4.72.7 Examination Guidelines for IRC 415(c)

Manual Transmittal

September 23, 2021

Purpose

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

Material Changes

(1) IRM 4.72.7.1.3 (2) was updated for TBOR guidance from the Division Counsel/Associate Chief Counsel (National Taxpayer Advocate Program) and Branch 3 of the Associate Chief Counsel (Procedure and Administration).

(2) Updated IRM 4.72.7.5.1 to add the dollar limit for 2021.

(3) Updated for editorial and plain language changes.

Effect on Other Documents

This supersedes IRM 4.72.7 dated September 29, 2020.

Audience

Tax Exempt and Government Entities
Employee Plans

Effective Date

(09-23-2021)

Eric D. Slack
Director, Employee Plans
Tax Exempt and Governmental Entities

Program Scope and Objectives

  1. Purpose: This IRM helps Employee Plans (EP) specialists examine 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. 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. The Employee Retirement Income Security Act of 1974, Pub. Law 93-406 (ERISA) added IRC 415 to the Code.

    2. 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.

      Reminder:

      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 SBJPA repealed IRC 415(e) effective for limitation years beginning after 1999.

  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. (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. (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. The amount of employer and employee contributions that may be allocated to an individual’s account under a DC plan is limited by IRC 415(c).

  4. The primary objective of the Employee Plans examination program is regulatory, with emphasis on continued qualification of employee benefit plans (Policy Statement 4-119). Plans are examined to determine whether they meet the applicable qualification requirements in operation. (IRM 1.2.1.5.36).

  5. The Director, Employee Plans has the authority to enter into and approve a written agreement with any person relating to their tax liability (Delegation Order 8-3). (IRM 1.2.2.9.3).

Responsibilities

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

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

    2. Filed all required tax and information returns. (IRM 4.71.1.14).

    3. Reported information and excise tax liabilities correctly. (IRM 4.71.1.4).

  2. Agents must be familiar with and act according to the Taxpayer Bill of Rights. The Taxpayer Bill of Rights (TBOR) lists rights that already existed in the tax code, putting them in simple language and grouping them into 10 fundamental rights. Employees are responsible for being familiar with and acting in accord with taxpayer rights. See IRC 7803(a)(3), Execution of Duties in Accord with Taxpayer Rights. For additional information about the TBOR, see https://www.irs.gov/taxpayer-bill-of-rights

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
    TBOR Taxpayer Bill Of Rights

Specific Plan Requirements

  1. A qualified DC plan must, by its terms, prevent contribution amounts from exceeding the IRC 415 limits. (26 CFR 1.415(a)-1(d)). If two or more DC plans are aggregated under the rules of IRC 415(f), each plan’s provisions must specify how it will limit benefits to prevent an IRC 415(c) violation, without any employer discretion.

  2. Plans may incorporate IRC 415 limits by reference, but the incorporation by reference can’t violate the definitely determinable requirement of 26 CFR 1.401(a)-1(b)(1). Therefore, the plan terms must:

    1. Prevent employer discretion.

    2. State any rules that allow optional methods of compliance. (26 CFR 1.415(a)-1(d)(3)).

  3. When plans incorporate IRC 415 limits by reference in a manner that may be applied in more than one way, the plan must either:

    1. Have a default rule, which will apply unless the plan states otherwise or,

    2. In the absence of a default rule, the plan terms must state how the 415 limit will apply.

General Definitions and Concepts

  1. IRM 4.72.7.3.1, IRM 4.72.7.3.2 and 4.72.7.3.3 contain general definitions and concepts that are relevant to IRC 415(c).

Employer

  1. For IRC 415 purposes, treat all employees of affiliated employers determined under IRC 414(b), IRC 414(c) and IRC 414(m) as employed by a single employer:

    1. All corporations which are members of a controlled group of corporations (per IRC 1563(a)), as modified by IRC 1563(f)(5) and not considering IRC 1563(a)(4) and IRC 1563(e)(3)(C).

    2. All employees of trades or businesses (whether or not incorporated) which are under common control.

    3. All employees of the members of an affiliated service group are treated as employed by a single employer. (26 CFR 1.415(a)-1(f)(1) and (2)).

