4.72.13 IRC 403(b) Plans

Manual Transmittal

December 18, 2020

Purpose

(1) This transmits revised IRM 4.72.13, Employee Plans Technical Guidelines, IRC 403(b) Plans.

Material Changes

(1) Updated IRM 4.72.13.1.1, IRM 4.72.13.15.3.1 and IRM 4.72.13.15.4.1 to reflect the final hardship distribution regulations under IRC 401(k) that were published in the Federal Register on September 23, 2019, and that apply to an IRC 403(b) plan.

(2) Updated IRM 4.72.13.1.3 to include CSIS, RAL, RAP and SECURE Act.

(3) Updated IRM 4.72.13.7.6 and IRM 4.72.13.7.7 to reflect Rev. Proc. 2019-39, which established a recurring cycle of remedial amendment periods for IRC 403(b) individually designed and pre-approved plans.

(4) IRM 4.72.13.11 and IRM 4.72.13.11.3 were updated for 2020 IRC 402(g) and IRC 415 contribution limits.

(5) Revised IRM 4.72.13.13, IRM 4.72.13.15.1, IRM 4.72.13.15.2 and IRM 4.72.13.15.4.1.1 (8) to reflect changes made by the Setting Every Community Up for Retirement Enhancement Act of 2019 (Division O of Pub. L. 116-94) and the Taxpayer Certainty and Disaster Tax Relief Act of 2019 (Division Q of Pub. L. 116-94).

(6) Updated IRM 4.72.13.15.3, IRM 4.72.13.15.3.1 and IRM 4.72.13.15.4.1 for changes made by final hardship regulations under IRC 401(a) which generally apply to IRC 403(b).

(7) Added IRM 4.72.13.15.4 (10) to explain records to be examined to determine if hardship distribution was necessary and proper.

(8) Updated IRM 4.72.13.17 (6) to provide reference to Rev. Rul. 2020-23 concerning distribution of an Individual Custodial Account to a participant upon plan termination.

(9) Updated IRM throughout for editorial changes and for reference to current revenue procedures.

Effect on Other Documents

This supersedes IRM 4.72.13 dated November 07, 2019.

Audience

Tax Exempt and Government Entities
Employee Plans

Effective Date

(12-18-2020)

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

Program, Scope and Objectives

  1. Purpose: IRM 4.72.13, Employee Plans Technical Guidelines, IRC 403(b) Plans, gives technical guidance and examination steps for Employee Plans (EP) agents to use when examining Internal Revenue Code IRC 403(b) plan. This IRM section also aids group managers in reviewing an agent’s case file.

  2. Audience: This IRM gives procedures for agents, group managers and support staff in EP Examinations.

  3. Policy Owner: Director, EP Examinations.

  4. Program Owner: EP Examinations.

  5. Program Authority: IRC 6201 confers the authority to make tax liability determinations. IRC 7602 grants authority to conduct examinations of taxpayers. Delegation Order 25-8 grants revenue agents the authority to issue document requests. Delegation Orders 7-1 through 7-16 give Employee Plans the authority to resolve pension plan issues.

  6. Program Goals: The goal is to promote quality IRC 403(b) examinations. To achieve this goal, this IRM considers two areas: qualification and taxation. For each area, this IRM discusses the applicable law then outlines the examination steps the agent may take to verify compliance with the law. This IRM also helps group managers review 403(b) cases, give technical help to their agents and resolve IRC 403(b) issues with the taxpayer.

Background

  1. EP Examinations determines:

    • IRC 403(b) plan compliance with current law.

    • Tax liability for non-complaint IRC 403(b) plans.

    • Resolution of unresolved tax liabilities.

  2. The history and regulatory framework of IRC 403(b) plans are as follows:

    Legal Authority Provision
    The Technical Amendments Act of 1958, Public Law 85-866 Created IRC 403(b).
    The first 403(b) regulations were TD 6783 (29 FR 18356), published in 1964. Detailed some of the basic statutory provisions of IRC 403(b). As new provisions were added to IRC 403(b), these regulations were amended.
    The Tax Reform Act of 1986 (TRA ‘86) Required certain 403(b) plans to follow nondiscrimination and coverage rules including IRC 401(a)(4), IRC 401(m) and IRC 410(b).
    26 CFR 1.401(a)(31)-1, Q&A-1 States that the direct rollover requirements apply to IRC 403(b) plans, effective for years beginning after 1992, IRC 403(b)(10).
    The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) Amended various IRC 403(b) sections, effective for years beginning after 2001, for compensation, deferral limitations, age 50 catch-up contributions, rollovers, and distributions.
    The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) Permits IRC 403(b) plans to have Roth contributions, effective for tax years beginning after 2005, IRC 402A.
    Proposed regulations were issued on November 16, 2004 Comprehensively updated the IRC 403(b) regulations.
    The Pension Protection Act of 2006 (PPA ‘06) Amended various IRC 403(b) provisions by making certain EGTRRA provisions permanent and changing hardship distributions.
    Regulations under IRC 415 issued April 4, 2007, effective for limitation years beginning after June 30, 2007 Changed the definition of 415 compensation to include certain types of post-severance compensation.
    Final IRC 403(b) regulations (T.D. 9340) were issued on July 26, 2007, (generally effective on January 1, 2009). Reflect PPA amendments to IRC 403(b) and require that, effective January 1, 2009, all IRC 403(b) plans adopt a written plan document.
    Rev. Proc. 2007-71 Gives model plan language that public schools may use to follow the written plan requirement. Other 403(b) plan sponsors may rely on the language if it applies to their organization.
    The Heroes Earning Assistance and Relief Tax Act of 2008 (HEART), Added death benefits for a participant performing qualified active military service under the Uniform Services Employment and Re-employment Rights Act of 1994 (USERRA) as required under IRC 403(b)(14) and IRC 401(a)(37).
    The Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) added provisions effective for plan years beginning after December 31, 2009. Required plan sponsors to offer a direct rollover of benefits by a nonspouse beneficiary, generally subject to the same rules as other eligible rollovers, IRC 401(a)(31) and IRC 402(f)(2)(A).
    Notice 2009-3 Delayed the date by which to adopt written plan requirement to December 31, 2009, if certain requirements were met.
    Rev. Rul. 2009-18 Listed obsolete IRC 403(b) guidance.
    Announcement 2009-34 Included a draft revenue procedure for an IRC 403(b) pre-approved program. The IRS also issued a Listing of Required Modifications (LRMs) for IRC 403(b) plans.
    Announcement 2009-89 Announced an initial remedial amendment period (RAP) for IRC 403(b) plans that meet certain conditions and either adopt a pre-approved plan with a favorable opinion letter or apply for a determination letter when those programs are available.
    Rev. Rul. 2011–7 Gives guidance on an IRC 403(b) plan termination.
    Rev. Proc. 2013-12
    Rev. Proc. 2019-19 - current version
    Expanded the Employee Plans Correction Resolution System (EPCRS) to resolve matters arising from a failure to follow new requirements of the final IRC 403(b) regulations. This includes the failure to adopt a written plan in 2009 and later plan years.
    Rev. Proc. 2013-22
    • Gave the procedures for issuing opinion letters for pre-approved IRC 403(b) prototype plans and IRC 403(b) volume submitter plans.

    • Modified the RAP in Announcement 2009-89 and said that IRS doesn’t expect to issue determination letters for individually designed IRC 403(b) plans.

    • In connection with Rev. Proc. 2013-22, the IRS issued revised LRMs for IRC 403(b) plans which were updated later in 2015.

    Rev. Proc. 2014-28, issued on March 25, 2014, Amended the program for pre-approved plans and extended the deadline to submit plan documents for IRS review to April 30, 2015.
    Rev. Proc. 2017-18 Set the last day of the RAP for IRC 403(b) plans, for purposes of Section 21 of Rev. Proc. 2013-22, to March 31, 2020.
    Notice 2018-95 Gave transition relief for Notice 403(b) plans that didn’t follow the "once-in-always-in" condition for excluding employees under the universal availability requirement.
    The Tax Cuts and Jobs Act of 2017 (TCJA), Public Law 115-97 Added IRC 165(h)(5), which states that for years 2018 to 2025, the deduction for a personal casualty loss is available only to the extent the loss is attributable to a federally declared disaster.
    The Tax Cuts and Jobs Act of 2017 (TCJA), Public Law 115-97 Amended IRC 402(c)(3)(C) to give an extended rollover period for certain loan offset amounts.
    The Bipartisan Budget Act of 2018 (BBA) Modified some of the rules for hardship distributions from IRC 401(k) plans.
    Final regulations were issued on September 23, 2019, on hardship distributions from 401(k) plans Added new rules that apply to IRC 403(b) plans through 26 CFR 1.403(b)-6(d)(2) as discussed below.
    Rev. Proc. 2019-39 Provides a system of recurring RAPs for IRC 403(b) individually designed and pre-approved plans and gives deadlines for the adoption of plan amendments.
    The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), Public Law 116-94, Division O Made changes to IRC 403(b) custodial accounts, IRC 403(b)(9) retirement income accounts and IRC 403(b) distribution requirements.
    The Taxpayer Certainty and Disaster Tax Relief Act of 2019, Public Law 116-94, Division Q Provided disaster relief that applies to IRC 403(b) plans.
    Notice 2020-35 Extended the deadline established in Rev. Proc. 2019-39 from March 31, 2020 to June 30, 2020.

Program Controls

  1. Tax Exempt Quality Measurement System (TEQMS) is the quality control system used to oversee the TE/GE examination program.

  2. Do all examinations according to the Taxpayer Bill of Rights as listed in IRC 7803(a)(3). You can find more information at IRS.gov at www.irs.gov/taxpayer-bill-of-rights.

Acronyms/ Abbreviations, Forms and Pubs

  1. This manual uses the following acronyms and abbreviations and it references the following forms.

    Acronym/Abbreviations Definition
    ACP Average Contribution Percentage
    ADP Average Deferral Percentage
    Audit CAP Audit Closing Agreement Program
    BBA Bipartisan Budget Act of 2018
    CARES Act Coronavirus Aid Relief and Economic Security Act
    CAS Computer Audit Specialist
    CFR Code of Federal Regulations
    CODA Cash or Deferred Arrangement
    CP&C Compliance, Planning and Classification
    CSIS Compliance Strategy Information Sheet
    DOL Department of Labor
    EBSA Employee Benefits Security Administration
    EGTRRA Economic Growth and Tax Relief Reconciliation Act of 2001
    EO Exempt Organizations
    EP Employee Plans
    EPCRS Employee Plans Compliance Resolution System
    ERISA Employee Retirement Income Security Act of 1974
    FAB Field Assistance Bulletin
    FICA Federal Insurance Contributions Act
    FSLG Federal State and Local Governments
    FSL-ET Federal State and Local Governments - Employment Tax
    FUTA Federal Unemployment Tax Act
    HEART Heroes Earning Assistance and Relief Tax Act of 2008
    ICA Individual Custodial Account
    IDRs Information Document Requests
    IDRS Information Data Retrieval System
    IRA Individual Retirement Arrangement
    IRC or Code Internal Revenue Code
    IRM Internal Revenue Manuel
    IRS Internal Revenue Service
    MDIB Minimum Distribution Incidental Benefit
    PPA ‘06 Pension Protection Act of 2006
    QDRO Qualified Domestic Relations Order
    QMAC Qualified Matching Contribution
    QNEC Qualified Nonelective Contribution
    RAL Required Amendments List
    RAP Remedial Amendment Period
    RBD Required Beginning Date
    SECURE Act Setting Every Community Up for Retirement Enhancement Act of 2019
    SCP Self-Correction Program
    SEP Simplified Employee Pension
    SIMPLE Savings Incentive Match Plan for Employees
    SPD Summary Plan Description
    TCJA Tax Cut and Jobs Act of 2017
    TRA '86 Tax Reform Act of 1986
    USERRA Employment and Re-employment Rights Act of 1994
    VCP Voluntary Correction Program
    WRERA Worker, Retiree, and Employer Recovery Act of 2008
    YOS Years of Service
    Form Forms and Pubs
    Name
    Form 940 Employer's Annual Federal Unemployment (FUTA) Tax Return
    Form 941 Employer's Quarterly Federal Tax Return
    Form 990 Return of Organization Exempt From Income Tax
    Form 990-T Exempt Organization Business Income Tax Return
    Form 1023 Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code
    Form 1040 U.S. Individual Income Tax Return
    Form 1065 U.S. Return of Partnership Income
    Form 1099-R Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
    Form 1120 U.S. Corporation Income Tax Return
    Form 5329 Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts
    Form 5330 Return of Excise Taxes Related to Employee Benefit Plans
    Form 5457 Response to Reviewer’s Memorandum – EP/EO
    Form 5464 Case Chronology Record
    Form 5500 Annual Return/Report of Employee Benefit Plan
    Form 8821 Tax Information Authorization
    Form 8955-SSA Annual Registration Statement Identifying Separated Participants with Deferred Vested Benefits
    Form W-2 Wage and Tax Statement
    Document 6379 Exempt Organizations Management Information Systems Codes
    Pub 557 Tax-Exempt Status For Your Organization

Overview

  1. These guidelines:

    1. Give relevant information for examining a plan described in IRC 403(b).

    2. Help EP agents identify issues in IRC 403(b) plans.

    3. Are subject to future change as the laws governing IRC 403(b) change.

    4. Cannot be used as precedent or as an official statement of the legal position of the IRS.

    5. Shouldn’t be relied on or cited as authority by neither agents or taxpayers.

  2. When examining IRC 403(b) plans, agents must:

    1. Decide if the plan satisfies the applicable requirements of the Treasury Regulations (regulations or 26 CFR) in both form and operation.

    2. Consult the IRC, Treasury Regulations and other relevant guidance to further develop issues. Access the Treasury Regulations at: https://www.irs.gov/retirement-plans/treasury-regulations.

  3. The issues discussed in this IRM may not be relevant for every examination. You may:

    1. Change examination steps and techniques based on the examination issues you encounter.

    2. Find examination procedures for IRC 403(b) plans in IRM 4.71.17, Employee Plans Examination of Returns, Non-Return Unit Examination Procedures.

General Requirements

  1. Historically, an IRC 403(b) plan was an arrangement under which an employer purchased an individual annuity contract from an insurance company on a tax-deferred basis for an employee. Over the years, IRC 403(b) plans became more like qualified retirement plans. IRC 403(b) plans must, in part:

    1. Be maintained per a written plan that satisfies the requirements of IRC 403(b) in form and operation effective January 1, 2009. The written plan must set forth the material terms and conditions for eligibility, benefits, limitations, available contracts, and the time and form of benefit distributions that apply to the plan. The plan must be operated consistent with its terms.

    2. Follow certain nondiscrimination and coverage rules (including IRC 401(a)(4), IRC 401(a)(17),IRC 401(m), IRC 410(b), and universal availability).

    3. Ensure that elective deferrals don’t exceed the RC 402(g) limit.

    4. Conform to the minimum distribution rules of IRC 401(a)(9).

    5. Offer a participant a meaningful opportunity to elect a direct rollover to another eligible retirement plan.

    6. Satisfy the incidental benefit requirements in IRC 401(a)(9).

    7. Follow the limitations of IRC 415(c).

    8. Provide that the contract is not transferable.

    9. Provide that the rights of the employees under the annuity contract are nonforfeitable (non-vested amounts are permitted but are treated as a 403(c) contract until they vest).

    Note:

    See 26 CFR 1.403(b)-3(a).


    Example 1: The employees of Public School District Y participate in an IRC 403(b) plan. The written plan consists of several documents, including documents that are incorporated by reference, rather than a single written plan document. The 403(b) plan may satisfy the written plan requirement under 26 CFR 1.403(b)-3(b)(3) if the plan has the material terms and conditions listed in this regulation.

  2. When starting an IRC 403(b) plan examination, consider whether the plan is subject to Title I of ERISA, because it might affect the scope of examination, IRM 4.72.13.1.9, for more information. If the plan is subject to ERISA Title I, find information on the plan by using DOL's "Form 5500/Form 5500-SF Search" at: https://www.efast.dol.gov/welcome.html.

General Characteristics

  1. An IRC 403(b) plan is a retirement plan under which a public school or an IRC 501(c)(3) tax exempt organization purchases annuity contracts or contributes to custodial accounts for its employees. Certain IRC 403(b) plans may also include a retirement income account under IRC 403(b)(9).

  2. IRC 403(b) plans are exempt from the requirements that apply to qualified annuity plans under IRC 403(a) and are governed by their own separate requirements under IRC 403(b).

  3. IRC 403(b) plans are also known as:

    • IRC 403(b) arrangements

    • Tax-sheltered annuities

    • Tax-deferred annuities

    • Annuity contracts

      Note:

      Throughout this IRM, the term "annuity contract" includes custodial accounts and retirement income accounts unless otherwise specified.

  4. Contributions to an IRC 403(b) plan may consist of:

    1. Elective deferrals (including Roth contributions)

    2. Employer contributions (including contributions made per a one-time irrevocable election or as a condition of employment)

    3. Matching Contributions

    4. After-tax employee contributions

    5. Rollover contributions

  5. In an IRC 403(b) plan that permits elective deferrals, an employer gives participants a choice between receiving an amount in cash or having the employer contribute that amount to the IRC 403(b) plan.

  6. Contributions made to an IRC 403(b) plan are generally not includible in the participants' gross income for income tax purposes until distributed, even if the participants had the ability to receive the contributions as taxable wages in the year of the contributions. However, a plan may allow contributions to be treated as Roth contributions, so participants include the contributions in their gross income when made.

