 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 such limitation year. See 26 CFR 1.415(c)-1(b)(6)(i)(C).

Medical Benefit Accounts

  1. IRC 415(l) provides that contributions allocated to any individual medical account which is part of a pension or annuity plan must be treated as an annual addition to a DC plan for IRC 415(c) purposes. However, IRC 415(c)(1)(B) (the DC compensation limitation) does not apply to such amount. For this purpose, an individual medical benefit account is any separate account:

    1. Established for a participant under a pension or annuity plan, and

    2. From which benefits described in IRC 401(h) are payable solely to such participant, (and his spouse and dependents).

  2. Under IRC 401(h), where a pension or annuity plan provides for such medical benefits (which may include payment of benefits for sickness, accident, hospitalization and medical expenses of retired employees, their spouses and dependents), such benefits must be subordinate to the retirement benefits provided by the plan.

    The requirement that benefits be subordinate to the plan’s retirement benefit will not be satisfied if the actual contributions for medical benefits, when added to actual contributions for life insurance protection under the plan, exceed 25 percent of the total actual contributions to the plan (other than contributions to fund past service credits) after the date on which the account is established. See 26 CFR 1.401-14.

  3. IRC 401(h) also provides that a separate account must be established and maintained for such benefits, and the employer’s contributions to such separate account must be reasonable and ascertainable.

    1. All plan liabilities to provide such benefits must be satisfied before any part of the corpus or income of the account can be used for, or diverted to, any purpose other than providing such benefits.

    2. Once all liabilities for such benefits are satisfied, the plan must provide that amounts remaining in the separate account are returned to the employer.

    3. For benefits payable to each key employee (and his spouse and dependents), a separate account is established and maintained, and benefits payable for that key employee attributable to plan years beginning after March 31,1984, for which the employee is a key employee, must be paid from such separate account. For these purposes, a key employee is any employee, who at any time during the plan year or any preceding plan year during which contributions were made on their behalf, is or was a key employee as defined in IRC 416(i).

  4. IRC 419A(d) provides that contributions for post-retirement medical benefits for key employees are treated as annual additions for IRC 415(c) purposes. However, the DC compensation limitation (IRC 415(c)(1)(B)) does not apply to such amounts.

  5. Under IRC 419A(d), such amounts must be allocated to separate accounts, and benefits with respect to such key employees after retirement must be paid from these separate accounts. For these purposes a key employee is any employee who, at any time during the plan year or any preceding plan year, is or was a key employee as defined in IRC 416(i).

  6. In the event that aggregating a medical account described in 26 CFR 1.415(c)-1(a)(2)(ii)(C) or (D) and a DC plan other than such a medical account causes a participant’s account to exceed the limitations of IRC 415(c), for a particular limitation year, the DC plan other than the medical account is disqualified for the limitation year. See 26 CFR 1.415(g)-1(b)(3)(iv)(B).

Employee Stock Ownership Plans (ESOPs)

  1. The rules for determining the amount of annual additions allocated to a participant’s account under an ESOP are discussed in IRM 4.72.4, Employee Stock Ownership Plans (ESOPs).

DROP Design

  1. Under a typical DROP design, a DB plan participant who is eligible to retire and immediately receive retirement payments under the DB plan continues to work and makes an election under which the participant’s benefit accruals under the DB plan are frozen (i.e., no additional service or compensation credits accrue). Pursuant to the election, the amounts that the participant would have received as a DB retirement payment had the participant in fact retired are credited to a DROP (these amounts will be referred to as DB Benefit Amounts). The DROP may also provide for employee or employer contributions to be made to the DROP in addition to the DB Benefit Amounts credited to the DROP (Additional Contributions).

  2. Administrative Guidelines

    1. If you are reviewing a governmental DB plan, you should not treat DB Benefit Amounts credited to a DROP as annual additions subject to the IRC 415(c) limitation that applies to DC plans.

    2. Accordingly, if you are reviewing a governmental DB plan that does not allow Additional Contributions to be made to the DROP, the plan will not be required to apply IRC 415(c) limitation provisions for the DROP.

    3. If you are reviewing a governmental DB plan that allows Additional Contributions to be made to the DROP, these Additional Contributions also will not be treated as annual additions subject to the IRC 415(c) limits unless all three criteria described below are satisfied. You should review the plan documents to determine if this is the case.