  2. When applying IRC 415 to related employers in a parent-subsidiary controlled group, replace the phrase "at least 80 percent" with "more than 50 percent" in IRC 1563(a)(1). See IRC 415(h) and 26 CFR 1.415(a)-1(f)(1). Don’t make this substitution to determine whether two or more organizations are a brother-sister group of trades or businesses under common control.

  3. Leased employees: For IRC 415, the recipient company must treat leased employees as their employees, unless the leasing organization covers the leased employee in a money purchase plan per IRC 414(n)(5). See IRC 414(n) and 26 CFR 1.415(a)-1(f)(3). The benefits or contributions the leasing organization provides attributable to services the employee performed for the recipient are treated as though provided by the recipient.

    Exception:

    The leasing organization doesn’t have to cover the leased employees in a money purchase plan under IRC 414(n)(5) if both of the following conditions are met:

    1. Leased employees are covered by the leasing organization’s plan that meets IRC 414(n)(5)(B).

    2. Leased employees aren’t more than 20% of the recipient’s non-highly compensated workforce. (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 has a plan, and the company leaves the group and establishes an unrelated new plan, aggregate the prior group’s plan with the new plan to apply the IRC 415 limits to employees covered by both plans. Treat the former plan as if it had terminated immediately before the company left the group with sufficient assets to pay benefit liabilities under the plan, and had purchased annuities to provide plan benefits. (26 CFR 1.415(f)-1(b)(2)).

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

  6. A multiemployer plan, per IRC 414(f), isn’t combined with other multiemployer plans to apply 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. A DC plan, per IRC 414(i), is defined 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 that 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) aren’t subject to IRC 415. Roth IRAs are treated the same way as individual retirement plans under IRC 408A(a), except as noted in IRC 408A.

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

    1. A DC plan described in IRC 401(a), which includes a trust which is exempt from tax under IRC 501(a), 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 (SEP plan) under IRC 408(k). (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 under the employer’s control. (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) limit:

    1. Mandatory employee contributions to a DB plan (unless the employer picks up these contributions as described in IRC 414(h)(2)). (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 per IRC 401(h), and amounts attributable to medical benefits allocated to an account established for a key employee per IRC 419A(d). (26 CFR 1.415(c)-1(a)(2)(ii)(C) and (D)).

  4. To apply the IRC 415(c) limitations, treat all DC plans an employer (or a predecessor employer) maintains as one DC plan. See IRC 415(f) and 26 CFR 1.415(f)-1(a)(2).

    Example:
    Company A has a money purchase pension plan and a profit sharing plan covering the same group of employees. For purposes of IRC 415(c), treat these two plans as one plan, and make sure each participant’s combined annual additions under both plans don’t exceed the IRC 415(c) limitation.

Limitation Year

  1. The IRC 415 limits apply to amounts for or with respect to a limitation year. A plan’s limitation year is the calendar year unless the plan terms state 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 have one limitation year regardless of the number or identity of the employers maintaining the plan.

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

    3. Once established, the plan sponsor may only change the limitation year by amending the plan.

  2. If the plan sponsor changes the limitation year (including specifying a limitation year other than the default), the new limitation year must be a consecutive 12-month period which begins on any day within the current limitation year. (26 CFR 1.415(j)-1(d)(1)).

    1. Adjust the IRC 415(c) DC dollar limit to reflect the short limitation period created by the limitation year change. (26 CFR 1.415(j)-1(d)(2)).

      Example: Short Limitation Year
      Plan X, a profit-sharing plan, has a calendar year limitation year. On June 30, 2020, the plan sponsor amends the plan to change the limitation year to a July 1 to June 30 year. Therefore, the new limitation year begins July 1, 2020, and a short limitation period is created (January 1, 2020 to June 30, 2020).
      Since the short limitation period ends in 2020, a calendar year for which the dollar limitation is $57,000, the dollar limitation for the short limitation period is: $57,000 x 6/12 = $28,500.
      Therefore, annual additions allocated to a participant in the short limitation period can’t exceed the lesser of (1) $28,500; or (2) 100% of IRC 415 compensation earned (or accrued where applicable) during the short limitation period.