  7. Earnings on non-Roth contributions are tax deferred until distributed. Earnings on Roth contributions are generally not taxed when distributed.

  8. Distributions from an IRC 403(b) plan are taxable under IRC 72, relating to annuities.

  9. Generally, contributions per a salary reduction agreement to an IRC 403(b) plan, as defined in IRC 3121(a)(5)(D) (including elective deferrals, one-time elections and conditions of employment), are subject to FICA tax at the time of contribution, unless the employee is exempt from FICA tax.

    1. Employees of certain governmental and church employers may be exempt from FICA, IRC 3121(b)(7) and IRC 3121(b)(8).

    2. The employer sponsoring an IRC 403(b) plan is generally not entitled to a deduction for wages paid to employees because the employer is exempt from income tax. The employer is responsible for withholding income and FICA taxes from the employee’s wages and for paying the employer’s share of FICA, if applicable.

  10. The following examples show that IRC 403(b) plans may involve both employer and individual tax matters.

    Example 2: Hospital M, a tax-exempt organization, has an annuity plan intended to be an IRC 403(b) plan (Plan). Hospital M isn’t exempt from FICA and the Plan doesn’t allow Roth contributions. The Plan has only employer contributions that aren’t elective deferrals and it’s funded through annuity contracts. The agent discovers that the Plan doesn’t satisfy the requirements under IRC 403(b). Unless Hospital M can correct under EPCRS, the plan failure has the following tax impact for all open years under the statute of limitations, beginning in the year of the failure:

    1. Contributions made to the Plan, adjusted for earnings, are includible in the employees' gross income to the extent they are vested.

    2. The annuity contracts are subject to IRC 403(c).

    3. The Employer must withhold income tax and FICA taxes.

    Example 3: Assume the same facts as in Example 2, except that the Plan satisfies the requirements of an IRC 403(b) plan and offers both elective deferrals and employer contributions that aren’t elective deferrals. In this case:

    1. Elective deferrals are subject to FICA tax at the time of contribution. Specifically, Hospital M is responsible for FICA tax, and FICA withholding for the employee’s share at the time of contribution.

    2. Elective deferrals and employer contributions aren’t subject to income tax until distributed.

    3. Hospital M must withhold income tax on distributions from the Plan (except for direct rollovers).

Aggregated Annuity Contracts

  1. All annuity contracts (including custodial accounts and retirement income accounts) and employer purchases on behalf of an employee are treated as a single annuity contract to apply the requirements of IRC 403(b), IRC 403(b)(5) and 26 CFR 1.403(b)-3(b)(1).

IRC 403(b) and Qualified Plans

  1. Although there are many similarities, IRC 403(b) plans differ from qualified plans in some important respects such as:

    1. Only certain types of employers are eligible to maintain an IRC 403(b) plan: A 501(c)(3) organization, a state, political subdivision, or agency/instrumentality, but only for employees who perform services for an educational organization, a church, a convention or association of churches and certain ministers may sponsor an IRC 403(b) plan, IRC 403(b)(1)(A).

    2. IRC 403(b) plans may only be funded by annuity contracts and custodial accounts (and retirement income accounts for a church, or a convention or association of churches, or an organization described in IRC 414(e)(3)(A)).

    3. Elective deferrals made to an IRC 403(b) plan are subject to universal availability, a special nondiscrimination rule instead of the average deferral percentage (ADP) test that applies to cash or deferred arrangements under IRC 401(k)(3).

    4. IRC 403(b) plans don’t have a special 10-year averaging rule to calculate the taxable portion of a lump sum distribution from an IRC 403(b) plan.

    5. IRC 402(g) has an increased limit on elective deferrals for certain participants in an IRC 403(b) plan.

    6. IRC 415 compensation is defined as includible compensation which is figured under IRC 403(b)(3).

    7. IRC 403(b) plans may make certain nonelective employer contributions for former employees for up to five taxable years after the taxable year in which he or she ceases to be an employee, IRC 403(b)(3) and 26 CFR 1.403(b)-4(d).

    8. Once an employee makes contributions per a salary reduction agreement, they are always considered a participant, IRM 4.72.13.14.1 (17) for a discussion of the transition relief in Notice 2018-95.

IRC 403(b) Filing Requirements

  1. Only IRC 403(b) plans subject to Title I of ERISA are required to file Form 5500. Some exceptions to ERISA coverage are:

    1. Church plans as defined in IRC 414(e), that haven’t made an election under IRC 410(d)

      Note:

      This definition is different from the definition of church for IRC 403(b) purposes, IRC 403(b)(12)(B) and 26 CFR 1.403(b)-2(b)(5).

    2. Governmental plans

    3. 403(b) plans that are not employee pension benefit plans under Title I of ERISA by virtue of the safe harbor in DOL Reg 2510.3-2(f).

  2. In general, the DOL safe harbor provides that an IRC 403(b) plan is not subject to Title I of ERISA if both:

    1. The plan has only elective deferrals, and doesn’t allow employer contributions.

    2. The employer's involvement is limited to the minimal functions permitted under DOL Reg. 2510.3-2(f).

      Note:

      See Field Assistance Bulletin (FAB) 2007-02 and FAB 2010-01 on the DOL website at the link below. These FABs discuss types of employer involvement (including, authorizing plan distributions, hardship withdrawals, or loans) that can trigger ERISA coverage.

  3. The Employee Benefits Security Administration (EBSA) of the DOL issues FABs and other DOL guidance at: https://www.dol.gov/agencies/ebsa/key-topics/retirement/403b-plans. EBSA issued the following guidance on IRC 403(b) plan filing requirements:

    FAB Description
    FAB 2007-02 Discussed the final 403(b) regulations’ effect on the DOL safe harbor regulations in DOL Reg 2510.3-2(f) on when an employer remains outside the coverage of ERISA.
    FAB 2009-2 Gave transitional relief from requirements for IRC 403(b) plans for Form 5500 annual reporting.
    FAB 2010-01
    • Supplemented FAB 2009-02 on the scope and conditions required for FAB 2009-02 transitional relief.

    • Discussed questions on the scope of the DOL’s safe harbor regulations in DOL Reg. 2510.3-2(f).

  4. An IRC 403(b) plan may be required to file Form 8955-SSA with the IRS.

    1. Plans file Form 8955-SSA with the IRS to satisfy the reporting requirements of IRC 6057(a).

    2. Plans subject to Title I of ERISA must file Form 8955-SSA.

      Exception:

      Governmental plans and church plans (as defined in IRC 414(e)) that haven’t elected under 410(d) are generally excluded from coverage under Title I of ERISA, FAB 2009-2 and, therefore, don’t need to file a Form 8955-SSA.

Scope of the Examination

  1. We use the focused examination method to do IRC 403(b) examinations.

  2. The Compliance Strategy Information Sheet (CSIS) identifies the issue or issues you should examine.

    1. Decide based on your pre-contact review if you see other issues.

    2. Review the document for current law as a standard issue, if plan document review is not on the CSIS.

    3. Discuss the scope of the examination with your manager.

  3. See IRM 4.71.1.5, Overview of Form 5500 Examination Procedures, Scope of the Examination, for a more detailed description of the focused examination method.

Pre-Contact Analysis

  1. A comprehensive pre-contact analysis per IRM 4.71.1.6, Overview of Form 5500 Examination Procedures, Pre-examination Analysis lists pre-contact responsibilities and is important to:

    • Organize the examination.

    • Identify potential issues before you send an appointment letter.

  2. For plans required to file, find their Forms 5500 on DOL's "Form 5500/Form 5500-SF Search" at: https://www.efast.dol.gov/welcome.html. IRC 403(b) plans not subject to Title I of ERISA aren’t required to file a Form 5500.

  3. Review other information to identify potentially significant issues, such as the Internet, Form 990, W-2 data, 5500 returns for related plans, and IDRS.

    1. Look at the Employment Code shown on the INOLES to determine the type of employer. Also review other IDRS information. Find codes in Document 6379.

      Note:

      See IRM 4.71.2, Overview of IDRS and Non-Master File Transcript Requests, for a description of IDRS command codes.

    2. BMFOLO shows the IRC 501(c) ruling date and the Code section the organization is exempt under.

    3. Determine if the plan sponsor is under examination by EO or FSLG, and if so, if they’ve already begun an examination. Contact and coordinate with the EO or FSLG specialist. Resolve any conflicts through the group managers.

  4. Determine if you need help from specialists such as Computer Audit Specialists (CAS), EO, and FSLG. See IRM 4.10.2.7.5.1, Examination of Returns - Pre-Contact Responsibilities, Referral Criteria, for procedures to request specialist help.

  5. When you complete the pre-contact analysis, prepare Letter 1346-D, Form 5464 and proper Information Document Requests (IDRs) for the various types of records you need to conduct the examination. Include a copy of Pub. 1, Your Rights as a Taxpayer, with your first letter to the taxpayer. https://www.irs.gov/pub/irs-pdf/p1.pdf.

    Note:

    EO Examination developed Initial IDRs you may use.

  6. Request a copy of the written plan before your initial appointment. Reviewing the plan will provide valuable information on how the plan should operate.

Package Examination

  1. Package examinations include assessing the employer’s various filing requirements.

  2. The types of returns that fall within the EP package examination requirements include:

    • Form 5500

    • Form 5330

    • Form 990-T

    • Form 990

    • Form 940

    • Form 941

    • Form W-2

    • Form 1040

      Note:

      Because only exempt organizations and governmental entities are eligible to maintain IRC 403(b) plans, Form 1120 and Form 1065 are generally not part of the package examination in an IRC 403(b) plan.

  3. Research IDRS to determine filing requirements and whether returns have been timely filed.

  4. See IRM 4.71.1.14, Overview of Form 5500 Examination Procedures, Package Examination Requirements.

Initial Interview

  1. The initial interview is an essential part of the examination process and is a productive way to gather information.

  2. You should hold the initial interview with persons who are familiar with the employer’s organization, the various deferred compensation plans maintained, and the day-to-day operation of the IRC 403(b) plan under examination.

  3. A properly planned and executed interview will give you an understanding of the employer’s history, operations, and accounting records.

  4. Prepare specific questions in advance of the initial interview. Consider the type and structure of the employer and the types of deferred compensation plans the entity has. Ask questions about the day-to-day operation of the IRC 403(b) plan. All of these help you prepare your focused examination plan.

  5. Some important things to consider when you prepare for and conduct an initial interview:

    1. Know what you want to do.

    2. Develop a strategy.

    3. Use a questionnaire as an aid but remain flexible.

    4. Interview people who can best answer your questions.

    5. Listen to answers.

    6. Follow up immediately if responses are ambiguous.

    7. Document responses.

  6. IRMs on interviews:

    • IRM 4.71.1.12, Overview of Form 5500 Examination Procedures, Initial Interview

    • IRM 4.10.3.3, Examination of Returns, Examination Techniques

Evaluation of Internal Controls

  1. Internal controls are the plan administrator’s procedures and practices that are designed to promote and protect sound practices in plan administration and compliance with the law.

  2. The evaluation of internal controls is a continuous process beginning during the pre-contact analysis.

  3. You’ll get most of the information about the plan’s internal controls during the initial interview.

  4. The adequacy of the plan administrator’s internal controls determines the sample size you’ll use and will set parameters for the depth of your review.

  5. Evaluate internal controls for each aspect of plan administration.

  6. A well-designed questionnaire will help you evaluate internal controls and help you understand the plan’s administrative and accounting systems. Direct your questionnaire to employees who are directly responsible for the plan administration. You may combine internal controls questions with the initial interview questionnaires.

  7. Plan records and persons responsible for maintaining them are usually located at the employer’s place of business; therefore, you should conduct the initial interview and the assess internal controls at the plan sponsor's place of business, 26 CFR 301.7605-1(d) and IRM 4.10.3.5, Examination Techniques, Evaluating the Taxpayer's Internal Controls.

Written Plan Requirement Overview

  1. Regulations 26 CFR 1.403(b)-3(b)(3)(i) introduced a new IRC-based written plan requirement for IRC 403(b) plans. It requires that an IRC 403(b) program both:

    1. is maintained per a written defined contribution plan, and

    2. satisfies the requirements of IRC 403(b) and underlying regulations in form and operation.

  2. The written plan requirement gives employers a central location to determine benefits and administrative responsibilities under the IRC 403(b) program, and is intended to improve the administration and coordination of the various legal requirements.

  3. Originally, employers had to have a written plan by January 1, 2009, the effective date of the IRC 403(b) regulations. However, in Notice 2009-3, the IRS extended the deadline to December 31, 2009, if certain conditions were met, IRM 4.72.13.7.5,

  4. An employer that didn’t adopt a written plan document by December 31, 2009, may still do so by complying with the procedures in Rev. Proc. 2019-19, Sections 5.02(2)(a) and 6.10(3).

  5. An IRC 403(b) written plan may be an individually designed or pre-approved plan document. The plan document may incorporate other documents by reference, however, if a plan provision conflicts with another document, the plan document governs.

Written Plan Requirement

  1. The IRC 403(b) written plan requirement doesn’t require that there must be a single plan document. Instead, the written plan may be made up of multiple documents, including documents that are incorporated by reference. These documents, when taken together, must satisfy the requirements of IRC 403(b).

  2. The IRC 403(b) written plan must contain all of the material terms and conditions for eligibility, benefits, limitations, available contracts, and the time and form of distribution to satisfy the written plan requirement in 26 CFR 1.403(b)-3(b)(3).

  3. Rev. Proc. 2007-71, Section 8, has guidance on the written plan requirement for 403(b) contracts under which contributions have ceased.

    1. Contracts that stopped receiving contributions before January 1, 2005, are excluded from the written plan document requirement. Therefore, if a plan sponsor stopped making all IRC 403(b) contributions before January 1, 2005, the plan sponsor does not need a written plan document.

    2. Contracts issued after December 31, 2004, and before January 1, 2009, by an issuer that doesn’t receive contributions under the plan in a year after the contract was issued, are excluded from the written plan requirement if the employer makes a "good faith, reasonable effort" to include the contract as part of the employer's plan. A good faith, reasonable effort should entail the employer collecting available information about the issuers and notifying them of the plan administrator's name and contact information for purposes of coordinating information necessary to satisfy IRC 403(b).

    Example 4: Organization A offered employees the opportunity to defer compensation in an IRC 403(b) arrangement. On December 30, 2004, Organization A discontinued allowing any of its employees the opportunity to defer compensation to the IRC 403(b) arrangement and instead adopted an IRC 401(k) plan. Organization A doesn’t have to comply with the written plan requirements as long as it made a good faith, reasonable effort, because its contract stopped receiving contributions before January 1, 2005.

Written Plan Exclusions

  1. In general, a contract doesn’t satisfy IRC 403(b) unless it is part of a written plan that satisfies 26 CFR 1.403(b)-3(b)(3).

  2. However, the written plan requirement doesn’t apply to contributions by a church unless the contributions are made to a retirement income account under IRC 403(b)(9) and 26 CFR 1.403(b)-3(b)(3)(iii).

Sample Plan Language

  1. Public school plans may use the model plan language in Rev. Proc. 2007-71 to follow the written document requirement.

    1. Although the model plan language in Rev. Proc. 2007-71, Section 5, is directed towards public schools, other 403(b) plan sponsors may use the language in the revenue procedure as a guide when drafting their plans, Rev. Proc. 2007-71, Section 5.

    2. Public schools that use the language in Rev. Proc. 2007-71 have reliance that their plan documents follow the written plan requirement in the regulations, Rev. Proc. 2007-71, Section 4.

    Note:

    Rev. Proc. 2007-71 includes added guidance that applies to all IRC 403(b) plans.

  2. The LRMs have sample plan language for IRC 403(b) plans and are available on the IRS website at https://www.irs.gov/retirement-plans/listing-of-required-modifications-lrms.

Written Provision for Information Sharing Agreements

  1. An information sharing agreement is generally required between the employer sponsoring an IRC 403(b) plan and any vendor that isn’t an approved vendor (for example, a payroll slot vendor) under the plan, 26 CFR 1.403(b)-10(b)(2)(i)(C).

  2. Certain contracts that aren’t required to be brought under an employer’s written IRC 403(b) plan have an information sharing requirement, under Rev. Proc. 2007-71, Section 8.01:

    1. Contracts which received contributions on or between January 1, 2005, and December 31, 2008, by an issuer that doesn’t receive contributions under the plan in a year after the contract was issued, aren’t required to be part of the employer's written plan if the employer makes "a reasonable, good faith effort to include those contracts as part of the employer's plan."

    2. "A good faith, reasonable effort to include the contract as part of the employer's plan" includes collecting available information about the issuers and notifying them of the plan administrator's name and contact information to coordinate information needed to satisfy IRC 403(b).

    3. Plans may follow an alternative to b), above. "A reasonable, good faith effort to include a contract as part of the employer’s plan" also includes the issuer making a reasonable, good faith effort to contact the employer and exchanging any needed information to satisfy IRC 403(b) with the person in charge of administering the employer’s plan before it makes any distribution or loan to the participant or beneficiary.

  3. If the 403(b) plan allows contract exchanges, the employer must enter into an information sharing agreement with the issuer of the other contract. See 26 CFR 1.403(b)-10(b)(2)(i)(C) and Rev. Proc. 2007-71, Section 8.04, which refer to Section 6.4(d) of the model plan included in the revenue procedure. The information sharing agreement must require the employer and the vendor from time to time, to share with each other with the following:

    1. The employer must notify the vendor when the participant has had a severance from employment.

    2. The vendor must notify the employer of any hardship withdrawal that results in a six-month suspension of the participant’s right to make elective deferrals under the plan.