      1. The DROP consists of segregated accounts for each participant;

      2. Earnings on amounts in the DROP are based solely on actual investment earnings, i.e., the DROP does not provide for a fixed or guaranteed rate of return on funds in the DROP; and

      3. The DROP does not provide for cessation of the accrual of earnings in the DROP at any time.

    4. With respect to the first criterion, if the plan’s language indicates that the plan provides for segregated accounts for each participant, you should contact the plan’s representative to receive written confirmation under penalties of perjury of how the plan is actually operated.

    5. If the DROP does not meet any one of the above three criteria, the Additional Contributions will not be treated as annual additions subject to the IRC 415(c) limits.

    6. IRM 4.72.7.4.5, Detailed Explanation of the Three Criteria Used for Determining Whether IRC 415(c) Limits Apply to Additional Contributions in a DROP, provides an explanation of the three criteria and examples of plan language to assist you in reviewing the plan documents.

Detailed Explanation of the Three Criteria Used for Determining Whether IRC 415(c) Limits Apply to Additional Contributions in a DROP

  1. If a DROP provides for Additional Contributions, the following information is designed to facilitate the application of the three criteria listed in IRM 4.72.7.4.4, DROP Design.

    I. Segregated accounts for each participant

    1. Additional Contributions will not be treated as annual additions subject to IRC 415(c) limits where the plan language does not indicate that it provides for segregated accounts for each participant or the plan’s representative confirms that the plan is actually not operated with segregated accounts. Examples of non-segregated account plan language include:

      Example:

      All benefits payable to a DROP participant shall be paid from the general assets of the Plan.

      Example:

      All benefits payable under the DROP shall be paid only from the assets of the DROP, and the Employer shall have no duty or liability to furnish the DROP with any funds except to the extent required by applicable law. (The language groups the DROP accounts for all participants together so they are not segregated.)

    2. If the plan’s language indicates that the plan provides for segregated accounts for each participant, you should contact the plan’s representative to receive written confirmation under penalties of perjury of how the plan is actually operated. If the plan does not operate as if benefits paid to a participant are paid only from the assets in the participant’s DROP account, this first criterion is not met. Examples of segregated account plan language include:

      Example:

      All DROP benefits payable to a participant shall be paid only from the assets in the participant’s DROP account.

    II. Actual investment earnings

    1. If a DROP provides for a rate of return based on something other than actual investment earnings (such as a fixed or guaranteed rate), the DROP account is not based “solely” upon contributions and earnings and the Additional Contributions will not be treated as annual additions subject to the IRC 415(c) limits. DROP designs that are treated as having a fixed or guaranteed rate of return include designs where:

      1. The rate of return is fixed at a pre-stated rate, such as x% (this includes setting the earnings rate as a rate external to the plan (e.g., 10-year Treasury bills) or at a 0% rate of return (i.e., no earnings)).

      2. There is a maximum and/or minimum set for investment returns (e.g., a participant may choose from individual investments but is guaranteed a return of not less than x%).

      3. A participant may choose from different investment options and the choices include either (1) or (2).

    2. The following are examples of plan language providing for fixed or guaranteed rates of return:

      • Fixed rate on assets in DROP account:

        Example:

        A member’s DROP account is credited each month with earnings based on an interest rate of X percent per annum compounded monthly.
        If the plan language provides for a rate of return equal to the return on the assets of the entire DB plan, this is treated as a fixed or guaranteed rate and not actual investment earnings of the participant’s DROP account.

      • Maximum or minimum rate:

        Example:

        The DROP account shall be credited annually with earnings equal to the actual investment return on the assets in the participant’s DROP account (as selected by the participant), but in no event more than X percent or less than Y percent.

      • Interest rate determined by participant election:

        Example:

        Participant can choose interest at:
        (a) a fixed rate of X percent,
        (b) the rate equal to the net investment return of Plan assets, or
        (c) the net investment return of the assets in the DROP account as selected by the DROP participants.

        Example:

        Payment to the DROP shall be credited or debited with interest according to one of the following options chosen by the DROP participant:
        (a) the DROP account is credited or debited with the same percentage as the net investment return of the Plan as a whole, or
        (b) the participant’s DROP account is credited with the actual investment return on the mutual funds in the participant’s DROP account (as selected by the participant).