    2. When a plan terminates, it’s a deemed change in limitation year. If a DC plan’s termination date is effective on a date other than the last day of the plan’s limitation year, the plan is treated as if the plan sponsor adopted an amendment to change the limitation year to a period ending on the termination date. Prorate the applicable dollar limit for the allocation of annual additions for the final, short year in which the plan is an active plan. (26 CFR 1.415(j)-1(d)(3)).

      Example: Deemed Change of Limitation Year Due to Plan Termination
      Plan Y, a 401(k) plan, has a calendar year limitation year. On August 31, 2020, the plan is terminated. The plan allocated both elective deferrals and matching contributions to participants’ accounts as of August 31, 2020. 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, 2020, through August 31, 2020. Since the short limitation period ends in 2020, a calendar year for which the dollar limitation is $57,000, the dollar limitation for the short limitation period is $57,000 x 8/12 = $38,000. Therefore, the total annual additions credited to any participant for this deemed short year may not exceed the lesser of (1) $38,000; or (2) 100% of IRC 415 compensation earned during the short limitation period.

  3. If an employer has more than one qualified plan, those plans may have different limitation years. See 26 CFR 1.415(j)-1(c)(2) for testing rules that apply to an individual who participates in more than one of their employer’s DC plans, having different limitation years.

Examination Steps

  1. Determine whether the employer is a member of:

    • A controlled group of corporations, or

    • Trades or businesses (whether or not incorporated) under common control.

  2. Consider IRC 415(h) to determine if you treat the employer with other members of these groups as a single employer for the IRC 415 limits. If you include other members, determine the same information for their DC plans, as you do for the employer using the exam steps below.

    1. Identify all DC plans and arrangements treated as DC plans the employer and its controlled group has.

    2. Identify the limitation years each DC plan or arrangement treated as a DC plan uses.

    3. If the sponsor changed the limitation year, creating a short limitation period - make sure they used for the short limitation period: i) a prorated dollar limitation and ii) compensation earned (or accrued) during the short limitation period.

    4. If an employee participates in two or more plans that have different limitation years, make sure all the allocations under each plan have been taken into account per 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 - elective deferrals under 401(k) plans (other than catch-up contributions), both traditional and Roth contributions.

    2. Employee contributions - employee after-tax contributions (whether voluntary or mandatory) other than designated Roth 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 per IRC 401(h).

    6. Amounts derived from contributions paid or accrued after December 31, 1985, in taxable years ending after that 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.

      Note:

      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 are still considered annual additions even if they’re excess deferrals, excess contributions, excess aggregate contributions or corrected excess contributions through distribution or recharacterization. (26 CFR 1.415(c)-1(b)(1)(ii)). However, excess deferrals distributed per 26 CFR 1.402(g)-1(e)(2) or (3) are not annual additions. (26 CFR 1.415(c)-1(b)(2)(ii)(D)).

  3. Annual additions are not:

    1. Catch-up contributions made under IRC 414(v). (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. (26 CFR 1.415(c)-1(b)(1)(iii)).

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

    4. Participant loan repayments. (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. (26 CFR 1.415(c) -1(b)(4)).

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

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

    7. Employer restoration of an employee’s accrued benefit resulting from the repayment of cash-outs (generally under a governmental plan). (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. An employer or employee contribution of property other than cash is considered a contribution equal to the fair market value of the property on the date the contribution is made. (26 CFR 1.415(c)-1(b)(5)).

General Rules Applicable to Annual Additions

  1. An amount is an annual addition if it’s credited to a participant for a limitation year. An amount is credited if it’s allocated to a participant’s account under the plan terms as of any date within that limitation year. (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’re actually made by 30 days after the period described in IRC 404(a)(6) for the tax year with or within which the limitation year ends. (26 CFR 1.415(c)-1(b)(6)(i)(B)). Under IRC 404(a)(6), payments made by the time prescribed by law for filing the return for a taxable year (including extensions) and on account of that taxable year, are 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 doesn’t apply because the employer doesn’t file a tax return, so the IRC 404 (a)(6) reference point for calculating the 30 day period does not apply. Instead, the IRC 415 crediting deadline is 91/1 months after the close of the taxable year in which the limitation year ends for the contribution to be treated as an annual addition for the prior year.