      Note:

      The six-month suspension isn’t required for plan years beginning after December 31, 2018, and can’t be imposed for hardship distributions made after December 31, 2019.

    3. The vendor must give information to the employer or other vendors so a vendor knows the amount of any participant outstanding plan loan so the vendor can determine whether another plan loan is not a deemed distribution under IRC 72(p)(1).

    4. Information necessary for the resulting contract or custodial account to which contributions have been made to satisfy other tax requirements, including the following: (i) the amount of any outstanding plan loan that is outstanding so a vendor can determine whether another plan loan satisfies the limitation in IRC 72(p), and (ii) information about a participant’s after-tax employee contributions to allow a vendor to determine the extent to which a distribution is includible in gross income.

Notice 2009-3 - Transitional Relief Regarding the Written Plan Requirement

  1. 403(b) plan sponsors had transitional relief during 2009 for the written plan requirement to be in place by January 1, 2009. The IRS won’t treat the IRC 403(b) plan, per Notice 2009-3, as failing to satisfy the IRC 403(b) requirements during the 2009 calendar year if:

    1. The sponsor adopts a written plan that is intended to satisfy IRC 403(b) and the related regulations on or before December 31, 2009;

    2. The plan is operated, during 2009, according to a reasonable interpretation of IRC 403(b), taking into account the regulations; and

    3. The sponsor makes its "best efforts" on or before December 31, 2009, to retroactively correct any operational failure during the 2009 calendar year to follow the terms of the written plan.

  2. The relief in Notice 2009-3 applies only to the 2009 calendar year and sponsors may not rely on it for an IRC 403(b) plan’s operation or to correct operational defects in any prior or subsequent year.

  3. Offer an IRC 403(b) plan sponsor who didn’t take the necessary actions in Notice 2009-3 by December 31, 2009, the opportunity to resolve the plan document qualification issue through Audit CAP procedures, Rev. Proc. 2019-19.

IRC 403(b) Remedial Amendment Period

  1. Plan sponsors had an initial RAP with a last day of March 31, 2020, for form defects in their IRC 403(b) plans (announced in Announcement 2009-89, modified in Rev. Proc. 2013-22, and clarified by Rev. Proc. 2017-18. Rev. Proc. 2017-18), but it was extended to June 30, 2020 (Notice 2020-35).

  2. IRS established a system of recurring RAPs for form defects first occurring after the end of the initial RAP, March 31, 2020 (Rev. Proc. 2019-39) and then announced that the new rules apply to form defects first occurring after June 30, 2020 (Notice 2020-35).

  3. The RAP is a time frame (or period) during which an employer is permitted to correct certain form defects retroactive to the first day of the plan’s RAP by timely adopting an IRC 403(b) pre-approved plan or by otherwise timely amending its plan.

    1. The first day of the initial RAP means the later of January 1, 2010, or the plan’s effective date, Rev. Proc. 2019-39, Section 4.03. The last day of the initial RAP was June 30, 2020, Notice 2020-35.

    2. A "form defect" per Rev. Proc. 2019-39, Section 4.02 is a provision, or the absence of a required provision, that causes the plan to fail to satisfy the requirements of IRC 403(b).

      Note:

      There is no RAP for failure to timely adopt an IRC 403(b) plan by December 31, 2009.

  4. The form of a plan is treated as satisfying IRC 403(b) requirements as of the first day of the plan’s initial RAP if:

    1. On or before such day, the employer adopts a written plan that is intended to satisfy the requirements of IRC 403(b), and

    2. On or before the last day of the initial RAP, the employer amends the plan, including any investment arrangements and any other documents incorporated by reference into the plan, to the extent necessary to correct any form defects retroactive to the first day of the initial RAP.

  5. The amendment requirement under IRM IRM 4.72.13.7.6 (4) is automatically satisfied (except if any documents the sponsor incorporated by reference must be amended) if the employer retroactively adopts an IRC 403(b) pre-approved plan with an opinion letter on or before the last day of the initial RAP.

    1. An IRC 403(b) pre-approved plan with an opinion letter means a plan for which an opinion letter is issued per a timely filed application under Rev. Proc. 2013-22, Section 21.04 as modified by Rev. Proc. 2014-28 and Rev. Proc. 2015-22, or its successors.

  6. IRS doesn’t have an individually designed determination letter program for 403(b) plans.

  7. Recurring and separate RAPs apply to individually designed and pre-approved IRC 403(b) plans after the initial RAP under Rev. Proc. 2019-39. In general:

    1. Pre-approved plans are on remedial amendment cycles. Plan sponsors must adopt interim amendments for law changes and restated plans by the end of each remedial amendment cycle.

    2. Plan sponsors must generally amend individually designed plans for law changes by the end of the second calendar year after the year in which the change appears on the Required Amendments List (RAL).

  8. For an individually designed plan, the RAP period begins for a form defect for:

    1. A provision or absence of a provision in a new plan, the date the plan is put into effect.

    2. An amendment to an existing plan (other than a form defect in c or d below), the earlier of the date the amendment is adopted or put into effect.

    3. A provision that fails 403(b) by reason of a change in IRC 403(b) requirements, the date the change became effective.

    4. A provision that is integral to a change in IRC 403(b) requirements, the first day on which the plan was operated in accordance with that provision.

  9. For an individually designed plan that is non-governmental, the RAP ends on:

    1. For a new plan, the last day of the second calendar year following the calendar year in which plan was put into effect.

    2. For an amendment to an existing plan, the last day of the second calendar year following the later of the calendar year in which the amendment was adopted or became effective.

    3. For a change in IRC 403(b) requirements (a form defect for or integral to a change in requirements), the last day of the second calendar year that begins after issuance of the RAL in which the change appears.

  10. For a governmental individually designed plan, the RAP is extended to:

    1. the later of: the last day of the second calendar year following the calendar year in which the amendment is adopted or effective, or

    2. 90 days after the close of the third legislative session of the legislative body with the authority to amend the plan.

  11. Rev. Proc. 2019-39 established recurring RAPs for IRC 403(b) plans based on pre-approved plan cycles. It generally treats the initial RAP as Cycle 1 and Cycle 2 applies to form defects first occurring after June 30, 2020. For pre-approved IRC 403(b) plans, the RAP:

    1. begins on the same date that applies to an individually designed plan.

    2. ends no earlier than the end of Cycle 2 per future guidance, if the employer timely adopted interim amendments in good faith.

Written Plan Examination Steps

  1. Request and review plan documents for compliance with the written plan requirement under IRC 403(b, 26 CFR 1.403(b)-3(b)(3)(i).

    Note:

    If a plan incorporates other documents by reference and you find a conflict between the written plan and another document, the plan document governs.

  2. If the plan sponsor does not have a single written plan document, request all documents for the IRC 403(b) plan, including:

    1. Any letter issued by the IRS regarding the IRC 403(b) plan

    2. The Summary Plan Description (SPD)

    3. Annuity contracts

    4. Custodial account agreements

    5. Salary reduction agreements

    6. Employment contracts

    7. Third party administrator contracts and agreements

    8. Other communications between the plan sponsor and employees

    Note:

    SPDs are only required for 403(b) plans subject to ERISA. An IRC 403(b) plan sponsor often doesn’t have a separate SPD, so ask for any written policies or procedures for eligibility, etc.

  3. Verify the sponsor timely adopted and made a good faith efforts to comply by December 31, 2009, with IRC 403(b).

  4. Verify the sponsor adopted amendments needed to follow IRC 403(b) by June 30, 2020. For form defects first occurring after June 30, 2020, consider whether the sponsor can correct the form defect within the RAP in Rev. Proc. 2019-39.

    Note:

    See IRM 4.72.13.7.6, IRC 403(b) Remedial Amendment Periods.

  5. Review the written plan for compliance with any changes in the applicable law and regulations.

  6. Review information provided to employees about the plan and verify that the information is consistent with the plan document. Note any discrepancies and ask the plan sponsor to correct them. The plan sponsor may provide information through various methods, including:

    1. Employee benefits package or other participant handbook-type materials

    2. Emails and other communications made available by the plan sponsor related to the operation of the plan

    3. The plan sponsor’s internet site, including but not limited to, the plan sponsor’s human resources webpage

      Note:

      The above information will help you determine whether the plan satisfies the universal availability requirement of 26 CFR 1.403(b)-5(b)(2), for effective opportunity, IRM 4.72.13.14.1, Elective Deferrals —Universal Availability.

  7. Verify that the annuity contracts and custodial accounts meet the language requirements and do not contradict the plan. If any conflicts exist, the plan terms govern.

  8. For a plan funded through multiple vendors, and the employer has adopted a separate document from each vendor, review each vendor’s document for compliance and determine if any conflicting provisions exist.

  9. Verify the plan operates according to the terms of the plan document.

    1. Consider SCP and Audit CAP under Rev. Proc. 2019-19 for any failures you find.

IRC 403(b) Eligibility

  1. There are only four types of employers eligible to maintain an IRC 403(b) plan:

    1. A State, but only with respect to employees that perform services for an educational organization, 26 CFR 1.403(b)-2(b)(8)(i)(A).

      Note:

      The term “State” is defined to include a political subdivision of a State, or an agency or instrumentality of a State, 26 CFR 1.403(b)-2(b)(20). Thus, an eligible employer may be a State, or it may be a county, city, town, school district, or similar type of political subdivision, agency or instrumentality.

    2. An IRC 501(c)(3) organization with respect to any employee of the IRC 501(c)(3) organization.

    3. An employer of a minister described in IRC 414(e)(5)(A), but only with respect to the minister.

    4. A minister described in IRC 414(e)(5)(A), but only with respect to a retirement income account established for the minister, 26 CFR 1.403(b)-2(b)(8).

  2. An entity is not an eligible employer under 26 CFR 1.403(b)-2(b)(8)(i) if it treats itself as not being a state for any other purpose of the Internal Revenue Code (26 CFR 1.403(b)-2(b)(8)(ii)), and a subsidiary or other affiliate of an eligible employer is not an eligible employer under 26 CFR 1.403(b)-2(b)(8)(i) if the subsidiary or other affiliate is not an entity described in 26 CFR 1.403(b)-2(b)(8)(i).

  3. Some key issues to look at when considering eligibility are whether:

    1. The employer is eligible to maintain an IRC 403(b) plan for participating employees.

    2. Participants in the IRC 403(b) plan perform services for the employer as employees.

    3. Self-employed ministers and certain other ministers satisfy the requirements of IRC 414(e)(5)(A).

  4. If an ineligible employer maintains a plan intended to be an IRC 403(b) plan, the plan is not an IRC 403(b) plan.

    Note:

    For resulting tax consequences, IRC 403(c) and IRC 72.

  5. Ineligible employer issues may be resolved through Audit CAP in a way that limits or prevents unfavorable tax treatment, Section 6.03 of Rev. Proc. 2019-19 and IRM 4.71.3.5.1, Unagreed Form 5500 Examination Procedures and EP Exam Closing Agreements, EPCRS Closing Agreements.

Public Schools

  1. One type of employer that may sponsor an IRC 403(b) plan is a public school.

  2. To be a public school, the organization must be a State-sponsored educational organization described in IRC 170(b)(1)(A)(ii)which relates to educational organizations that normally maintain a regular faculty and curriculum, and normally have a regularly enrolled body of students in attendance at the place where it regularly carries on educational activities, 26 CFR 1.403(b)-2(b)(14).

  3. Included in this category are:

    1. K-12 public schools

    2. State colleges

    3. State universities

  4. Both non-academic staff (for example, a custodial employee) and faculty may be covered.

  5. Elected or appointed officials holding positions are not eligible unless the office held requires experience or training in the field of education (for example, a member of the school board, university regent or trustee may not be eligible), 26 CFR 1.403(b)-2(b)(10).

    Example 5: Employee A is an employee of a State department, not an educational institution, in a division which supervises payroll and time keeping functions for public schools. The employee in this case works in a service division under a department that is not an educational institution and, hence, is not performing services directly for an educational institution. Neither Employee A, nor the division in which he works, is performing services involving the operation or direction of the State's educational program as carried on through educational institutions. Therefore, Employee A is not performing services indirectly for such institutions for purposes for IRC 403(b), Rev. Rul. 72-390.

    Example 6: Employee B, a state employee, provides in-home teaching services for the public school system. Employee B may be covered by an IRC 403(b) plan maintained by Employee B's employer because Employee B performs services for a public school.

501(c)(3) Organizations

  1. Another type of eligible employer is an organization described in IRC 501(c)(3) and exempt from federal income tax under IRC 501(a).

  2. An IRC 501(c)(3) organization is defined generally as one organized and operated exclusively for:

    1. Charities

    2. Social welfare agencies

    3. Private hospitals

    4. Health care organizations

    5. Private schools

    6. Religious institutions

    7. Research facilities

  3. IRC 501(c)(3) organizations may include:

    1. Charities

    2. Social welfare agencies

    3. Private hospitals

    4. Health care organizations

    5. Private schools

    6. Religious institutions

    7. Research facilities

  4. To be recognized as an IRC 501(c)(3) organization, all organizations except churches and certain church-related organizations, and other organizations excepted under IRC 508, must apply to the IRS for a determination letter by filing Form 1023. See Pub 557.

Indian Tribal Governments

  1. A designated Indian Tribal Government is treated as a State for certain purposes of IRC 403(b), so an educational organization associated with a tribal government is eligible to maintain an IRC 403(b) plan as long as it is a public school as defined in IRC 170(b)(1)(A)(ii), 26 CFR 1.403(b)-2(b)(20).

  2. In addition, an Indian Tribal Government, a subdivision, agency or instrumentality of an Indian Tribal Government, or a corporation chartered under federal, state, or tribal law which is owned in whole or in part by any of the foregoing is treated as an employer described in IRC 501(c)(3) with respect to any annuity contract purchased in a plan year beginning before January 1, 1995, Section 1450(b) of the Small Business Job Protection Act of 1996 and 26 CFR 1.403(b)-2(b)(20).

Ministers Described in IRC 414(e)(5)(A)

  1. A self-employed minister may deduct, within the limits of IRC 404(a)(10), contributions to a retirement income account described in IRC 403(b)(9), 26 CFR 1.403(b)-2(b)(8)(i)(D).

  2. Similar deductions may be taken by a minister employed by a non-501(c)(3) organization with which the minister shares common religious bonds. Contributions to an IRC 403(b) plan are not includible in the gross income of the minister, IRC 414(e)(5)(E).

Eligible Employees

  1. An IRC 403(b) plan can only cover the employees of an eligible employer (with the exception of ministers described in IRC 414(e)(5)(A)), 26 CFR 1.403(b)-2(b)(8)(i)(D).

  2. Employee status under IRC 403(b) is generally figured by employee status for federal employment tax purposes under common law principles.

  3. "Employee" means a common-law employee performing services for the employer and does not include a former employee or an independent contractor, 26 CFR 1.403(b)-(2)(b)(9).

    Note:

    See 26 CFR 1.403(b)-4(d) for special 5-year rule for nonelective employer contributions for former employees.

    1. Whether an individual is a common law employee or independent contractor is most likely to arise with professionals such as physicians, Rev. Rul. 87-41.

    2. FSL-ET or EO has the authority to determine the employee status. A referral should be made through the Specialist Referral System (SRS) to request help.

    3. To utilize SRS, search on the IRS intranet home page for the Specialist Referral System, or go to https://srs.web.irs.gov.

Eligibility - Examination Steps

  1. Determine if the sponsoring employer is an "eligible employer" as defined in 26 CFR 1.403(b)-(2)(b)(8).

  2. If the employer indicates that it is a public school, confirm that it meets the requirements of 26 CFR 1.403(b)-(2)(b)(14) and IRC 170(b)(1)(A)(ii).

  3. If the employer holds itself out to be an IRC 501(c)(3) organization, you can verify its status in the following ways:

    1. Request a copy of any IRS determination letter for the organization’s tax-exempt status under IRC 501(a) as an entity described in IRC 501(c)(3).

    2. Secure an INOLES and/or a BMFOLO print on IDRS. Subsection code "03" and status code "01" on INOLES indicates that the organization is an IRC 501(c)(3) organization. BMFOLO shows the date that the IRS granted the IRC 501(c)(3) status.

    3. Use "Tax Exempt Organizations Search, (TEOS)" an online search tool in which users select an exempt organization and check certain information about its federal tax status and filings. Find the TEOS link on www.irs.gov.

    4. Search Guide Star®, a database of IRC 501(c)(3) charitable organizations, including online copies of Forms 990, Forms 990-EZ and Forms 990-PF and other information at www.guidestar.org

    5. Use Foundation Center to find information about exempt organizations at: www.foundationcenter.org.

    6. Before October 9, 1969, organizations may claim to be tax-exempt under IRC 501(c)(3) without having to obtain IRS recognition by filing Form 1023 and receiving a determination letter. Of course, that status is subject to challenge on examination by EO. The organization can’t be a State, political subdivision or integral part, Rev. Rul. 60-384. You might need to make a referral to EO to determine the employer’s status.

  4. If an IRC 403(b) plan examination is conducted in connection with an Exempt Organizations examination, a loss of IRC 501(c)(3) status will automatically cause the plan to fail the requirements of IRC 403(b) for any plan year during which the employer was ineligible. Consider a closing agreement under Rev. Proc. 2019-19.

  5. If the IRC 403(b) plan examination is not initiated by EO, the EP agent must refer any questions about the IRC 501(c)(3) status of the employer to EO. Use the Specialist Referral System (SRS) to request help from EO or to make a referral at https://srs.web.irs.gov.

  6. Only employees of eligible employers may participate in an IRC 403(b) plan. Independent contractors are not allowed to participate.