    III. No cessation of the crediting of earnings in the DROP at any time

    1. Most DROPs provide for the crediting of the DB Benefit Amounts into the DROP only over a defined time period, often five years (the DROP period).

    2. If crediting of investment earnings ceases at any time while assets remain in the DROP (for example after the DROP period), the DROP is not treated as providing for actual investment earnings and the Additional Contributions will not be treated as annual additions subject to the IRC 415(c) limits.

    3. The following are examples of plan language providing for cessation of earnings.

      Example:

      Except as otherwise provided in the section above (providing that interest ceases at end of DROP period), the DROP account shall be credited with…

      Example:

      If an employee does not terminate employment at the end of participation in the DROP, interest shall no longer be credited to the DROP account.

Examination Steps

  1. Determine whether the limitations on annual additions are tested using the sum of the annual additions for all DC plans of the employer, including features of plans which are to be treated as DC plans for purposes of IRC 415 testing (such as employee contributions under contributory DB plans), and all DC plans of any other employer(s) which are to be treated along with the employer’s plan(s) as a single plan.

  2. Are contributions allocated to any individual medical account that is part of a pension or annuity plan treated as an annual addition to a DC plan (although the IRC 415(c)(1)(B) compensation limitation will not apply to such amounts)? See IRC 415(l) and IRC 401(h).

  3. Are amounts attributable to medical benefits allocated to accounts for post-retirement medical or life insurance benefits provided to key employees, under IRC 419A(d), treated as an annual addition to a DC plan for IRC 415(c) purposes (although the IRC 415(c)(1)(B) compensation limitation will not apply to such amounts)?

Defined Contribution Plan Limitation

  1. Contributions and other additions with respect to a participant exceed the limitation of IRC 415(c) if, when expressed as an annual addition to the participant’s account, such annual addition is greater than the lesser of:

    1. $40,000 (DC dollar limitation, adjusted pursuant to section 415(d) cost-of-living adjustments), or

    2. 100 percent of the participant’s compensation (DC compensation limitation),

IRC 415(c) Dollar Limitation

  1. The dollar limit on annual additions to a DC plan under IRC 415(c)(1)(A) (DC dollar limitation) is $40,000 as adjusted for cost-of-living.

    1. Each year the IRS publishes the limitations applicable to qualified plans under IRC 415, adjusted for cost-of-living increases as provided for under IRC 415(d), and effective for the calendar year beginning January 1. The adjusted limitation applies to limitation years ending with or within that calendar year.

    2. Accordingly, if a plan has a limitation year that is not the calendar year, the limitation that applies to the plan’s limitation year is the limitation in effect for the calendar year in which the plan’s limitation year ends.

    3. Annual additions for a limitation year cannot exceed the current dollar limitation (as in effect before the January 1 adjustment) prior to January 1. However, after a January 1 adjustment is made, annual additions for the entire limitation year are permitted to reflect the dollar limitation as adjusted on January 1. See 26 CFR 1.415(d)-1(b)(2)(iii).

      Example 4:
      Clarification of Timing: The dollar limit increased from $54,000 for 2017 to $55,000 for 2018. For a limitation year ending June 30, 2018, the $55,000 limit applies. However, annual additions for such year that are credited before January 1, 2018, must be limited to the 2017 limit of $54,000, even though total annual additions for the entire year could be up to $55,000. A participant could not receive an allocation of contributions in the amount of $55,000 which are credited on October 1, 2017, simply because the dollar limit for the year which includes October 1, 2017 (i.e., the limitation year ending June 30, 2018), is $55,000.
      Example 5:
      Clarification of Timing: Same facts as Example 4, except monthly employer contributions of $4,700 per month are made on behalf of the participant for the period July 1, 2017 to June 30, 2018. The participant’s annual addition is limited to $55,000 because for a limitation year ending June 30, 2018, the $55,000 limit applies.
    IRC 415(c)(1)(A) Dollar Limitations Amount
    Limitation added by ERISA $25,000
    January 1, 1976 $26,825
    January 1, 1977 $28,175
    January 1, 1978 $30,050
    January 1, 1979 $32,700
    January 1, 1980 $36,875
    January 1, 1981 $41,500
    January 1, 1982 $45,475
    January 1, 1983 - January 1, 2000 $30,000
    January 1, 2001 $35,000
    January 1, 2002 $40,000
    January 1, 2003 $40,000
    January 1, 2004 $41,000
    January 1, 2005 $42,000
    January 1, 2006 $44,000
    January 1, 2007 $45,000
    January 1, 2008 $46,000
    January 1, 2009 $49,000
    January 1, 2010 $49,000
    January 1, 2011 $49,000
    January 1, 2012 $50,000
    January 1, 2013 $51,000
    January 1, 2014 $52,000
    January 1, 2015 $53,000
    January 1, 2016 $53,000
    January 1, 2017 $54,000
    January 1, 2018 $55,000
    January 1, 2019 $56,000