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

  4. There are four special timing rules in which 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. (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 (SEP IRA) described in IRC 408(k).

    4. Certain contributions made per a veteran’s reemployment rights under IRC 414(u)(1)(B).

  5. Employee contributions (voluntary and mandatory) are not treated as credited to a participant’s account for a particular limitation year unless the contributions are actually made to the plan no later than 30 days after the close of that limitation year. (26 CFR 1.415(c)-1(b)(6)(i)(C)).

Medical Benefit Accounts

  1. 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). (IRC 415(l)). However, the DC compensation limitation (IRC 415(c)(1)(B)) doesn’t apply to this 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 that participant, (and his spouse and dependents).

  2. When a pension or annuity plan has medical benefits (which may include benefit payments for sickness, accident, hospitalization and medical expenses of retired employees, their spouses and dependents), these benefits must be subordinate to the plan’s retirement benefits. (IRC 401(h)).

    Note:

    This requirement that benefits be subordinate to the plan’s retirement benefit is not met if the actual contributions for the plan’s medical benefits plus contributions for life insurance protection exceed 25% of the total actual contributions to the plan (other than contributions to fund past service credits) after the date the account is established. (26 CFR 1.401-14).

  3. The plan must set up and maintain a separate account for these benefits, and the employer’s contributions to this separate account must be reasonable and determinable. (IRC 401(h)).

    1. All plan liabilities for these 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 these benefits.

    2. Once the plan satisfies all liabilities for these benefits, the plan must return remaining amounts in the separate account to the employer.

    3. For benefits payable to each key employee (and his spouse and dependents), a separate account is established and maintained, and the plan must pay benefits payable for that key employee attributable to plan years beginning after March 31,1984, for which the employee is a key employee, from that separate account. 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. Contributions for post-retirement medical benefits for key employees (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)) under IRC 419A(d):

    1. Are treated as annual additions for IRC 415(c). However, the DC compensation limitation (IRC 415(c)(1)(B)) doesn’t apply to these amounts.

    2. Must be allocated to separate accounts, and benefits for key employees after retirement must be paid from these separate accounts.

  5. If a participant’s account exceeds the IRC 415(c) limits when aggregating a medical account in 26 CFR 1.415(c)-1(a)(2)(ii)(C) or (D) and a DC plan other than a medical account, for a particular limitation year, the DC plan other than the medical account is disqualified for the limitation year. (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 to freeze the DB plan benefit accruals (in other words, no additional service or compensation credits accrue). Per the election, the amounts the participant would’ve received as a DB retirement payment had he in fact retired are credited to a DROP (these amounts are referred to as DB Benefit Amounts). The DROP may also permit employee or employer contributions in addition to the DB Benefit Amounts (Additional Contributions).

  2. Administrative Guidelines - If you’re reviewing a governmental DB plan:

    1. Don’t treat the DB benefit amounts credited to a DROP as annual additions subject to the IRC 415(c) limitation that applies to DC plans.

    2. If it doesn’t allow additional contributions to the DROP, the plan isn’t required to apply IRC 415(c) limitation provisions for the DROP.

  3. If you’re reviewing a governmental DB plan that allows additional contributions to the DROP, treat these additional contributions as annual additions subject to the IRC 415(c) limits if the DROP meets all three criteria below. Review the plan document to see if it meets these criteria:

    1. The DROP has segregated accounts for each participant. For this criterion, if the plan’s language states it has segregated accounts for each participant, contact the plan’s representative to receive written confirmation under penalties of perjury of how the plan is actually operated.

    2. DROP earnings are based solely on actual investment earnings, (in other words, the DROP doesn’t have a fixed or guaranteed rate of return on funds in the DROP).

    3. The DROP doesn’t stop accruing earnings at any time.

      Note:

      If any of the above three criteria are not satisfied, then additional contributions aren’t treated as annual additions subject to the IRC 415(c) limits.