    Note:

    An IRC 403(b) plan document may allow nonelective employer contributions for former employees for up to five taxable years after the taxable year of severance of employment, 26 CFR 1.403(b)-4(d)(1).

Funding Vehicles

  1. Amounts contributed to an IRC 403(b) plan may only be invested in certain funding vehicles. Funding vehicles refer to the type of investment arrangement for the plan assets, 26 CFR 1.403(b)-8.

  2. The funding vehicles for IRC 403(b) plans are generally limited to any of the following:

    1. Annuity contracts

    2. Custodial accounts for regulated investment company stock

    3. Retirement income accounts for a church, or a convention or association of churches, including an organization described in IRC 414(e)(3)(A)

      A 403(b) plan sponsored by a church, or a convention or association of churches, including an organization described in IRC 414(e)(3)(A) can include any combination of the funding vehicles described in a)-c). A 403(b) plan sponsored by any other eligible employer is limited to any combination of the funding vehicles described in a)-c).

      Note:

      26 CFR 1.403(b)-8(a)

  3. Custodial accounts and retirement income accounts are treated as annuity contracts for purposes of the IRC 403(b). Thus, custodial accounts and retirement income accounts are generally subject to the rules that apply to IRC 403(b) annuity contracts (in addition to their own special requirements). 26 CFR 1.403(b)-8(d) and (e).

  4. Contributions to an IRC 403(b) plan must be transferred to the insurance company issuing the annuity contract (or the entity holding assets of any custodial or retirement income account that is treated as an annuity contract) within a period that’s reasonable for proper plan administration. The plan may provide for transfer of IRC 403(b) elective deferrals to the annuity contract within a specified time after the amounts would have otherwise been paid (for example, 15 business days following the month in which these amounts would have otherwise been paid to the participant), 26 CFR 1.403(b)-8(b).

    Note:

    For plans that are subject to ERISA, contributions must be transferred per the applicable rules under ERISA.

  5. For any taxable year in which the employer purchases two or more annuity contracts for the employee, these contracts are treated as one contract (IRC 403(b)(5),26 CFR 1.403(b)-3(b)(1).

    Note:

    Failure to aggregate contracts causes the annuity contracts to lose IRC 403(b) status.

  6. A contract purchased by an employer must follow the requirements of IRC 401(a)(30), which states that the amount of elective deferrals under the employer’s plan must not exceed the limit under IRC 402(g), (IRC 403(b)(1)(E)). So, to be a valid contract under IRC 403(b), the contract by its terms must reflect the IRC 402(g) limit and require distribution of any excess deferrals before April 15 of the following tax year.

    Note:

    Designated Roth contributions are treated as elective deferrals, except that they aren’t excludable from gross income, (IRC 402A(a)(1)).

Annuity Contracts

  1. The most common type of funding vehicle for an IRC 403(b) plan is an annuity contract under IRC 403(b)(1).

    1. The annuity contract may be offered only by an insurance company.

    2. The annuity contract may be owned by the individual, or in the case of a group annuity contract, by the employer.

    3. The annuity may be either variable or guaranteed.

  2. Regulations extend the non-transferability requirement of IRC 401(g) to IRC 403(b) annuity contracts. Thus, an IRC 403(b) annuity contract must provide that it is nontransferable, 26 CFR 1.403(b)-3(a)(5).

    1. Loans may be made from an annuity contract.

    2. Amounts held under the contract may be transferred or rolled over to another IRC 403(b) plan under certain conditions.

    3. Contributions other than after tax employee contributions and rollover contributions to an annuity contract and their earnings are subject to certain early distribution restrictions to ensure that they are used for retirement purposes.

    4. Excess contributions to an annuity contract are not subject to the excise tax under IRC 4973.

    5. Life insurance contracts (as defined in IRC 7702), endowment contracts, health or accident insurance contracts, property insurance contracts, casualty insurance contracts, and liability insurance contracts do not meet the definition of an annuity contract, 26 CFR 1.403(b)-8(c)(2).

  3. An annuity contract may provide life insurance protection as long as the death benefit is merely incidental to the primary purpose of providing retirement benefits. The rules for determining whether life insurance is incidental in IRC 401(a) plans also apply to IRC 403(b) plans, 26 CFR 1.403(b)-8(c)(2).

    1. Life insurance is incidental if less than 50 percent of total employer contributions made on behalf of a participant are used to purchase an ordinary life insurance contract, or in the case of term or universal life insurance, no more than 25 percent of total contributions are used to purchase the life insurance contract.

    2. As in IRC 401(a) plans, the portion of each year's premium representing the cost of life insurance protection (referred to as PS-58 costs) is includible in gross income and counts toward the employee's basis in the annuity contract on distribution.

    3. In addition, a contract on a participant's life must be converted to cash or an annuity or distributed to the participant at retirement, Rev. Rul. 60-84, 1960-1 C.B. 159, Rev. Rul. 66-143, 1966-1 C.B. 79, and Rev. Rul. 68-31, 1968-1 C.B. 151.

  4. The annuity contract must follow the terms of the written plan, IRM 4.72.13.7.1, Written Plan Requirement.

  5. If a plan is structured so that contributions are placed in an employer's savings account to purchase annuity contracts for employees at retirement, the plan is not an IRC 403(b) plan, Rev. Rul. 68-487, 1968-2 C.B. 187.

    Example 7: ABC Foundation, an IRC 501(c)(3) organization, has an annuity plan intended to be an IRC 403(b) plan. ABC Foundation makes both elective deferrals and employer contributions that are not elective deferrals to individual investment accounts (not mutual funds) for each of its employees. ABC Foundation purchases annuity contracts for employees at their retirement. The arrangement is not an IRC 403(b) plan.

    Example 8: Employer A is a public education organization maintaining a plan intended to be an IRC 403(b) plan (Plan). All contributions under the Plan are invested in life insurance policies for its employees. Because life insurance must be incidental to the primary purpose of providing retirement benefits, the Plan is not an IRC 403(b) plan.

Custodial Accounts

  1. A custodial account under IRC 403(b)(7) is treated as an annuity contract and must satisfy the various requirements of IRC 403(b), IRC 403(b)(7) and 26 CFR 1.403(b)-8(d)(1).

  2. The assets of a custodial account must be:

    1. held by a bank or an approved non-bank trustee or custodian under IRC 401(f)(2), 26 CFR 1.403(b)-8(d)(2).

    2. invested exclusively in regulated investment company stock (i.e., mutual funds) and so a custodial account may not provide life insurance. 26 CFR 1.403(b)-8(d)(2)(i).

    3. used only for the exclusive benefit of plan participants or their beneficiaries, 26 CFR 1.403(b)-8(d)(2)(iii).

      Note:

      For this purpose, assets are treated as impermissibly diverted to the employer if the employer borrows assets from the account.

  3. The plan must meet the distribution restrictions of IRC 403(b)(7) for amounts held in the custodial account, 26 CFR 1.403(b)-6(c)and (d).

  4. If the custodial account is part of a retirement income account, it is not treated as a custodial account, 26 CFR 1.403(b)-8(d)(2)(iv).

  5. A custodial account may permit loans to participants, 26 CFR 1.403(b)-6(f).

  6. Unlike contributions to annuity contracts, excess contributions to a custodial account, if not distributed before April 15 of the following tax year, are subject to the excise tax under IRC 4973, IRC 4973(a)(3).

  7. The custodial account must follow the terms of the written plan, IRM 4.72.13.7.1.

Retirement Income Accounts

  1. Retirement income accounts are generally subject to the rules and requirements of annuity contracts, 26 CFR 1.403(b)-9(a).

  2. The funding vehicles for retirement income accounts can be varied, 26 CFR 1.403(b)-9(a)(2).

  3. A retirement income account is defined under IRC 403(b)(9) as a defined contribution program established or maintained by a church or church-related organization, 26 CFR 1.403(b)-2(b)(5), (6), and (15) and 26 CFR 1.403(b)-9(a)(2).

    Note:

    A church-related organization has a special definition under the regulations.

    1. The retirement income account’s interest in the underlying assets must be accounted for separately, 26 CFR 1.403(b)-9(a)(2)(i)(A).

    2. Investment performance must be based on gains and losses on those assets, 26 CFR 1.403(b)-9(a)(2)(i)(B).

    3. The assets held in the account must be used for the exclusive benefit of plan participants or their beneficiaries. For this purpose, assets are treated as impermissibly diverted to the employer if there is a loan or other extension of credit from assets in the account to the employer, 26 CFR 1.403(b)-9(a)(2)(i)(C).

  4. A retirement income account must be maintained per a written plan, which must state the intent to create a retirement income account, 26 CFR 1.403(b)-9(a)(2)(ii).

  5. Any asset of a retirement income account that is owned or used by a participant or beneficiary is treated as having been distributed to that participant or beneficiary, 26 CFR 1.403(b)-9(a)(3).

  6. A retirement income account is not a custodial account (as defined in 26 CFR 1.403(b)-8(d)(2)), even if it is only invested in regulated investment company stock, 26 CFR 1.403(b)-9(a)(4). The distribution rules of IRC 403(b)(11) would apply rather than IRC 403(b)(7), 26 CFR 1.403(b)-6(d).

  7. A retirement income account may distribute benefits in a form that includes a life annuity only if:

    1. The amount of the distribution has an actuarial present value at the annuity starting date that is equal to the participant’s or beneficiary’s accumulated benefit, based on reasonable actuarial assumptions, including interest and mortality; and

    2. The plan sponsor guarantees benefits if a payment is due that exceeds the participant’s or beneficiary’s accumulated benefit, 26 CFR 1.403(b)-9(a)(5).

  8. A retirement income account may take the form of a defined benefit plan if it is

    1. established by a church or a convention or association of churches, and

    2. in effect on September 3, 1982.

      Note:

      This type of arrangement doesn’t fail to satisfy the requirements of IRC 403(b) merely because it’s a defined benefit arrangement, Section 251(e)(5) of Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and 26 CFR 1.403(b)-10(f).

Funding Vehicles - Examination Steps

  1. Review the plan document(s) and the funding vehicles under the plan, 26 CFR 1.403(b)-3(b)(3).

  2. Review and document whether custodial account documents and annuity contracts contain the language required under 26 CFR 1.403(b)-8(c) and (d).

  3. Verify that the language in the custodial account agreement or annuity contract agrees with the terms of the plan document. The plan controls if any conflicts exist.

  4. Request and review any third-party administrator contracts and agreements.

  5. Request and review any Information Sharing Agreements with vendors that were formerly used for funding vehicles under the plan.

  6. Ask about any contracts issued subject to good faith requirements of Section 8.02 of Rev. Proc. 2007-71.

Elective Deferral Contributions

  1. IRC 403(b) plans are usually funded in whole or in part through elective deferral contributions under a salary reduction agreement. The requirements for elective deferrals and contributions other than elective deferrals differ under IRC 403(b). This subsection focuses on requirements that apply only to elective deferral contributions.

  2. Elective deferrals are contributions made by an employer per a salary reduction agreement where an employee elects a reduction in salary or foregoes an increase in salary, bonuses or other wages.

  3. An IRC 403(b) plan is neither required to permit, nor precluded from permitting, an employee to make multiple salary reduction agreements in a single taxable year. Keep in mind that the universal availability rule under 26 CFR 1.403(b)-5(b)(1) applies to elective deferrals. This generally means that if a 403(b) plan allows one employee to make elective deferrals, all the other employees must have that option as well. Universal availability also requires that employees have an effective opportunity to make deferral elections. For more information on universal availability and the effective opportunity requirement, IRM 4.72.13.14.1 and 26 CFR 1.403(b)-5(b).

  4. An IRC 403(b) salary reduction agreement applies to compensation that is not yet paid or available to the employee at the effective date of the agreement.

  5. The salary reduction agreement must be legally binding.

  6. Amounts subject to a salary reduction agreement must be in the nature of compensation.

  7. Elective deferrals are generally treated as employer contributions (for purposes of IRC 403(b), IRC 402(g) and IRC 415) but are treated as employee contributions for other purposes, including FICA.

  8. Elective deferrals under an IRC 403(b) plan are also subject to specific requirements such as:

    1. Annual contribution limits, IRM 4.72.13.11.

    2. Nondiscrimination rules (universal availability), IRM 4.72.13.14.

    3. Withdrawal restrictions, IRM 4.72.13.15.

Elective Deferrals - Examination Steps

  1. Review the plan provisions for elective deferrals (including any Roth provisions).

  2. Determine if contributions are elective deferrals, and closely analyze one-time irrevocable elections and contributions employes made as a condition of employment to determine whether the contributions are elective deferrals subject to IRC 402(g) and 403(b)(12)(A)(ii), IRM 4.72.13.11.1.

  3. Request deposit reconciliations from the vendors.

  4. Sample and reconcile amounts shown on Form W-2 to vendor deposits:

    1. Verify that only elective deferrals are shown in Box 12 of Form W-2.

    2. IRC 414(h) pick-up contributions may be incorrectly reported in Box 12. Pick-up contributions, which are made to a governmental plan qualified under IRC 401(a), may be shown in Box 14 of Form W-2 but are not required to be shown, Rev. Rul. 2006-43, Rev. Rul. 77-462, Rev. Rul. 81-35, Rev. Proc. 81-36 and Rev. Rul. 87-10 for more information on pick-up contributions.

    3. Discrepancies should be explained, and if significant, investigated further

  5. Sample and review deferral agreements to ensure timeliness of execution and the type of compensation to be deferred. Determine whether the agreement applies to amounts not available to the employee at the time the agreement is effective.

    Note:

    Participants may fill out separate agreements for some forms of compensation, such as unused sick, vacation and back pay.

  6. Verify that employee elective deferrals don’t exceed the IRC 402(g) limit.

Contribution Limitations

  1. There are two separate limitations on the amount of contributions to an IRC 403(b) plan that are excludable from gross income, IRC 402(g) and IRC 415.

  2. IRC 402(g) imposes a limit on the annual dollar amount of elective deferrals made by a participant during the year. This limit is updated periodically. The IRC 402(g)(1)(B) limit is $19,500 for 2020.

  3. All elective deferrals a participant makes to a Simplified Employee Pension Plan (SEP), cash or deferred arrangement (CODA), IRC 403(b) plan, and Savings Incentive Match Plan for Employees (SIMPLE) plan are aggregated in applying the limit. The limit is designed to restrict the total amount that may be deferred by a participant on a salary reduction basis.

  4. IRC 415 places an overall limit on elective deferrals and contributions other than elective deferrals that may be made annually on an employee's behalf to an IRC 403(b) plan during a single limitation year. IRC 415 imposes a limit of the lesser of $57,000 (for 2020) or 100% of includible compensation on the maximum amount that may be contributed to an IRC 403(b) plan for the year, IRM 4.72.13.12, IRC 415 Limit.

  5. IRC 415(k)(4) provides that IRC 403(b) plans and other forms of qualified defined contribution plans (such as SEPs, 401(k) plans, profit sharing plans, and money purchase plans) must be aggregated for IRC 415 contribution limits in the event that a participant has a greater than 50% ownership in another company that sponsors such a plan. The IRC 403(b) plan is responsible for refunding an excess if IRC 415 is exceeded, IRM 4.72.13.12.3(1)

  6. Under IRC 414(u), contributions by an employer or employee per veterans' re-employment rights under USERRA, are not treated as contributions made in the year the contributions are made, but in the year to which they relate, for purposes of IRC 402(g) and IRC 415.

  7. Under IRC 414(v), contributions made per the age 50 catch-up election are not treated as contributions for the purposes of IRC 415.

Salary Reduction Contributions other than Elective Deferrals

  1. Elective deferrals under an IRC 403(b) plan are employer contributions which are used to purchase an annuity contract (or made to a custodial account) under a salary reduction agreement, 26 CFR 1.403(b)-2(b)(7) and IRC 402(g)(3).

  2. Elective deferrals do not include:

    1. Salary reduction contributions that are made per a one-time irrevocable election on or before the employee first becomes eligible to participate in the employer’s plan; or

    2. Pre-tax contributions made as a condition of employment, 26 CFR 1.402(g)(3)-1(b)).

  3. If a participant has the right or ability to terminate or modify an election, the contributions are elective deferrals even if the participant never exercises this right.

    Example 9: Employee X participates in an IRC 403(b) plan (Plan). In order to receive employer contributions under the Plan, Employee X is required to elect to defer 3% of salary in the form of mandatory contributions. Employee X has the option of revoking this election at any time, although Employee X never terminates his election. The mandatory contributions are elective deferrals because the election is revocable. These contributions are therefore included in applying the IRC 402(g) limit. They are also subject to FICA (if applicable).

    Example 10: Assume the same facts as in Example 10, except that the Plan further states that a participant’s election to terminate participation in the Plan is irrevocable. Thus, an employee who terminates his election will be permanently excluded from participating in the Plan. Even so, since the election to participate is revocable, the mandatory contributions are elective deferrals under IRC 402(g). The contributions are subject to FICA (if applicable).

    Note:

    Example 10 points out that if an employee may terminate his election to participate in a plan, the election is not considered to be irrevocable.

402(g) Elective Deferral Limits

  1. Elective deferrals under an IRC 403(b) plan are subject to the limitation under IRC 402(g).

  2. For purposes of IRC 403(b), an elective deferral is any contribution that arises because of an employee's election between current cash compensation or deferral under the plan, 26 CFR 1.403(b)-2(b)(7), IRC 402(g)(3), 26 CFR 1.402(g)(3)-1(b), IRC 3121(a)(5)(D) and 26 CFR 31.3121(a)(5)-2(a).