DC Compensation Limitation

  1. If 100 percent of a participant’s compensation for a limitation year is less than the DC dollar limitation for that limitation year, then annual additions allocated to a participant’s account for the limitation year cannot exceed such 100 percent of compensation (DC compensation limitation).

  2. Compensation is defined in 26 CFR 1.415(c)-2.

  3. While the terms of a plan may provide a different definition of compensation for purposes of calculating the rate of employer contributions, a definition of compensation within the meaning of IRC 415(c)(3) must be used to determine whether the maximum permissible contributions have been exceeded. A plan that incorporates IRC 415 by reference must specify which definition of compensation is used.

IRC 415(c)(3) Compensation
  1. For purposes of the DC compensation limitation, a plan must specify the definition of compensation used by the plan. The definition of compensation for purposes of the IRC 415 limitation may differ from the plan’s definition of compensation on which allocation amounts are determined.

  2. If an employee is employed by two or more members of a controlled group of corporations, members of commonly controlled trades or businesses or an affiliated service group, compensation for such employee includes compensation from all of the employers in the group, whether or not they maintain the plan. See 26 CFR 1.415(c) -2(g)(2).

  3. Total compensation received by a participant from all of the employers maintaining a multiemployer plan is taken into account when applying the limitations of IRC 415, unless the plan specifies otherwise.

Amounts Includible as IRC 415(c)(3) Compensation
  1. For purposes of applying the IRC 415 limitations, the term compensation includes all of the following and does not include any other form of remuneration.

    1. Wages, salaries, fees for professional services and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the employer maintaining the plan to the extent that the amounts are includible in gross income (or to the extent amounts would have been received and includible in gross income but for an election under IRC 125(a), IRC 132(f)(4), IRC 402(e)(3), IRC 402(h)(1)(B), IRC 402(k) or IRC 457(b)). These amounts include, but are not limited to, commissions paid to salespersons, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits and reimbursements or other expense allowances under a nonaccountable plan as described in 26 CFR 1.62-2(c).

    2. Earned income in the case of a self-employed individual (see IRC 401(c)(1) and (2) for definitions) plus amounts deferred at the election of the employee that would be includible in gross income but for the rules of IRC 402(e)(3), IRC 402(h)(1)(B), IRC 402(k), or IRC 457(b).

    3. Amounts described in IRC 104(a)(3), IRC 105(a) and IRC 105(h), but only to the extent that these amounts are includible in the gross income of the employee.

    4. Amounts paid or reimbursed by the employer for moving expenses incurred by an employee, but only to the extent that at the time of the payment it is reasonable to believe that these amounts are not deductible by the employee under IRC 217.

    5. The value of a nonstatutory option (which is an option other than a statutory option as defined in 26 CFR 1.421-1(b)) granted to an employee by the employer, but only to the extent that the value of the option is includible in the gross income of the employee for the taxable year in which granted.

    6. The amount includible in the gross income of an employee upon making the election described in IRC 83(b).

    7. Amounts that are includible in the gross income of an employee under the rules of IRC 409A or IRC 457(f)(1)(A) or because the amounts are constructively received by the employee.

    See 26 CFR 1.415(c)-2(b).

  2. In determining amounts under IRM 4.72.7.5.2.1.1 (1)(a) and IRM 4.72.7.5.2.1.1 (1)(b), foreign earned income (as defined in IRC 911(b)), whether or not excludible from gross income under IRC 911, is included. Compensation under IRM 4.72.7.5.2.1.1 (1)(a) is to be determined without regard to the exclusions from gross income in IRC 872, IRC 893, IRC 894, IRC 911, IRC 931 and IRC 933. See 26 CFR 1.415(c)-2(g)(5)(i).