      Note:

      See 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, for the three criteria and examples of plan language to help you review 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 permits additional contributions, use the following information in paragraphs 2 - 4 to help apply the three criteria listed in IRM 4.72.7.4.4, DROP Design.

  2. Segregated accounts for each participant

    1. If the plan’s language indicates it has segregated accounts for each participant, contact the plan’s representative to receive written confirmation under penalties of perjury of how the plan is actually operated. If the plan doesn’t operate by paying benefits only from the assets in the participant’s DROP account, this first criterion is not met. An example of segregated account plan language follows:

      Example:

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

    2. If the plan language doesn’t require segregated accounts for each participant or the plan’s representative confirms that the plan isn’t actually operated with segregated accounts, then don’t treat additional contributions as annual additions subject to IRC 415(c) limits. 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.)

  3. Actual investment earnings

    1. If a DROP’s rate of return is based on a rate other than actual investment earnings (such as a fixed or guaranteed rate), the DROP account is not based "solely" on contributions and earnings and the additional contributions aren’t treated as annual additions subject to the IRC 415(c) limits. Examples of DROP designs that have a fixed or guaranteed rate of return include designs where:

      Example:

      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 (for example 10-year Treasury bills) or at a 0% rate of return (in other words, no earnings)).

      Example:

      The plan sets a maximum and/or minimum for investment returns (for example a participant may choose from individual investments but is guaranteed a return of not less than x%).

      Example:

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

       

    2. The following examples show plan language that has fixed or guaranteed rates of return:

      Example:

      Fixed rate on assets in DROP account: 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.

      Example:

      Maximum or minimum rate: 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.

      Example:

      Interest rate determined by participant election: . Payment to the DROP shall be credited with interest according to one of the following options chosen by the DROP participant:
      (a) The DROP account is credited 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).
      (c) The Drop account is credited with a fixed rate of X percent, or the rate equal to the net investment of Plan assets or the net investment return of the assets in the DROP account as selected by the DROP participants.

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

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

    2. If the DROP stops crediting investment earnings while assets remain in the DROP (for example after the DROP period), the DROP isn’t using actual investment earnings and the additional contributions aren’t annual additions subject to the IRC 415(c) limits.

    3. The following examples of plan language show 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 plan tests annual addition limitations using:

    1. All annual additions for all DC plans of the employer, including features of plans treated as DC plans for IRC 415 testing (such as employee contributions under contributory DB plans), and

    2. All DC plans of any other employers treated along with the employer’s plan as a single plan.

  2. Verify that the plan treats contributions allocated to any individual medical account that’s part of a pension or annuity plan as an annual addition to a DC plan (although the IRC 415(c)(1)(B) compensation limitation doesn’t apply to these amounts). See IRC 415(l) and IRC 401(h).

  3. Verify that the plan treats amounts attributable to medical benefits allocated to accounts for post-retirement medical or life insurance benefits for key employees, under IRC 419A(d), as an annual addition to a DC plan for IRC 415(c) (although the IRC 415(c)(1)(B) compensation limitation doesn’t apply to these amounts).

Defined Contribution Plan Limitation

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

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

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

IRC 415(c) Dollar Limitation

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

    1. Each year, the IRS publishes the limitations that apply to qualified plans under IRC 415, adjusted for cost-of-living increases 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 other than the calendar year, the limit for the plan’s limitation year is the limitation in effect for the calendar year in which the plan’s limitation year ends.

    3. A participant’s annual additions for a limitation year can’t exceed the current dollar limitation (as in effect before the January 1 adjustment). However, after a January 1 adjustment is made, a participant’s annual additions for the entire limitation year can be measured against the January 1 adjusted dollar limitation. (26 CFR 1.415(d)-1(b)(2)(iii)).