  3. An elective deferral is any elective contribution by a participant made to the following types of plans, IRC 402(g)(3).

    1. Qualified CODA

    2. SARSEP

    3. IRC 403(b) plan

    4. SIMPLE plan

  4. Elective deferrals, one-time elections made at the time of initial eligibility, and mandatory contributions as condition of employment are subject to FICA, IRC 3121(a)(5)(D) and 26 CFR 31.3121(a)(5)-2.

  5. The IRC 402(g) limit on participant contributions applies to all the elective deferrals made on behalf of a participant, 26 CFR 1.403(b)-4(c)(1) and 26 CFR 1.403(b)-3(a)(4).

    Example 11: An employee participating in two salary reduction IRC 403(b) plans with separate employers must aggregate the elective deferrals made under both plans in applying the limit. If this employee also participated in a CODA under IRC 401(k), or a SIMPLE under IRC 408(p), elective deferrals under these plans would also be aggregated, IRC 402(g)(3).

    Note:

    It is critical to determine which (if any) contributions are elective deferrals because the IRC 402(g) limit only applies to elective deferrals.

  6. In addition to the IRC 402(g) limit that applies to the participant, IRC 403(b)(1)(E) requires the contract to satisfy IRC 401(a)(30). The terms of the contract must provide that elective deferrals won’t exceed IRC 402(g) limits.

  7. The contract requirement under IRC 403(b)(1)(E) applies only to limit elective deferrals under annuity contracts purchased by a single employer, IRM 4.72.13.9.

  8. Consider the IRC 402(g) limit when you examine an IRC 403(b) plan with elective deferrals.

    Example:

    Considering the contribution limits in 2020, even if the limitation under IRC 415 is $ 57,000, IRC 402(g) further limits elective deferrals to $19,500 (or a maximum of $29,000 ($19,500 plus $3,000 if the full IRC 402(g)(7) 15-year catch-up limit applies plus $6,500 age 50 catch-up contribution (if applicable).

  9. The IRC 402(g) limits are adjusted periodically per IRC 402(g)(4). See COLA Increases for Dollar Limitations on Contributions and Benefits for dollar limitations from 1986 to the current year at https://www.irs.gov/retirement-plans/cola-increases-for-dollar-limitations-on-benefits-and-contributions .

Catch-Up Contributions

  1. Certain long-term employees have a special election to catch-up on the funding of their IRC 403(b) retirement benefit by increasing their elective deferrals over the normal dollar limit (IRC 402(g)(7)).

  2. The election is available per 26 CFR 1.403(b)-4(c)(3) only to an employee who has completed at least 15 years of service (as defined in CFR 403(b)(4) and 26 CFR 1.403(b)-4(e)) with an employer that is:

    1. An educational organization as described in IRC 170(b)(1)(A)(ii)

    2. A hospital

    3. A home health service agency

    4. A health and welfare service agency

    5. A church-related organization, as defined in 26 CFR 1.403(b)-2(b)(6)

    6. An organization as described in IRC 414(e)(3)(B)(ii)

      Note:

      A year of service is based on the employer's annual work period, not the employee's taxable year.

  3. With the exception of church related organizations or organizations controlled by church related organizations a participant’s years with different employers can’t be added together to satisfy the 15-year requirement, 26 CFR 1.403(b)-4(c)(3)(ii)(B), and 26 CFR 1.403(b)-4(e)(3).

    Example 12: Employee A is a teacher with the County W school system. She has been employed by County W for six years, but worked for County V for 10 years, before coming to County W. There is a State Teachers Retirement System that covers all of Employee A’s years with both County W and County V. Employee A may only count the years she worked while a teacher for County W for purposes of using the 15-year catch-up.

  4. Under the IRC 402(g)(7) election, the IRC 402(g)(1)(B) dollar limitation is

    1. $ 3,000;

    2. $15,000 minus any elective deferrals previously excluded under this catch-up election, plus designated Roth contributions in prior years under this catch-up; or

    3. $ 5,000 multiplied by the employee's years of service minus the elective deferrals made to plans of the organization in prior taxable years.

      Note:

      For purposes of item c, years of service (YOS) are calculated through the end of the year for which the calculation is being made. For example, to determine the limit for 2020, count YOS through 2020.

  5. There is a lifetime limit of $15,000 for this catch-up election, IRC 402(g)(7)(A)(ii).

  6. In addition to the 15-year catch-up, IRC 414(v) allows an individual who is age 50 at the end of the year to make an additional catch-up of $6,500.

  7. For an employee eligible to use both the 15-year catch-up and the age 50 catch-up, the 15-year catch-up must be applied first. An amount may be contributed as an age 50 catch-up to the extent the age 50 catch-up limit exceeds the 15-year catch-up limit, 26 CFR 1.403(b)-4(c)(3)(iv).

  8. The following examples show how the limits under IRC 402(g) and IRC 414(v) apply to elective deferrals under IRC 403(b) plans:

    Example 13: In 2020, Employee A, age 45, has taxable compensation of $70,000 before IRC 403(b) elective deferrals, and 12 years of service (YOS) with the County W school system. Employee A hasn’t made any other elective deferrals under any other IRC 403(b) or IRC 401(k) plan in 2020. For 2020, the maximum elective deferral that Employee A may contribute to the IRC 403(b) plan is determined as follows:

    1. The IRC 402(g)(1)(B) limit for 2020 is $19,500.

    2. Employee A does not have 15 YOS, therefore, the 15 YOS catch-up under IRC 402(g)(7) is not available.

    3. Employee A has not attained age 50, therefore the age 50 catch-up is not available.

      Note:

      Employee A is not eligible for any catch-up contributions, so the maximum amount Employee A can defer is $19,500.

    Example 14: In 2020, Employee B, age 45, has taxable compensation of $70,000 before IRC 403(b) elective deferrals, and 15 YOS with the County W school system, and hasn’t made any other elective deferrals under any other IRC 403(b) or IRC 401(k) plan in 2020. Employee B has not made any contributions to the IRC 403(b) plan before 2020. For 2020, the maximum elective deferral that Employee B may contribute to the IRC 403(b) plan is determined as follows:

    1. The IRC 402(g)(1)(B) limit for 2920 is $19,500.

    2. Employee B has 15 YOS, and can use the 15 YOS catch-up of $3,000 (no prior deferrals under the plan or prior use of this catch-up rule).

    3. Employee B has not attained age 50; therefore, the age 50 catch-up is unavailable.

      Note:

      The maximum amount Employee B can defer is $22,500 ($19,500 plus the $3,000 15 YOS catch-up).

    Example 15: In 2020, Employee C, age 50, has taxable compensation of $70,000 prior to IRC 403(b) elective deferrals, and 10 YOS with the County W school system. Employee C has made no other elective deferrals under any other IRC 403(b) or IRC 401(k) plan in 2020. For 2020, the maximum elective deferral that maybe contributed to the IRC 403(b) plan is determined as follows:

    1. The IRC 402(g)(1)(B) limit for 2020 is $19,500.

    2. Employee C does not have 15 YOS; therefore, she is not eligible to use the 15 YOS catch-up.

    3. Employee C has reached age 50; therefore, she is eligible for the age 50 catch-up of $6,500.

    The maximum amount Employee C can elect to defer is $26,000 ($19,500 plus the $6,500 age 50 catch-up).

    Note:

    The age 50 catch-up does not count against the IRC 402(g) or IRC 415 limit.

    Example 16: In 2020, Employee D, age 50, has taxable compensation of $70,000 before IRC 403(b) elective deferrals, and 15 YOS with Hospital H. Employee D hasn’t made any other elective deferrals under an IRC 403(b) or IRC 401(k) plan in 2020 and this is the first year Employee D has contributed to the IRC 403(b) plan. For 2020, the maximum elective deferral that Employee D may defer under the IRC 403(b) plan is determined as follows:

    1. The IRC 402(g)(1)(B) limit for 2020 is $19,500.

    2. Employee D has 15 YOS; therefore, he can use the 15 YOS catch-up of $3,000 (no prior deferrals under the plan or prior use of this catch up rule).

    3. Employee D has reached age 50; therefore, he is eligible for the age 50 catch-up of $6,500.

    Note:

    The maximum amount Employee D can elect to defer is $29,000 ($19,500 plus $3,000 plus $6,500), because Employee D is eligible for both the 15 YOS catch-up and the age 50 catch-up. If Employee D defers only $24,000, then $3,000 will count as the 15 YOS catch-up contribution (reducing future 15 YOS catch-up contributions because of the $15,000 lifetime limit) and $2,000 will count as the age 50 catch-up.

    Note:

    The age 50 catch-up does not count against the IRC 402(g) or IRC 415 limit. The 15 YOS catch-up contribution does not count against the IRC 402(g) limit only.

    Example 17: In 2020, Employee E, age 45, has taxable compensation of $70,000 before IRC 403(b) elective deferrals and 15 YOS under the state Teachers’ Retirement System. Employee E worked 5 years at City College X and has 10 YOS with State University Y. Employee E hasn’t made any other contributions under any other IRC 403(b) or IRC 401(k) plan in 2020 and this is the first year Employee E has contributed to the State University Y IRC 403(b) plan. For 2020, the maximum elective deferral Employee E may contribute to the IRC 403(b) plan is determined as follows:

    1. The IRC 402(g)(1)(B) limit for 2020 is $19,500.

    2. Employee E does not have 15 YOS with State University Y, therefore, she cannot use the 15 YOS catch-up under 402(g)(7).

    3. Employee E has not attained age 50; therefore, she is not eligible for the age 50 catch-up.

    Note:

    The maximum amount Employee E can elect to defer is $19,500 because Employee E is not eligible for any catch-up.

    Example 18: In 2020, Employee F, age 50, has taxable compensation of $70,000 before IRC 403(b) elective deferrals and 20 YOS with Hospital H. Employee F hasn’t made any elective deferrals under any other IRC 403(b) or IRC 401(k) plan in 2020. Employee F has made $175,000 in elective deferrals in prior years under the IRC 403(b). For 2020, the maximum amount that Employee F can elect to defer is determined as follows:

    1. The IRC 402(g)(1)(B) limit for 2020 is $19,500.

    2. Employee F has 15 YOS, however, because Employee F had deferrals in prior years, IRC 402(g)(7) is only available if prior deferrals do not exceed $5,000 x YOS or $100,000 (20 YOS x $5,000). Employee F had prior deferrals of $175,000 which exceeds $100,000, therefore the 15 YOS catch-up limit is $0.

    3. Employee F has reached age 50; therefore, he is eligible for the IRC 414(v) age 50 catch-up of $6,500.

    Note:

    The maximum amount Employee F can elect to defer is $26,000 ($19,500 plus $6,500 under the age 50 catch-up).

Contributions in Excess of the IRC 402(g) Limit

  1. An excess deferral is an elective deferral in excess of the IRC 402(g) limit.

  2. An excess deferral made to an IRC 403(b) contract(s) purchased by a single employer is includible in the participant’s gross income in the year of contribution and again in the year of distribution unless it is timely corrected as described in (3), below. The earnings are taxable in the year of distribution.

  3. To the extent permitted by the terms of an IRC 403(b) contract, excess deferrals plus any earnings may be distributed by April 15th of the following taxable year. If such a distribution is made, the excess deferrals are included in gross income in the year of contribution and the earnings are includible in gross income in the year of distribution, IRC 402(g) and 26 CFR 1.403(b)-4(f)(4). The distribution may be made notwithstanding any other provision of law.

  4. The issuer must file a Form 1099-R reporting the distribution using distribution code “8”.

  5. The employer is responsible for applicable employment taxes and income tax withholding.

  6. If excess deferrals are made by an employee to contracts of two unrelated employers, the excess is taxed both in the year contributed and again on distribution, unless the excess deferrals and the earnings thereon are timely distributed as provided in (3) above.

    Example 19: Association, an IRC 501(c)(3) organization, has an IRC 403(b) plan (Plan) with a calendar plan year. In 2020, each of the highly compensated employees who are not age 50 elects to make a contribution of $50,000 on the mistaken assumption that the contributions aren’t elective deferrals limited by IRC 402(g). The excess deferrals of $30,500 ($50,000 - $19,500) are not timely corrected by April 15, 2021. All contributions made to the affected annuity contracts in 2020 are includible in the employees' gross income for taxable year 2020 and are subject to FICA, 26 CFR 1.403(b)-3(a)(4) and IRC 401(a)(30). In addition, Association is responsible for employment taxes and withholding. The excess deferrals are taxable again on distribution.

    Note:

    All contracts or custodial accounts a participant holds that exceed the deferral limit will lose their IRC 403(b) status. Correction may be available under EPCRS if the excess was not distributed before the April 15 deadline. Timing of the return of excess deferrals determines how and when the excess is taxed.

    Example 20: The same facts as Example 20, except that $20,000 of the $50,000 contributed to the Plan in 2020 consists of non-elective employer contributions. The excess deferrals plus earnings are distributed to the employees by April 15, 2021. The excess elective deferrals of $10,500 ($30,000 - $19,500) are includible in gross income for tax year 2020. For excess elective deferrals made in tax year 2019, the April 15, 2020, deadline was extended to July 15, 2020, Notice 2020-23.

    Note:

    Earnings through the date of correction are taxable in the year distributed. There is no 10% early distribution tax, 20% income tax withholding, or spousal consent requirement on amounts timely distributed.

Examination Steps for IRC 402(g)

  1. Check the plan documents, summary plan description (SPD), election forms and funding vehicles to determine whether elective deferrals are properly limited per IRC 402(g). Review the plan for Roth provisions.

  2. Determine if the plan allows for any catch-up contributions.

  3. Sample participants and compare amounts withheld on Form W-2 to amounts required or allowed by the terms of the plan.

    Note:

    A plan must operate in accordance with its terms. Plans subject to ERISA may need to be referred to the DOL.

  4. Analyze whether deferrals exceeding the basic IRC 402(g) limit are based on the 15-year catch-up and/or age 50 catch-up.

    1. Request the employer’s 15-year calculations for the participants.

    2. Verify participants’ age and years of service through personnel records.

    3. Review prior year allocation reports, W-2s, and salary deferral election forms. Related plan documents may also be needed to determine entitlement to catch-up contributions.

    4. The employer is expected to complete this information, not the agent. The agent’s role is to verify the data provided. This tool is intended to help the agent understand the calculation and/or can be provided to the employer if they had not previously performed the calculation or cannot provide one and need to reconstruct the data.

  5. For elective deferrals in excess of the basic IRC 402(g) limit, request and analyze employer/vendor calculations, salary deferral election forms and other appropriate source documentation to determine if any 15-year catch-up contributions are properly coordinated with age 50 catch-up contributions, 26 CFR 1.403(b)-4(c)(3)(iv).

  6. If the employer has any other plan covering the same employees, verify that the combined amount of elective salary deferrals is within the IRC 402(g) limit.

  7. If any information indicates that the employees are covered by another plan maintained by an unrelated employer, which allows for elective deferrals under IRC 402(g), determine whether the combined amount of elective deferrals meets the IRC 402(g) limit for the individual.

  8. Determine whether any excess elective deferrals were timely distributed. Excess deferrals are includible in income for the year in which the excess occurred. If not timely corrected, excess deferrals and earnings should also be reported in the year distributed. In the absence of timely corrective distributions, consider proper enforcement and corrective action under EPCRS for the affected individuals’ contracts, 26 CFR 1.403(b)-3(d)(1)(i). Document whether there is compliance with the withholding and reporting requirements, 26 CFR 1.403(b)-7(g),Rev. Proc. 92-93, Notice 89-32, Notice 88-33 and Notice 87-77.

  9. Review salary reduction contributions that have been excluded from the IRC 402(g) limit due to a one-time irrevocable election or as a condition of employment.

  10. Determine whether contributions are elective deferrals by examining the substance of the arrangement. When determining whether deferrals are elective, consider:

    1. The operation of the plan and whether participants have revoked their elections.

    2. Employment conditions and whether contributions are a condition of employment.

    3. Plan documents, SPDs, funding vehicles and any memoranda or other communications to employees.

    Note:

    Employer’s descriptive labels - such as employer, employee, mandatory, one-time irrevocable or condition of employment- may be misleading.

  11. If contributions are found not to be made as a condition of employment or per one-time irrevocable elections, the amount contributed is included in the IRC 402(g) limit.

IRC 415 Limit

  1. An IRC 403(b) plan is treated as a defined contribution plan for purposes of the IRC 415 contribution limits.

  2. In general, IRC 415 places an overall limit on the amount of annual additions (elective deferrals and contributions other than elective deferrals) that may be made annually on an employee’s behalf to an IRC 403(b) plan during a single limitation year. The maximum IRC 415 contribution may not exceed the lesser of 100% of includible compensation, (IRM 4.72.13.12.1, or the dollar limits identified in IRC 415(c) (adjusted per IRC 415(d)) in the limitation year. Also see 26 CFR 1.403(b)-4(b), as well as COLA Increases for Dollar Limitations on Benefits and Contributions for current and prior year dollar limitations: https://www.irs.gov/retirement-plans/cola-increases-for-dollar-limitations-on-benefits-and-contributions

  3. The IRC 415 limit applies to contributions made to an IRC 403(b) plan with respect to the limitation year regardless of whether they are vested.

    1. Generally, the limitation year is the calendar year unless a participant elects another 12-month period, 26 CFR 1.415(j)-1(e)(1).

    2. If a participant is in control of an employer, the limitation year is the limitation year of the employer, 26 CFR 1.415(j)-1(e)(2).