  3. Following are examples of remuneration not included in compensation.

    1. Contributions (other than elective contributions described in IRC 402(e)(3), IRC 408(k)(6), IRC 408(p)(2)(A)(i) or IRC 457(b)) made by the employer to a plan of deferred compensation (including a simplified employee pension described in IRC 408(k) or a simple retirement account described in IRC 408(p), and whether or not qualified) to the extent that the contributions are not includible in the gross income of the employee for the taxable year in which contributed.

    2. Any distributions from a plan of deferred compensation, regardless of whether such amounts are includible in the gross income of the employee when distributed. Although amounts received from an unfunded nonqualified plan are permitted to be considered as compensation for IRC 415 purposes in the year the amounts are includible in the employee’s gross income. If the plan so provides, any amounts received by an employee pursuant to a nonqualified unfunded deferred compensation plan are permitted to be considered as compensation for IRC 415 purposes in the year the amounts are actually received, but only to the extent such amounts are includible in the employee's gross income.

    3. Amounts realized from the exercise of a nonstatutory stock option or when restricted stock (or property) held by an employee either becomes freely transferable or is no longer subject to a substantial risk of forfeiture. See IRC 83 and the Treasury regulations thereunder.

    4. Amounts realized from the sale, exchange or other disposition of stock acquired under a statutory stock option.

    5. Other amounts which receive special tax benefits, such as premiums for group-term life insurance (but only to the extent that the premiums are not includible in the gross income of the employee and are not salary reduction amounts that are described in IRC 125).

    6. Other items of remuneration that are similar to any of the items a) through e) above.

    See 26 CFR 1.415(c)-2(c).

  4. SBJPA amended IRC 415(c)(3) to provide that, for years beginning after December 31, 1997, compensation for IRC 415 purposes includes any elective deferral (as defined in IRC 402(g)(3)) and any amount which is contributed or deferred by the employer at the election of the employee and which is not includible in the gross income of the employee by reason of IRC 125 or IRC 457.

  5. CRA amended IRC 415(c)(3)(D) to include a salary reduction contribution to purchase qualified transportation fringe benefits as elective deferrals. This change is retroactive to years beginning after December 31, 1997.

  6. For limitation years beginning on or after July 1, 2007, compensation for IRC 415 purposes may not reflect compensation for a plan year that is in excess of the dollar limitation under IRC 401(a)(17). See 26 CFR 1.415(c)-2(f).

  7. HEART Act amended IRC 219(f)(1) to include “differential wage payments” in the definition of compensation for plan years beginning after December 31, 2008. Section 105(b)(2) of the Act amended IRC 219(f)(1) to provide that, for purposes of determining the limitation on contributions to an IRA, the term “compensation” includes differential wage payments. A “differential wage payment” occurs when an employee is called to active military duty and the employer has paid some or all of the compensation that a service member would have received from the employer during the service member’s period of active duty had the employee not been called to active duty. This amendment is effective for years beginning after December 31, 2008. See Notice 2010-15.

  8. Differential wage payments may (but are not required to be) be treated as compensation for purposes of determining contributions and benefits under a plan. However, such payments are treated as compensation for purposes of applying the Internal Revenue Code. Accordingly, these payments must be treated as compensation under IRC 415(c)(3) and 26 CFR 1.415(c)-2.

Safe Harbor Definitions of Compensation
  1. For purposes of the IRC 415 limitations, a plan may define compensation using any of the following safe harbor definitions:

    1. Simplified Definition - Includes only compensation described under (a) or (b) of IRM 4.72.7.5.2.1.1 (1) and excludes all amounts described in IRM 4.72.7.5.2.1.1 (3).

    2. IRC 3401(a) wages - Wages within the meaning of IRC 3401(a) for purposes of income tax withholding, plus amounts that would be included in wages but for an election under IRC 125(a), IRC 132(f)(4), IRC 402(e)(3), IRC 402(h)(1)(B), IRC 402(k) or IRC 457(b). However, any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in section 3401(a)(2)) are disregarded for this purpose.