      Example:
      Clarification of Timing: The dollar limit increased from $56,000 for 2019 to $57,000 for 2020. For a limitation year ending June 30, 2020, the $57,000 limit applies. However, annual additions for that year that are credited before January 1, 2020, must be limited to the 2019 limit of $56,000, even though total annual additions for the entire year could be up to $57,000. A participant could not receive an allocation of contributions of $57,000, credited on October 1, 2019, simply because the dollar limit for the year which includes October 1, 2019 (the limitation year ending June 30, 2020) is $57,000.
      Example:
      Clarification of Timing: Same facts as the previous Example, except that the plan makes monthly employer contributions of $4,800 per month for the participant for the period July 1, 2019 to June 30, 2020. The participant’s annual addition is limited to $57,000 because for a limitation year ending June 30, 2020, the $57,000 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
    January 1, 2020 $57,000
    January 1, 2021 $58,000
    See www.irs.gov/retirement-plans/cola-increases-for-dollar-limitations-on-benefits-and-contributions for current dollar limitations.

DC Compensation Limitation

  1. If a participant’s compensation for a limitation year is less than the DC dollar limitation for that limitation year, then the annual additions to that participant’s account for the limitation year are limited to 100% of their compensation (DC compensation limitation).

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

  3. For the DC compensation limitation, a plan must specify the definition of compensation it uses, which may differ from the plan’s definition of compensation on which it allocates contributions.

IRC 415(c)(3) Compensation
  1. While the terms of a plan may use a different definition of compensation to calculate the rate of employer contributions, it must use a definition of compensation per IRC 415(c)(3) to determine whether the maximum permissible contributions have been exceeded. A plan that incorporates IRC 415 by reference must specify which definition of compensation it uses.

  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 that employee includes compensation from all the employers in the group, whether or not they maintain the plan. (26 CFR 1.415(c) -2(g)(2)).

  3. Use total compensation a participant receives from all the employers maintaining a multiemployer plan for the IRC 415 limit, unless the plan specifies otherwise.

Amounts Includible as IRC 415(c)(3) Compensation
  1. To apply the IRC 415 limitations, the term compensation includes all the following and doesn’t include any other form of remuneration. (26 CFR 1.415(c)-2(b)).

    Type of remuneration Definition
    a 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 aren’t 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 non-accountable plan as described in 26 CFR 1.62-2(c).
    b 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).
    c 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.
    d 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.
    e The value of a non-statutory 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.
    f The amount includible in the gross income of an employee upon making the election described in IRC 83(b).
    g 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.
    h For years beginning after December 31, 1997, compensation for IRC 415 purposes includes any elective deferral (per IRC 402(g)(3)) and any amount the employer contributes or defers at the employee’s election and which is excludible in the employee’s gross income under IRC 125 or IRC 457. SBJPA amended IRC 415(c)(3) for years beginning after December 31, 1997.
    • A salary reduction contribution to purchase qualified transportation fringe benefits is an elective deferral. This change is retroactive to years beginning after December 31, 1997.

  2. In determining amounts under IRM 4.72.7.5.2.1.1(1)(a) and (b) in the table above: include foreign earned income (as defined in IRC 911(b)), whether or not excludible from gross income under IRC 911. Determine compensation under IRM 4.72.7.5.2.1.1 (1)(a) without considering the exclusions from gross income in IRC 872, IRC 893, IRC 894, IRC 911, IRC 931 and IRC 933. (26 CFR 1.415(c)-2(g)(5)(i)).

  3. ) 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). (26 CFR 1.415(c)-2(f)). For the dollar limitation amount, see COLA Increases for Dollar Limitations on Benefits and Contributions.

  4. 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, "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 .

  5. 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, these 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.

  6. To apply the IRC 415 limitations, "compensation" doesn’t include the following under 26 CFR 1.415(c)-2(c).

    Type of remuneration Definition
    a 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)) the employer made to a plan of deferred compensation (including a Simplified Employee Pension in IRC 408(k) or a SIMPLE retirement account in IRC 408(p), and whether or not qualified) if not includible in the employee’s gross income for the taxable year in which contributed.
    b Any distributions from a plan of deferred compensation, regardless of whether they’re includible in the employee’s gross income when distributed.