    3. Control and affiliation for purposes of 26 CFR 1.415(j)-1(e) are defined under IRC 414(b), IRC 414(c) and IRC 415(h).

  4. There are alternative limitations available for employees of a church or related organization per IRC 415(c)(7). These employees may elect to substitute the IRC 415 limit with an annual limit of $10,000 (even if more than 100 percent of includible compensation) up to a total lifetime limit of $40,000.

  5. IRC 415(k)(4) provides that IRC 403(b) plans and other forms of qualified defined contributions plans (such as SEPs, 401(k) plans, profit sharing plans, or money purchase plans) are required to be aggregated for 415 contribution limits in the event that a participant has a greater than 50% ownership in another company that sponsors such a plan. The 403(b) plan is responsible for refunding any excess if 415 is exceeded.

  6. Under IRC 414(u), contributions by an employer or employee per veterans' re-employment rights under USERRA, are not treated as contributions made in the year the contributions are made, but in the year to which they relate, for purposes of IRC 415.

  7. Under IRC 414(v), contributions made per the age 50 catch-up election are not treated as contributions for purposes of IRC 415, 26 CFR 1.403(b)-4(b)(2).

Includible Compensation

  1. Includible compensation is generally all compensation from the employer includible in gross income for federal income tax purposes for the employee's most recent one-year period of service ending with or within the taxable year, 26 CFR 1.403(b)-2(b)(11). Also see 26 CFR 1.403(b)-4(e) for rules to determine a year of service.

  2. Includible compensation also includes a participant's elective deferrals (all elective deferrals as described in IRC 402(g)(3)), and amounts not included in an employee's gross income by reason of IRC 125 or IRC 457(b), 26 CFR 1.403(b)-2(b)(11).

  3. Includible compensation does not include:

    1. Except for elective deferrals under an IRC 401(k) plan, contributions (vested or not vested) made by the employer to a qualified plan.

    2. Contributions picked up by the employer under IRC 414(h)(2), because they are not currently includible in compensation, Rev. Rul. 79-221.

    3. Non-elective employer contributions to an IRC 403(b) plan of the employer even if the contributions are includible in gross income.

    4. Compensation received while the employer was not an employer eligible to maintain the IRC 403(b) plan, 26 CFR 1.403(b)-2(b)(11).

    5. Compensation received prior to the employee's most recent one-year period of service, 26 CFR 1.403(b)-2(b)(11).

  4. For current and prior year dollar amounts for the maximum amount of compensation that may be taken into account, https://www.irs.gov/retirement-plans/cola-increases-for-dollar-limitations-on-benefits-and-contributions.

Special Rule for Former Employees

  1. IRC 403(b) allows contributions to be made for former employees with respect to:

    1. Certain compensation paid by the later of 2 ½ months after severance from employment or the end of the limitation year that includes the date of severance from employment, 26 CFR 1.415(c)-2(e)(3)(i), and

    2. Compensation paid to participants who are permanently and totally disabled or relating to qualified military service under IRC 414(u) ,26 CFR 1.415(c)-2(e)(4), 26 CFR 1.415(c)-2(g)(4), and 26 CFR 1.415(c)-2(g)(7).

  2. Under IRC 403(b)(3), certain contributions may be made to an IRC 403(b) plan for up to five years after an employee has a severance from employment, 26 CFR 1.403(b)-4(d).

    1. Only non-elective employer contributions are excludible from gross income and the contributions must fall within the IRC 415 limit.

    2. A former employee is deemed to have monthly includible compensation for the period through December 31 of the year in which he or she has a severance from employment and through the end of each of the next five taxable years, 26 CFR 1.403(b)-4(d).

    3. The amount of the monthly includible compensation is equal to one twelfth of the former employee's includable compensation during the former employee's most recent year of service.

    Example 22: Employee A, a schoolteacher, severs employment from a public school and is entitled to receive $25,000 in accumulated sick leave and annual leave which, under a collective bargaining agreement, may be received in cash. Three days before this amount is to be paid, Employee A requests that the payroll office pay this amount into her IRC 403(b) plan over the next five years

    Note:

    In this example, the contributions would be made per a salary reduction agreement because Employee A has the option to have the employer contribute the amount or receive the amount in cash. Employee A may not utilize the five-year provision because the five-year provision only applies to non-elective employer contributions.

    Example 23: The same facts as in Example 22, except that in the normal course of collective bargaining, a union has bargained away the right to receive the payment of accumulated sick and annual leave in cash and the amounts are required to be paid directly to the IRC 403(b) plan by the employer.

    Note:

    The amounts are non-elective employer contributions which can be contributed per plan terms over a period of five years following severance of employment per the five-year provision assuming they satisfy the limit under IRC 415 and the definition of includible compensation.

    Example 24: As part of an employment contract, Public School District Z agrees to contribute to Superintendent A's IRC 403(b) account $41,000 each year for five years following her retirement for a total of $205,000 in deferred compensation. Her last year's salary exceeds $41,000. This is a permissible use of the five-year provision because her includible compensation for her most recent one-year period of service is in excess of $41,000. This benefit does not violate nondiscrimination and coverage requirements which are not applicable to governmental IRC 403(b) plans with respect to non-elective employer contributions, IRM 4.72.13.14, Nondiscrimination and Coverage.

    Example 25: Public University A maintains an IRC 403(b) plan under which it contributes annually 10 percent of compensation for participants, including the first five calendar years following the date on which the participant ceases to be an employee. The plan provides that if a participant who is a former employee dies during the first five calendar years following the date on which the participant ceases to be an employee, a contribution is made that is equal to the lesser of:

    1. The excess of the individual’s includible compensation for that year over the contributions previously made for the individual for that year; or

    2. The total contributions that would have been made on the individual’s behalf thereafter if he or she had survived to the end of the five-year period.

    Individual C’s deemed annual includible compensation based on his last year worked is $72,000 (C’s monthly includible compensation is $6,000). A $600 contribution is made for C for January of the first taxable year following retirement (10 percent of individual C’s monthly includible compensation of $6,000). Individual C dies during February of that year. Public University A makes a contribution for Individual C for February equal to $11,400 (Individual C’s monthly includible compensation for January and February, reduced by $600).

    Note:

    The contribution does not exceed the amount of Individual C’s includible compensation for the taxable year for purposes of IRC 415(c), but any other contributions would exceed Individual C’s includible compensation for purposes of IRC 415(c).

IRC 415 Aggregation

  1. Under IRC 415, a participant is generally considered to exclusively control and maintain his or her own IRC 403(b) plan, 26 CFR 1.415(f)-1(f)(1).

  2. Contributions to an IRC 403(b) plan are not combined or aggregated with contributions to a qualified defined contribution plan except when a participant controls any employer. Generally, control is defined as having greater than 50% ownership of an entity. In this situation, the IRC 403(b) plan is treated as a defined contribution plan maintained by both the employer and the participant, 26 CFR 1.415(f)-1(f)(2).

  3. Where a participant controls any employer for a limitation year, the contributions to the IRC 403(b) plan are combined with contributions to a qualified defined contribution plan, including SEP’s, maintained by the controlled employer or any affiliated employer under IRC 415.

  4. Excess contributions are attributed to the IRC 403(b) plan and are includible in the participant’s gross income, 26 CFR 1.415(g)-1(b)(3)(iv)(C).

  5. An employee who is covered by a qualified defined contribution plan of the employer may also participate in an IRC 403(b) plan through the employer without having to aggregate the plans under IRC 415. Thus, annual additions could be contributed to each plan up to the IRC 415 limit. So, the employer could contribute non-elective deferrals of up to $57,000 (in 2020) to the IRC 403(b) plan even though the employee has contributions under the IRC 401(a) qualified defined contribution plan which are at the IRC 415 maximum. The following examples illustrate the application of the IRC 415 aggregation rules:

    Example 26: Employee A is employed by an IRC 501(c)(3) organization. The organization contributes to an IRC 403(b) plan on behalf of Employee A in the limitation year. Employee A is also a participant in the organization's defined contribution plan. Employee A is not required to aggregate contributions under the qualified defined contribution plan with those made under the IRC 403(b) plan for purposes of testing under IRC 415 because Employee A is not more than a 50% owner of the 501(c)(3) organization.

    Example 27: The facts are the same as in Example 26, except that Employee A is also a participant in a defined contribution plan of a corporation in which he is more than a 50 percent owner. The defined contribution plan of Employee A's corporation must be combined with Employee A's IRC 403(b) plan for purposes of applying the limit under IRC 415(c) because Employee A controls his corporation.

    Example 28: Employee A is employed by a University that maintains a 403(b) Plan for its employees. In 2020, Employee A files a Schedule C for royalties received from writing a book and speaking engagements. He takes a deduction of $57,000 for contributions made to his SEP. His IRC 415 limit has been maxed out in the SEP plan. Therefore, all salary deferrals and any employer contributions made to the University’s 403(b) plan would be excess contributions under IRC 415.

Contributions in Excess of the IRC 415 Limit

  1. Contributions to an IRC 403(b) plan in excess of the IRC 415 limit are includible in the employee's gross income for the tax year ending with or within the limitation year, 26 CFR 1.403(b)-4(a).

    Example 29: Foundation X is an IRC 501(c)(3) organization which maintains an IRC 403(b) plan (Plan) for its employees. The gross annual compensation of Employee A equals $100,000. Contributions to the Plan on behalf of Employee A equal $58,000 in the limitation year ending December 31, 2020, which is $1,000 above the allowable IRC 415 limit. The $1,000 excess is includible in Employee A's gross income for the 2020 taxable year.

  2. Under 26 CFR 1.403(b)-4(f)(2), amounts in excess of the IRC 415 limit must be placed in a separate account for purposes of IRC 72. The separate account is considered to be a 403(c) annuity contract.

  3. In the case of excess annual additions, 26 CFR 1.403(b)-3(b)(2) states that if an excess annual addition is made to a contract that otherwise satisfies the requirements of this section then the portion of the contract that includes such excess annual additions fails to be a Section 403(c) contract and the remaining portion is a 403(b) contract. However, this treatment only applies if the issuer maintains separate accounts for each portion of the contract. If not, the entire contract fails to satisfy 403(b) and the correction principles of Rev. Proc. 2019-19 apply, Section 5.02(3) of Rev. Proc. 2019-19.

Excise Tax

  1. IRC 4973 imposes a 6 percent cumulative excise tax on the employee for excess contributions made to an IRC 403(b)(7) custodial account, IRC 4973(a).

  2. Excess contributions are the excess of the amount contributed over the IRC 415 limit, IRC 4973(c).

  3. To the extent contributions exceed the IRC 415 limit, the contributions are taxable, 26 CFR 1.403(b)-4(f)(1) & (2).

  4. The IRC 4973 excise tax applies only to excess contributions to a custodial account and does not apply to an IRC 403(b)(1) annuity contract or IRC 403(b)(9) retirement income account, 26 CFR 1.403(b)-8(d).

  5. Excess contributions are figured at the end of the taxable year, IRC 4973(a).

  6. Contributions are tested on a yearly basis with respect to the applicable IRC 415 limit for the year.

    Example 30: Foundation A maintains an IRC 403(b) plan (Plan) on behalf of its employees. The funding vehicles for the Plan include both annuity contracts and custodial accounts. In the limitation year ending December 31, 2020, 50 employees receive contributions in excess of the IRC 415 limit. The excess contributions are includible in employees' gross income in taxable year 2020. Any portion of the excess IRC 415 amounts invested in the custodial accounts are subject to the excise tax under IRC 4973, IRC 4973(c) to calculate the applicable tax.

Examination Steps for IRC 415

  1. Review the plan documents, plan amendments and, if applicable, SPD to identify the types of contributions allowed under the plan and determine whether the plan language properly limits contributions, IRC 415.

  2. Determine the annual additions (after-tax employee contributions, matching contributions, non-elective employer contributions including contributions made per irrevocable one-time elections made at initial eligibility and mandatory contributions required as a condition of employment, and salary reduction contributions, including elective deferrals) made to the plan for the limitation year.

  3. Determine whether the IRC 403(b) participant is in control of any employer that maintains a qualified defined contribution plan including a SEP. If the employer is not aware of any employee’s outside employment, IDRS command code TRDBV or MeFile can be used to review the participant’s Form 1040. If it is found that the participant did control any employer, determine whether contributions have been aggregated.

  4. Sample contributions made to the IRC 403(b) plan and compare these with the amounts required by the terms of the plan. Determine if any annual additions have exceeded the yearly IRC 415(c) limitations.

  5. Determine whether the employer informs the employee of the aggregation of the IRC 403(b) account with any defined contribution plan of an employer controlled by the employee, 26 CFR 1.415(f)-1(f) and 26 CFR 1.415(g)-1(b)(3)(iv)(C).

  6. Determine the employer’s policy regarding outside employment and secure any records available regarding such outside employment.

  7. Verify whether contributions to aggregated plans exceed the IRC 415(c) limits.

    Example 31: Doctor A is employed by a tax-exempt hospital to which IRC 501(c)(3) applies and which provides him with an IRC 403(b) annuity contract. Doctor A also maintains a private practice as a shareholder owning more than 50 percent of a professional corporation. Any contribution allocated to Doctor A from the qualified defined contribution plan of the professional corporation must be aggregated with the IRC 403(b) annuity contract for purposes of applying the limitations of IRC 415(c) for the plan year, 26 CFR 1.415(c)-1 and 26 CFR 1.415(f)-1(f)(2)(i).

  8. Determine whether any participant has excess contributions that are made to a custodial account. Secure and process Form 5330 for the excise taxes due under IRC 4973, IRM 4.71.5 Employee Plans Examination of Returns, Form 5330 Examination Procedures.

Deemed IRAs under IRC 408(q)

  1. Under IRC 408(q), an IRC 403(b) plan may include traditional individual retirement accounts (IRAs) or Roth IRAs (or both) set up for employees of the employer maintaining the IRC 403(b) plan. Employee contributions to these IRAs ("deemed IRAs" ) are subject to the same requirements that apply to IRAs that are not deemed IRAs, 26 CFR 1.403(b)-10(e).

    1. There must be separate accounting for each employee’s deemed IRA and, if the deemed IRA is an annuity, it must be held under a separate contract from any contact holding non-deemed IRA assets of the IRC 403(b) plan, 26 CFR 1.408(q)-1(f)(2) and (3).

    2. The plan must state that the deemed IRAs meet the applicable requirements of IRC 408 or IRC 408A, or both, 26 CFR 1.408(q)-1(d).

    3. The deemed IRAs and the IRC 403(b) plan are treated as separate entities subject to separate rules.

    4. Unless the deemed IRAs are held within a single trust with the IRC 403(b) plan, a qualification defect in the plan will not have adverse consequences to the deemed IRAs, 26 CFR 1.408(q)-1(g).

  2. Because the IRA RMD rules apply to the deemed IRA portion of a plan, the required beginning date (RBD) for distributions depends on when the owner of the deemed traditional IRA turns age 70½. For owners turning 70½ before January 1, 2020 - The RBD is April 1st of the year following the year of the owner’s 70½ birthday, even if the employee is still working. For owners turning 70½ after December 31, 2019 - The RBD is April 1st of the year following the year of the deemed owner’s 72nd birthday, even if the employee is still working.

    Note:

    Section 2203 of the CARES Act enacted on March 27, 2020, waived RMDs for defined contribution plans and IRAs for calendar year 2020. For purposes of determining RMDs after 2020, without another change in the law, an individual’s RBD will be figured without regard to the 2020 waiver, Notice 2020-51 for more information.

Deemed IRAs Examination Steps

  1. Review the written plan document and all amendments to determine if the plan allows for deemed IRAs.

  2. Confirm that deemed IRA contributions have not been made prior to the adoption of plan provisions permitting such contributions.

  3. Make sure contributions to the deemed IRAs satisfy the limits under IRC 408 and IRC 408A.

  4. Confirm whether separate accounts are maintained, or the assets are commingled.

Nondiscrimination and Coverage

  1. TRA '86 imposed nondiscrimination and coverage rules on IRC 403(b) plans under IRC 403(b)(12).

    1. These rules were amended by PPA ‘06.

    2. 26 CFR 1.403(b)-5 describes the nondiscrimination rules reflected in PPA ‘06.

  2. Different nondiscrimination rules apply depending on the type of contribution.

    1. Elective deferrals are subject to the universal availability rule, IRC 403(b)(12)(A)(ii) and 26 CFR 1.403(b)-5(b).

    2. Contributions other than elective deferrals must follow discrimination rules similar to those for plans qualified under IRC 401(a), IRC 403(b)(12)(A)(i) and 26 CFR 1.403(b)-5(a).

  3. In general, nondiscrimination and coverage requirements ( IRC 401(a)(4), (5), and (26), IRC 401(m), and IRC 410(b)), with respect to contributions other than elective deferrals do not apply to governmental IRC 403(b) plans, IRC 403(b)(12)(C).

    1. A governmental plan, as defined in IRC 414(d), is one maintained by a state or local government or political subdivision, agency or instrumentality thereof.

    2. The compensation limit under IRC 401(a)(17) still applies to governmental plans, IRC 403(b)(12)(C) and 26 CFR 1.403(b)-5(a)(5).

  4. The nondiscrimination rules do not apply to churches or qualified church-controlled organizations (as defined by IRC 3121(w)(3)(B)), 26 CFR 1.403(b)-5(d) and 26 CFR 1.403(b)-2(b)(5).

  5. Under IRC 414(u), an IRC 403(b) plan is not treated as failing nondiscrimination or coverage requirements by reason of the making of employer or employee contributions (or the right to make such contributions) made per veterans' reemployment rights under USERRA.