    3. Information required to be reported under IRC 6041, IRC 6051 and IRC 6052 - The safe harbor definition of compensation under this paragraph includes amounts that are compensation under the safe harbor definition of IRM 4.72.7.5.2.1.2 (1)(b), plus all other payments of compensation to an employee by his employer (in the course of the employer's trade or business) for which the employer is required to furnish the employee a written statement under IRC 6041(d), IRC 6051(a)(3) and IRC 6052. See 26 CFR 1.6041-1(a), 26 CFR 1.6041-2(a)(1), 26 CFR 1.6052-1, 26 CFR 1.6052-2 and 26 CFR 31.6051-1(a)(1)(i)(C). This safe harbor definition of compensation may be modified to exclude amounts paid or reimbursed by the employer for moving expenses incurred by an employee, but only to the extent that, at the time of the payment, it is reasonable to believe that these amounts are deductible by the employee under IRC 217.

Timing Rules for IRC 415(c)(3) Compensation
  1. Generally, in order to be taken into account for a limitation year, compensation must be actually paid or made available to an employee (or, if earlier, includible in the gross income of the employee) within the limitation year. In addition, in order to be taken into account for a limitation year, compensation must be paid or treated as paid to the employee prior to the employee’s severance from employment with the employer maintaining the plan. See 26 CFR 1.415(c)-2(e)(1).

  2. Notwithstanding the above, certain minor timing differences are allowed. A plan may provide that compensation for a limitation year includes amounts earned during that limitation year but not paid during that limitation year solely because of the timing of pay periods and pay dates if all of the following conditions are met:

    1. The amounts are paid during the first few weeks of the next limitation year.

    2. The amounts are included on a uniform and consistent basis with respect to all similarly situated employees.

    3. No compensation is included in more than one limitation year.

    See 26 CFR 1.415(c)-2(e)(2).

  3. Compensation paid after severance from employment does not fail to be compensation within IRC 415(c)(3) merely because it is paid after the employee's severance from employment with the employer maintaining the plan, provided the compensation is paid by the later of 21/1 months after severance from employment with the employer maintaining the plan or the end of the limitation year that includes the date of severance from employment with the employer maintaining the plan. Amounts included in this paragraph include:

    1. Regular pay after severance from employment - the payment must be regular compensation for services during the employee's regular working hours, or compensation for services outside the employee's regular working hours (such as overtime or shift differential), commissions, bonuses or other similar payments; and the payment would have been paid to the employee prior to a severance from employment if the employee had continued in employment with the employer.

    2. Leave cash outs and deferred compensation – these amounts are either

      1. payment for unused 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; or

      2. received by an employee pursuant to a nonqualified unfunded deferred compensation plan, but only if the payment would have been paid to the employee at the same time if the employee had continued in employment with the employer and only to the extent that the payment is includible in the employee's gross income.

    3. Other post-severance payments that are not described in a) or b) above are not considered compensation under IRC 415(e)(3) if paid after severance of employment, even if paid within the correct time period. For example, compensation would not include severance pay, parachute payments within the meaning of IRC 280(G)(b)(2) or post-severance payments under a nonqualified unfunded deferred compensation plan unless the payments would have been paid at that time without regard to the severance from employment.

    See 26 CFR 1.415(c)-2(e)(3).

  4. Salary continuation payments for military service and disabled participants – if the plan provides, the rules regarding payment prior to severance do 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 IRC 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. Also if the plan provides, the rule of IRM 4.72.7.5.2.1.3 (1) above does not apply to compensation paid to a participant who is permanently and totally disabled if the conditions set forth in 26 CFR 1.415(c)-2(g)(4)(ii)(A) are satisfied (applied by substituting a continuation of compensation for the continuation of contributions). See 26 CFR 1.415(c)-2(e)(4).

  5. Special rule for governmental plans - for purposes of applying the rules under IRM 4.72.7.5.2.1.3 (3), a governmental plan (as defined in IRC 414(d)) may provide for the substitution of the calendar year in which the severance from employment with the employer maintaining the plan occurs for the limitation year in which the severance from employment with the employer maintaining the plan occurs.

Examination Steps
  1. Is an IRC 415 definition of compensation used under the plan for purposes of determining whether the IRC 415 limitations have been exceeded?

  2. Does the plan specify which definition is used for purposes of determining IRC 415(c)(3) compensation?

  3. Is the employee’s compensation from all members of a controlled group taken into account?