    Exception:

    If the plan so provides, any amounts an employee receives per a nonqualified unfunded deferred compensation plan may be considered compensation for IRC 415 purposes in the year the amounts are actually received, but only if includible in the employee's gross income.

    c Amounts realized from the exercise of a non-statutory stock option or when restricted stock (or property) an employee holds, either becomes freely transferable or is no longer subject to a substantial risk of forfeiture. See IRC 83 and the Treasury regulations thereunder.
    d Amounts realized from the sale, exchange or other disposition of stock acquired under a statutory stock option.
    e Other amounts which receive special tax benefits, such as premiums for group-term life insurance (but only the premiums are not includible in the employee’s gross income and aren’t salary reduction amounts described in IRC 125).
    f Other items of remuneration that are similar to any of the items a) through e) above

Safe Harbor Definitions of Compensation
  1. For purposes of the IRC 415 limits, a plan may use any of the following safe harbor definitions for compensation:

    Definition Name Safe Harbor compensation definition
    Simplified Definition Only compensation under IRM 4.72.7.5.2.1.1 (1)(a) or (b)
    excludes all amounts in IRM 4.72.7.5.2.1.1 (6).
    IRC 3401(a) wages Wages per IRC 3401(a) for 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, disregard any rules that limit the remuneration included in wages based on the employment’s nature or location or the services performed (such as the exception for agricultural labor in section 3401(a)(2)).
    Information required to be reported under IRC 6041, IRC 6051 and IRC 6052 Amounts that are compensation under the safe harbor definition of IRM 4.72.7.5.2.1.2 (1)(b), plus all other compensation an employer pays to an employee (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 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 definition may be modified to exclude amounts the employer paid or reimbursed for an employee’s moving expenses, but only if, at the time it’s paid, 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, to be considered for a limitation year, under 26 CFR 1.415(c)-2(e)(1), compensation must be:

    1. Actually paid or made available to an employee (or, if earlier, includible in the employee’s gross income) within the limitation year.

    2. Paid or treated as paid to the employee before his severance from employment with the employer who has the plan.

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

    1. Paid during the first few weeks of the next limitation year.

    2. Included on a uniform and consistent basis for all similarly situated employees.

    3. Not included in more than one limitation year.

      Note:

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

  3. Compensation paid after severance from employment may be IRC 415(c)(3) compensation even if it’s paid after the employee's severance from employment with the employer maintaining the plan, as long as it’s paid by the later of:

    1. 21/1 months after severance from employment with the employer who maintains the plan, or

    2. the end of the limitation year that includes the employee’s date of severance from employment with the employer who maintains the plan.

  4. Compensation items included after an employee leaves employment are:

    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’ve been paid to the employee before the severance from employment if the employee had continued in employment.

    2. Leave cash outs and deferred compensation (defined below).

  5. Leave cash outs and deferred compensation are:

    1. Payment to a terminated employee for unused accrued bona fide sick, vacation or other leave, but only if the employee could’ve used the leave if employment had continued; or

    2. Payment an employee received per a nonqualified unfunded deferred compensation plan, but only if the payment, i) would’ve been paid to the employee at the same time if the employee had continued employment with the employer and ii) is includible in the employee's gross income.

  6. Other post-severance payments not described in IRM 4.72.7.5.2.1.3 (4) and IRM 4.72.7.5.2.1.3 (5) above aren’t considered IRC 415(e)(3) compensation if paid after severance of employment, even if paid within the correct time period.

    Example:

    Compensation doesn’t include severance pay, parachute payments per IRC 280G(b)(2) or post-severance payments under a nonqualified unfunded deferred compensation plan unless the payments would’ve been paid at that time without considering the severance from employment. (26 CFR 1.415(c)-2(e)(3)).

  7. Salary continuation payments for military service and disabled participants – if the plan provides, the rules for payment before severance don’t apply to payments to an individual who doesn’t 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). (26 CFR 1.415(c)-2(e)(4)).

  8. Special rule for governmental plans - to apply the rules under IRM 4.72.7.5.2.1.3 (3), a governmental plan (as defined in IRC 414(d)) may substitute 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. Verify the plan uses an IRC 415 definition of compensation to determine whether a participant exceeded the IRC 415 limits.

  2. Determine the plan’s definition of IRC 415(c)(3) compensation and make sure they use this definition to calculate a participant’s IRC 415(c) limit.

  3. Verify an employee’s compensation from all members of a controlled group is taken into account when you calculate their IRC 415(c) limit.