Elective Deferrals —Universal Availability

  1. Elective deferrals are tested separately from non-elective employer contributions for nondiscrimination, IRC 403(b)(12)(A)(ii) and 26 CFR 1.403(b)-5(b).

  2. The nondiscrimination requirement for elective deferrals is satisfied only if the plan allows each employee (with very limited exceptions) to elect to defer more than $200 annually if any employee may make an elective deferral, IRC 403(b)(12)(A)(ii). This test is referred to as universal availability, 26 CFR 1.403(b)-5(b).

  3. Unlike a qualified cash or deferred arrangement (CODA), nondiscrimination with respect to elective deferrals is not satisfied through compliance with the ADP test.

  4. An IRC 403(b) plan is permitted to take into account coverage under another plan to satisfy universal availability through deferral opportunities under another plan, 26 CFR 1.403(b)-5(b)(4)(iii).

  5. Universal availability requires that all employees of a IRC 403(b) plan sponsor be permitted to make elective deferrals if any employee of the plan sponsor may make an elective deferral, subject to statutory exclusions described in IRM 4.72.13.14.1 (10) below, 26 CFR 1.403(b)-5(b).

  6. An employee is not considered to have had the right to make an election for an elective deferral if the employee does not have an "effective opportunity" to make such an election at least once during the plan year, 26 CFR 1.403(b)-5(b)(2).

  7. Effective opportunity is a facts-and-circumstances test. An effective opportunity is not considered to exist if there are any other rights or benefits that are conditioned (directly or indirectly) upon making or failing to make a cash or deferred election, 26 CFR 1.403(b)-5(b)(2).

  8. Factors that determine effective opportunity include:

    1. Notice to the employee of the election and its availability

    2. The period of time during which the election can be made

    3. Any conditions placed on the election by the plan sponsor

      Note:

      See 26 CFR 1.403(b)-5(b)(2).

  9. Additional catch-up contributions under IRC 414(v) or IRC 402(g)(7) must also be universally available to employees if these are made available to any employee, 26 CFR 1.403(b)-5(b)(2).

    Note:

    See also the special universal availability rule under 26 CFR 1.414(v)-1(e).

  10. Excludable employees may be disregarded in applying the universal availability test for salary reduction

    1. Non-resident aliens with no U.S. source income

    2. Employees who normally work less than 20 hours per week (or such lower number of hours per week as may be set forth in the plan)

      Note:

      This exception must be based on hours worked and cannot be based on a job classification (such as part-time employee or adjunct professor) unless the classification is defined in the plan using the permitted hours requirements. If an employee becomes eligible to make salary reduction contributions to the plan because the employee is no longer considered normally working less than 20 hours per week (or such lower number of hours per weeks as may be set forth in the plan) that employee can no longer be excluded on that basis (i.e., the once-in-always-in rule), 26 CFR 1.403(b)-5(b)(4)(iii)(B). However, see the discussion of Notice 2018-95 in IRM 4.72.13.14.1(16).

    3. Students performing certain services (as described in IRC 3121(b)(10))

      Note:

      Medical residents are not considered to be students under IRC 3121(b)(10), Mayo Foundation for Medical Education and Research v. United States, 562 U.S. 44 (U.S. 2011).

    4. Employees whose maximum elective deferrals under the plan would be no greater than $200

    5. Employees eligible to participate and make elective deferrals under an eligible governmental 457 plan, a qualified CODA (i.e., an IRC 401(k) plan) or another IRC 403(b) plan of the employer

      Note:

      For exclusions item b) and item c) above, if any employee who would be excluded under either exclusion is permitted to participate, then no employee may be excluded under that exclusion, 26 CFR 1.403(b)-5(b)(4)(i). Thus, if the plan allows an employee working less than 20 hours per week to participate, the plan cannot exclude any employee using the less than 20 hours per week exclusion.

    Example 32: Public School System A sponsors an IRC 403(b) plan. The plan document provides that all employees may participate except for employees who normally work less than 20 hours per week. The plan further states an employee normally works fewer than 20 hours per week if and only if:

    • For the 12-month period beginning on the date the employee’s employment started, the employer reasonably expects the employee to work fewer than 1,000 hours of service; and

    • For each plan year ending after the close of the 12-month period beginning on the date the employee’s employment started (or, if the plan so provides, each subsequent 12-month period), the employee worked fewer than 1,000 hours of service in the preceding 12-month period.

    In operation, however, the plan allows certain teachers who work less than 1,000 hours of service each year to participate. Thus, the plan cannot exclude any employees on the basis of working less than 1,000 hours in a year, 26 CFR 1.403(b)- 5(b)(4)(i).

    Example 33: The same facts apply as in Example 31. The school system does not treat substitute teachers as employees who are eligible for employee benefits. In operation the plan excludes substitute teachers because they are substitute teachers, regardless of hours worked. For purposes of IRC 403(b), the substitute teachers cannot be excluded based on employee classification or hours worked for purposes of universal availability testing because the plan has allowed other employees to participate with less than 1,000 hours of service for the plan year.

    Note:

    Unlike a qualified plan, an IRC 403(b) plan is not generally permitted to have any minimum age and service exclusion for elective deferrals, 26 CFR 1.403(b)-5(b)(4)(ii)(D).

  11. Plans that are subject to Title I of ERISA may not be eligible to use the exception in IRM 4.72.13.14.1 (10)b). (Excluding employees that work less than 20 hours per week), 26 CFR 1.403(b)-5(b)(4)(iii)(B)(2).

  12. Under 26 CFR 1.403(b)-5(b)(3) the universal availability requirement applies separately to each IRC 501(c)(3) organization unless they are considered to be under common control as explained in to 26 CFR 1.414(c)-5, IRC 414(c)(2).

  13. Where the employer is a government, the universal availability requirement applies separately to each governmental entity that is not part of a common payroll, 26 CFR 1.403(b)-5(b)(3).

  14. Examples 34-36 illustrate that elective deferrals are tested separately from other contributions for nondiscrimination and that these contributions must be offered universally to non-excludable employees.

    Example 34: University A maintains an IRC 403(b) plan. The plan provides that only senior administrative staff and faculty are eligible to make elective deferrals to the plan. University A also maintains a defined benefit plan for remaining employees. University A maintains no other plans of deferred compensation. Because the other employees cannot make elective deferrals to any plan, the plan does not satisfy IRC 403(b)(12)(A)(ii).

    Example 35: Only full-time employees are eligible to participate in an IRC 403(b) plan maintained by a university. There are 40 part-time clerical employees who are not students and who normally work 29 hours per week (or 1,508 hours per year). Since the part-time employees are not in a category of employees that may be statutorily excluded from making elective deferrals, the plan does not satisfy the requirements of IRC 403(b)(12)(A)(ii).

    Example 36: A hospital maintaining an IRC 403(b) plan provides for elective deferrals only. Under the plan, all medical doctors and senior administrative staff are eligible to participate in the plan immediately upon hire. All other employees, including nurses and other support staff, are eligible only after two years of service and being 21 or older. The plan does not satisfy the requirements of IRC 403(b)(12)(A)(ii).

  15. The effect of violating IRC 403(b)(12)(A)(ii) is the loss of IRC 403(b) status. Contributions to the plan are therefore subject to income tax, employment tax and withholding. See Rev. Proc. 2019-19 for remedies under EPCRS.

  16. Notice 2018-95 provides transition relief for plans that did not follow the “once-in-always-in” condition for excluding part-time employees under 26 CFR 1.403(b)-5(b)(4)(iii)(B), IRM 4.72.13.14.1(10)(b). During the relief period, a plan will not be treated as failing to satisfy the conditions of the part-time exclusion from the universal availability requirement merely because the plan was not operated in compliance with the “once-in-always-in” exclusion condition, Section 3.01(1) of Notice 2018-95.

    1. This relief is for the period that begins with taxable years beginning after December 31, 2008 until the end of the last “exclusion period” ending before December 31, 2019. For plans that use the plan year for determining if an employee worked at least 1,000 hours in a preceding 12-month period, as permitted under 26 CFR 1.403(b)-5(b)(4)(iii)(B)(2), the exclusion period is based on the plan year, and the relief period ends on the last day of the last plan year that ends before December 31, 2019. For plans that make the 1,000-hour determination based on the date an employee started employment (and anniversary date) instead of the plan year, the relief period will end on different dates for different employees based upon the date of each employee’s anniversary of employment, but no later than December 30, 2019.

    2. During the relief period, a 403(b) pre-approved plan will not be treated as failing to satisfy the conditions of the part-time exclusion, and the plan will not be treated as having a failure to follow plan terms, merely because the plan document does not match the plan’s operation during the relief period. On the other hand, an individually designed 403(b) plan may be amended to reflect that the “once-in-always-in” exclusion condition was not applied for all exclusion years. The amendment will be treated as a correction of a form defect during the remedial amendment period. The deadline for adopting such an amendment is June 30, 2020.

  17. Fresh-Start Opportunity after the Relief Period Ends. Notice 2018-95 provides that a plan may apply the “once-in-always-in” requirement as if the requirement first became effective January 1, 2018, provided that the plan operated in accordance with either the “once-in-always-in” condition for excluding part-time employees under 26 CFR 1.403(b)-5(b)(4)(iii)(B), or the relief provided by Notice 2018-95 during the relief period. The plan is not required to be amended to reflect the use of the fresh-start opportunity.

Elective Deferrals - Examination Steps
  1. Review the plan document for the eligibility requirements for IRC 403(b) elective deferrals.

  2. Determine that the plan document only excludes employees listed in 26 CFR 1.403(b)-5(b)(4).

    Note:

    If the plan has permitted any employee excludable under 26 CFR 1.403(b)-5(b)(4)(ii)(D) or (E) to make elective deferrals, then no other employees may be excluded under that provision, 26 CFR 1.403(b)-5(b)(4)(i).

  3. Verify that employees are provided meaningful information about the plan by reviewing resources such as:

    1. The plan sponsor's employee benefits package/handbook

    2. Emails made available by the plan sponsor related to the operation of the plan

    3. The plan sponsor's internet site

    4. The SPD, if available

    5. Required annual notices giving effective opportunity, 26 CFR 1.403(b)-5(b)(2)

  4. Request and review the employer’s payroll records, including position descriptions and job classification codes.

    1. Reconcile to Forms W-2.

    2. Determine whether employees of a specific job classification are improperly excluded from making elective deferrals.

  5. If the plan excludes employees who work less than 20 hours per week, or 1,000 hours per year, analyze and verify how the employer monitors hours worked. Verify that once eligible, the employer properly notifies the employee of eligibility and permits entry into the plan within a reasonable time frame no later than the first day of the next plan year and all subsequent years. See Notice 2018-95 regarding transition relief from the “once-in-always-in” exclusion condition.

  6. Review excluded employees to determine if they were properly excluded from making elective deferrals. After the first day of the first taxable year that begins after December 31, 2009, the following employees cannot be excluded from participating in IRC 403(b) plan:

    1. Employees who used a one-time election to participate in a governmental plan that is not an IRC 403(b) plan.

    2. Visiting professors for up to one year.

    3. Employees affiliated with a religious order who take a vow of poverty.

    4. Union employees who were excluded must be able to participate in the IRC 403(b) plan by January 1, 2009, or the earlier of the date on which the collective bargaining agreement terminates or July 26, 2010.

      Note:

      See 26 CFR 1.403(b)-11(d)

      Note:

      A governmental plan may have until January 1, 2011, before it has to start including the employees listed above.

Contributions Other Than Elective Deferrals

  1. For purposes of nondiscrimination, contributions other than elective deferrals include employer contributions and after-tax employee contributions, contributions made per a one-time irrevocable election made by the employee at the time of initial eligibility, and contributions made as a condition of employment.

  2. Contributions other than elective deferrals are tested separately from elective deferrals for nondiscrimination, IRC 403(b)(12) and 26 CFR 1.403(b)-5(a).

  3. IRC 403(b)(12)(A)(i) requires compliance with the following provisions:

    1. IRC 401(a)(4) (nondiscrimination)

    2. IRC 401(a)(5) (permitted disparity)

    3. IRC 401(a)(17) (compensation limit)

    4. IRC 401(m) (matching and after-tax employee contributions)

    5. IRC 410(b) (minimum coverage)

  4. Contributions other than elective deferrals made to IRC 403(b) plans maintained by public schools or governmental entities are not subject to the nondiscrimination or coverage requirements (other than IRC 401(a)(17)) beginning in tax years on or after August 5, 1997 (prior to that date, governmental plans are deemed to satisfy these requirements, except IRC 401(a)(17)).

  5. With respect to contributions other than elective deferrals, excludable employees are those employees who have not satisfied the age and service requirements set forth in the plan, 26 CFR 1.403(b)-5(a)(3) – in addition, student employees and employees normally working fewer than 20 hours per week may be excluded.

  6. "Employer" is generally defined for purposes of nondiscrimination with respect to contributions other than elective deferrals to include related entities under:

    • IRC 414(b) controlled groups,

    • IRC 414(c) groups under common control,

    • IRC 414(m) affiliated service groups, and

    • IRC 414(o) other organizations or arrangements described by regulations.

      See also IRC 414(c)(2).

    Note:

    Per Rev. Rul. 2009-18, Notice 89-23 is obsolete except to the extent described in the last paragraph of the "Treatment of Controlled Groups that Include Tax-Exempt Employers" section of the preamble to the Final IRC 403(b) Regulations. Therefore, the Notice 89-23 good faith, reasonable interpretation standard will continue to apply to state and local public schools (and certain church entities) for determining the controlled group.

Contributions Other Than Elective Deferrals - Examination Steps
  1. Review the plan document to determine what contributions other than elective deferrals are provided for under the plan.

  2. Review the employer’s payroll records and contribution allocation schedules to determine if employees are receiving contributions in accordance with plan provisions.

  3. Verify compensation is properly limited to IRC 401(a)(17).

  4. For non-governmental employers, or non-church organizations that maintain 403(b) plans with contributions other than elective deferrals, the following steps will also need to be taken:

    1. Determine if the employer has related entities under IRC 414(b), IRC 414(c), IRC 414(m), and IRC 414(o).

    2. Determine whether the employer aggregates plans to pass coverage under IRC 403(b)(12) and IRC 410(b).

    3. Determine the number of highly compensated employees (as defined in IRC 414(q) and non-highly compensated employees of the employer. Determine the number of HCEs and NHCEs that are eligible to participate in the IRC 403(b) plan or other plans of the employer.

    4. Determine whether the matching and after-tax contributions satisfy the IRC 401(m) ACP test.

    5. Determine if the plan satisfies IRC 401(a)(4), IRC 401(a)(5) and IRC 410(b)

Distribution Requirements

  1. Distributions from an IRC 403(b) plan are subject to different timing restrictions, depending on the source of the distribution. Different timing rules apply to:

    1. Distributions from contracts (including retirement income accounts) other than custodial accounts or amounts attributable to elective deferrals. Distributions of amounts attributable to nonelective contributions from an annuity contract may be made based on the timing rules for profit sharing plans, 26 CFR 1.403(b)-6(b).

    2. Distributions from custodial accounts that are not attributable to elective deferrals, 26 CFR 1.403(b)-6(c).

    3. Distributions of amounts attributable to elective deferrals from a custodial account or an annuity contract, 26 CFR 1.403(b)-6(d).

    4. Distributions of pre-1989 elective deferrals (not including interest).

Early Distribution Restrictions

  1. Congress intended that contributions to an IRC 403(b) plan should generally be used for retirement and thus, IRC 403(b) imposes early distribution restrictions on contributions to an IRC 403(b) plan.

    1. These restrictions are based on distribution events and relate to the earliest date at which distributions from an IRC 403(b) plan may be made.

    2. Distributions generally may not be made prior to a certain triggering event.

    3. An IRC 403(b) plan may properly distribute amounts any time after such an event has occurred (as long as it complies with the minimum distribution, incidental death benefit distribution and direct rollover rules).

    4. These early distribution restrictions do not apply to amounts held in a separate account for eligible rollover distributions received by the IRC 403(b) plan, 26 CFR 1.403(b)-6(i).

    5. Roth amounts must be distributed in accordance with IRC 402A.

  2. Under 26 CFR 1.403(b)-6(d), IRC 403(b)(7), and IRC 403(b)(11), elective deferral contributions (both Roth and non-Roth) and income on such contributions are not permitted to be distributed earlier than (except in the case of a plan termination, correction of excess deferrals, or a qualified reservist distribution under IRC 72(t)(2)(G)):

    1. Reaching age 59 ½,

    2. Death,

    3. Disability (as defined in IRC 72(m)(7)),

    4. Severance of employment,

    5. Hardship of the employee (subject to the rules of 26 CFR 1.403(b)-6(d)(2), which excludes earnings on elective deferrals, and 26 CFR 1.401(k)-1(d)(3)), IRM 4.72.13.15.3.1. (These distribution restrictions do not apply to elective deferrals made before January 1, 1989 (not including earnings on such contributions), 26 CFR 1.403(b)-6(d)(1)(ii) or

    6. Any qualified birth or adoption distribution as defined in IRC 72(t)(2)(H)(iii).

      Note:

      The total amount which may be treated as qualified birth or adoption distributions by any individual with respect to any birth or adoption shall not exceed $5,000.

  3. Under 26 CFR 1.403(b)-6(b), amounts (other than those attributable to elective deferrals) distributed from an annuity contract (not including a custodial account, but including a retirement income account) may not be distributed earlier than (with respect to a) - c), below per 26 CFR 1.401-1(b)(1)(ii)):

    1. Severance from employment,

    2. The occurrence of some event such as a fixed number of years or a stated age,

    3. Disability,

    4. Any qualified birth or adoption distribution as defined in IRC 72(t)(2)(H)(iii), or

      Note:

      The total amount which may be treated as qualified birth or adoption distributions by any individual with respect to any birth or adoption shall not exceed $5,000.

    5. Amounts invested in a lifetime income investment (as defined in IRC 401(a)(38)(B)(ii)), except as may be otherwise provided by regulations.

      Note:

      After-tax employee contributions (and earnings thereon) and contracts issued by an insurance company prior to January 1, 2009, are not subject to the early distribution rules, 26 CFR 1.403(b)-6(b) and 26 CFR 1.403(b)-11(e).

      Note:

      For the amounts described in e) above, such amounts will be distributed in the form of a qualified distribution (as defined in IRC 401(a)(38)(B)(i)) or a qualified plan distribution annuity contract (as defined in IRC 401(a)(38)(B)(iv)).

  4. Under 26 CFR 1.403(b)-6(c), distributions from a custodial account (not including amounts attributable to elective deferrals) may not be paid or made available to a distributee earlier than:

    1. Age 59 ½,

    2. Severance from employment,

    3. Death,

    4. Disability (as defined in IRC 72(m)(7), or

    5. Amounts invested in a lifetime income investment (as defined in IRC 401(a)(38)(B)(ii) and as provided by regulations, with respect to those amounts, or

      Note:

      For the amounts described in 5 above, such amounts will be distributed only in the form of a qualified distribution (as defined in IRC 401(a)(38)(B)(i)) or a qualified plan distribution annuity contract (as defined in IRC 401(a)(38)(B)(iv)), or

    6. Any qualified birth or adoption distribution as defined in IRC 72(t)(2)(H)(iii).

      Note:

      The total amount which may be treated as qualified birth or adoption distributions by any individual with respect to any birth or adoption shall not exceed $5,000.

    Example 37 Employee A is a participant in an IRC 403(b) plan . The plan is funded through both elective and non-elective employer contributions, which are invested in annuity contracts. Employee A is 30 years old, has not separated from service, is not experiencing a hardship, and is not disabled. Employee A withdraws $5,000 from his elective deferral account. The distribution violates 26 CFR 1.403(b)-6(d).

    Note:

    If the written plan allowed for this type of distribution, then the written plan would not satisfy the form requirements of 26 CFR 1.403(b)-3(b)(3).

    Example 38: Employee A is a participant in an IRC 403(b) plan (Plan) that is funded by IRC 403(b)(7) custodial accounts. Contributions to the Plan are limited to non-elective employer contributions. Employee A withdraws $10,000 from the Plan and has not severed employment or become disabled. Employee A is 40 years old. Employee A's distribution violates 26 CFR 1.403(b)-6(c).

  5. Certain loans may be treated as a distribution depending on the facts and circumstances under 26 CFR 1.403(b)-6(f). For example, a loan that is repaid through a reduction in the participant's accrued benefit results in an actual distribution under the plan.

  6. Under 26 CFR 1.403(b)-10(a)(1), an IRC 403(b) plan can provide for distributions on plan termination. Generally, this provision is effective January 1, 2009.

    Note:

    Section 110 of the SECURE Act provides that future guidance will provide that upon termination of a 403(b) plan, amounts contributed to a custodial account may be distributed in kind to a participant or beneficiary of the plan, and the distributed custodial account shall be maintained by the custodian on a tax-deferred basis as an IRC 403(b)(7) custodial account.

  7. Distributions from an IRC 403(b) plan due to natural disasters such as hurricanes may be permissible in-service distributions.

Early Distribution Tax
  1. IRC 72(t) restricts premature distributions from an IRC 403(b) plan by imposing a 10 percent additional income tax with respect to distributions that are made prior to the events described in IRC 72(t).

  2. The IRC 72(t) tax generally applies to all distributions to participants or their beneficiaries except for those:

    1. Made after turning 59 ½,

    2. Made upon separation from service and after age 55,

    3. Made upon death or disability, or,

    4. Which are part of a series of substantially equal payments made over the life or life expectancy of the employee or the joint lives or life expectancies of the employee and the employee's designated beneficiary.

  3. A distribution allowable under 26 CFR 1.403(b)-6 may nevertheless be subject to IRC 72(t). For example, the tax applies to early distributions of non-elective deferrals made to an annuity contract even though 26 CFR 1.403(b)-6 would not restrict such distributions.

  4. Exceptions may apply for disaster-related distributions.

    Note:

    In Examples 37 and 38, the distributions to Employee A are also subject to the additional tax under IRC 72(t).

Minimum Distribution Requirements

  1. IRC 403(b)(10) imposes minimum distribution requirements on IRC 403(b) annuity contracts.

  2. These requirements relate to the latest date at which distributions of a minimum amount must start.

  3. In applying the minimum distribution rules, IRC 403(b) plans generally are treated as individual retirement arrangements (IRAs) under IRC 408, 26 CFR 1.403(b)-6(e)(2).

    1. The rules in 26 CFR 1.408-8 generally apply for IRC 403(b) plans, except as otherwise provided.

    2. The rules that apply to IRAs are generally the same as those that apply to qualified plans under IRC 401(a)(9).

    3. The minimum distribution requirements under IRC 401(a)(9) relate to the form and timing of both before and after death distributions, 26 CFR 1.403(b)-6(e)(1).

    4. Under 26 CFR 1.408-8, Q&A-5, the surviving spouse rule does not apply to an IRC 403(b) contract. Thus, the surviving spouse of a participant is not permitted to treat an IRC 403(b) contract as the spouse’s own IRC 403(b) contract, even if the spouse is the sole beneficiary, 26 CFR 1.403(b)-6(e)(4).

    5. An IRC 403(b) contract is treated as an individual retirement plan for purposes of satisfying the minimum distribution rules. No reporting is required at this time with respect to required minimum distributions from IRC 403(b) contracts, Notice 2002-27, 2002-1 CB 814 (April 16, 2002).

  4. The RBD or the date at which distributions must start from a participant's IRC 403(b) annuity contract depends on when the employee turns 70½. For employees turning 70½ before January 1, 2020 - The RBD is the later of April 1st of the year following the year of the employee’s 70½ birthday or the calendar year in which the employee retires from the employer maintaining the plan. For employees turning 70½ after December 31, 2019 - The required beginning date is the later of April 1st of the year following the year of the employee’s 72nd birthday or the calendar year in which the employee retires from the employer maintaining the plan.

    Note:

    Section 2203 of the CARES Act enacted on March 27, 2020, waived RMDs for defined contribution plans and IRAs for calendar year 2020. For purposes of determining RMDs after 2020, without another change in the law, an individual’s RBD will be decided without regard to the 2020 waiver, 26 CFR 1.403(b)-6(e)(3) and Notice 2020-51 for more information.

    Example 39 Participant Q is a participant in an IRC 403(b) plan that is sponsored by an IRC 501(c)(3) organization. Participant Q is not a five percent owner, has not retired, and turned 70 ½ in 2019. Participant Q’s RBD is April 1 of the calendar year following the year in which the participant retires.

  5. For an IRC 403(b) sponsor which is not a government or church, the RBD for a five percent owner depends on when the five percent owner turns 70½. For a five percent owner turning 70½ before January 1, 2020 - The RBD is April 1st of the year following the year of the five percent owner’s 70½ birthday. For five percent owner turning 70½ after December 31, 2019 - The RBD is April 1st of the year following the year of the five percent owner’s 72nd birthday.

    Note:

    As a practical matter, generally there are no 5 percent owners for IRC 403(b) plans.

  6. A governmental plan, within the meaning of IRC 414(d), is treated as complying with IRC 401(a)(9) if the governmental plan applies a reasonable and good faith interpretation of IRC 401(a)(9), 26 CFR 1.401(a)(9)-1 Q&A-2(d) This rule also applies to an IRC 403(b) contract that is part of a governmental plan, 26 CFR 1.403(b)-6(e)(8).

  7. The required minimum distribution must be calculated separately for each IRC 403(b) contract.

    1. However, an employee who is a participant in more than one IRC 403(b) contract, with the same or a separate employer, may total the amounts required to be distributed from each and satisfy the minimum distribution requirement through distributions from one or more IRC 403(b) contracts, 26 CFR 1.403(b)-6(e)(7). Similarly, an individual may aggregate IRC 403(b) accounts held as a beneficiary of the same decedent for purposes of the minimum distribution requirement.

    2. IRC 403(b) contracts cannot be aggregated with IRAs or qualified plans for purposes of satisfying these minimums, 26 CFR 1.403(b)-6(e)(7).

  8. If the issuer or custodian keeps the records necessary to identify the pre-1987 account balance, the minimum distribution starting requirements apply only to benefits that accrue after December 31, 1986, including the income on pre-1987 contributions, 26 CFR 1.403(b)-6(e)(6).

    1. Prior law (generally requiring distributions by the end of the calendar year in which the participant turns 75) would apply to pre-1987 accruals.

    2. If records are not kept, the entire account balance is subject to IRC 401(a)(9).

    3. The minimum distribution incidental benefit (MDIB) requirement applies to the entire account balance, although prior law applies to the pre-1987 account balance in this regard under IRC 401(a)(9)(G), 26 CFR 1.401(a)(9)-6, Q&A 2.

    4. If no actual amount is required to be distributed by April 1, 1988, because of these rules, the participant may treat December 31, 1988, as the RBD for all purposes under IRC 403(b)(10), 26 CFR 1.403(b)-6(e)(6).

  9. In the case of missing participants and beneficiaries, a 403(b) contract will not be treated as violating the required minimum distribution standards for the failure to begin or make a distribution to a participant or beneficiary to whom a payment is due, if the plan has taken the following steps: searched plan and related plan, sponsor, and publicly-available records or directories for alternative contact information; used a commercial locator service, a credit reporting agency, or a proprietary internet search tool for locating individuals; and tried contact via United States Postal Service (USPS), certified mail, to the last known mailing address and through appropriate means for any address or contact information (including email addresses and telephone numbers). If the above steps have not been completed, the 403(b) plan may be challenged for violation of the required minimum distribution standards for the failure to make a distribution to a participant or beneficiary to whom a payment is due.

  10. The excise tax under IRC 4974 for failure to make minimum distributions applies to 403(b) plans.

  11. Before assessing the tax, the agent should figure if reasonable cause exists, IRC 4974(d) and Form 5329.

Hardship, Loans, and Qualified Domestic Relations Orders (QDRO)

  1. An IRC 403(b) plan may contain certain optional features that are consistent with but not required under IRC 403(b), such as:

    1. Hardship distributions

    2. Loans

    3. Plan-to-plan or annuity contract-to-annuity contract transfers, and

    4. Acceptance of rollovers

  2. Any optional provisions must meet, in both form and operation, the relevant requirements under IRC 403(b) and 26 CFR 1.403(b)-3 through 26 CFR 1.403(b)-11, 26 CFR 1.403(b)-3(b)(3)(i).

  3. A participant loan from an IRC 403(b) plan:

    1. Should have a fixed repayment schedule, 26 CFR 1.403(b)-6(f),

    2. Should bear a reasonable rate of interest, 26 CFR 1.403(b)-6(f), and

    3. Is subject to the requirements of IRC 72(p), 26 CFR 1.403(b)-7(d).

  4. Loans from plans that are subject to Title I of ERISA must also comply with Section 408(b)(1) of Title I of ERISA and 29 CFR 2550.408b-1 of the Department of Labor regulations.

  5. Participants may take hardship distributions if the plan allows, subject to the following rules:

    1. Hardship distributions have the same meaning as under 26 CFR 1.401(k)-1(d)(3).

    2. Changes made by the final hardship distribution regulations under IRC 401(k) generally apply to IRC 403(b).

    3. A plan that permits hardship distributions cannot suspend elective deferrals after a hardship distribution made on or after January 1, 2020. A plan can dispense the six-month suspension for plan years beginning after December 31, 2018, even if the distribution was made in a prior year.

    4. Although the BBA added IRC 401(k)(14) to permit hardship distributions of QNECs, QMACs and earnings on these amounts and on elective deferrals, the BBA did not amend IRC 403(b)(7), which limits hardship distributions to elective deferral contributions, or IRC 403(b)(11), which states that earnings on elective deferrals cannot be distributed in the case of hardship. Thus, hardship distributions of elective deferrals in an annuity contract or custodial account cannot include any income thereon. See the preamble to the final hardship distribution regulations.

    5. Amounts attributable to QNECs and QMACs in an IRC 403(b) plan that are in an annuity contract can be distributed on account of hardship to the extent that hardship is a distributable event with respect to these amounts under the plan. See 26 CFR 1.403(b)-6(b) and the preamble to the final hardship distribution regulations under IRC 401(k). QNECs and QMACs in a custodial account cannot be distributed for hardship, IRC 403(b)(7), 26 CFR 1.403(b)-6(c), and the preamble to the final hardship regulations.

      Note:

      See IRM 4.72.13.15.3.1, Hardship Distributions.

  6. IRC 414(p)(9) provides that a distribution from an IRC 403(b) plan per a QDRO is treated in the same manner as a distribution from a plan to which IRC 401(a)(13) applies, 26 CFR 1.403(b)-10(c). If the plan is subject to Title I of ERISA, see also Section 206(d)(3) of ERISA under which the prohibition against assignment or alienation of plan benefits under Section 206(d)(1) of ERISA does not apply to an order that is found to be a qualified domestic relations order.

Hardship Distributions
  1. The BBA made changes to the hardship distribution rules under IRC 401(k) and instructed the Secretary of the Treasury to issue regulations deleting the six-month suspension of elective deferrals following a hardship distribution and make other hardship distribution changes. Final hardship distribution regulations under IRC 401(k) were issued in September 2019. While the BBA did not amend the distribution restrictions under IRC 403(b)(7) or IRC 403(b)(11), existing IRC 403(b) regulations provide that a distribution on account of hardship has the same meaning as 26 CFR 1.401(k)-1(d)(3). Thus, the IRC 401(k) rules for hardship distributions generally apply to 403(b).

  2. The BBA-related amendments that do apply to a 403(b) plan include:

    1. New safe harbor categories for hardship distributions due to disaster-related expenses and losses (optional).

    2. Elimination of the six-month suspension period following a hardship distribution (mandatory, if the plan provides hardship distributions).

    3. Elimination of the requirement that the participant take a plan loan prior to requesting a hardship distribution (optional).

    4. Substitution of the prior facts and circumstances test with a general standard for determining whether a distribution amount is necessary to satisfy a financial need (mandatory, with additional conditions optional).

  3. The BBA amendment expanding the source of hardship distributions to include interest on elective deferrals made to an IRC 401(k) plan does not apply to IRC 403(b) plans, and amounts attributable to QMACs and QNECs cannot be distributed from a custodial account on account of hardship. The rule in 26 CFR 1.403(b)-6 (d)(2) limiting the amount of a hardship distribution of elective deferrals to the aggregate elective deferrals under the contract and not including any interest thereon, reduced by the aggregate dollar amount of the distributions previously received by the participant, still applies. QMACs and QNECs (and interest thereon) may be distributed from an annuity contract on a triggering event such as hardship, as provided in 26 CFR 1.403(b)-6(b).

  4. A hardship distribution must meet two requirements:

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

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

  5. An employee’s hardship amount can be increased for any taxes or penalties that are reasonably expected to result from the distribution.

  6. 26 CFR 1.403(b)-6(d)(2) provides that a hardship distribution for purposes of an IRC 403(b) plan has the same meaning as a distribution on account of hardship under 26 CFR 1.401(k)-1(d)(3) and is subject to the rules and restrictions set forth in 26 CFR 1.401(k)-1(d)(3). A plan may use either general hardship distribution standards, which is based on all relevant facts and circumstances, or deemed hardship distribution standards to establish the existence of an immediate and heavy financial need.

  7. A distribution is deemed to be on account of an immediate and heavy financial need under 26 CFR 1.401(k)-1(d)(3)(iii)(B) if it is for one or more of the following:

    1. Medical expenses deductible under IRC 213(d) that are incurred by the employee or the employee’s spouse, children or dependents (as defined in IRC 152), or a primary beneficiary under the plan;

    2. Costs directly related to the purchase of a principal residence (not including mortgage payments);

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

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

    5. Payments for burial or funeral expenses for the employee’s deceased parent, spouse, child, dependent (as defined in IRC 152) or a primary beneficiary under the plan;

    6. Expenses for the repair of damages to the employee’s principal residence that would qualify for the casualty deduction under IRC 165 (figured without regard to IRC 165(h)(5) and whether the loss exceeds 10 percent of gross income); and

    7. Expenses and losses (including loss of income) incurred by the employee on account of a disaster declared by the Federal Emergency Management Agency (FEMA) under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, Public Law 100-707, provided that the employee's principal residence or principal place of employment at the time of the disaster was located in an area designated by FEMA for individual assistance with respect to the disaster.

      Note:

      Plans may also make distributions when legislation is enacted to respond to disasters or per guidance issued per IRC 7508A. For example, the Taxpayer Certainty and Disaster Tax Relief Act of 2019, Division Q, Pub. L. 116-94, permits distributions and loans up to $100,000, as well as recontribution rights, for major federally declared disasters declared between January 1, 2018, and February 18, 2020.

  8. The list of deemed hardship expenses was amended in the final hardship distribution regulations under IRC 401(k). Item 7 was added and item 6 was revised to clarify the loss is figured “without regard to IRC 165(h)(5)” (limiting the deduction for losses to federally declared disaster areas). The revised language can be applied to distributions made on or after January 1, 2018. So, a plan may be amended to reflect hardship distributions made in 2018:

    • to repair a principal residence without regard to whether the casualty resulted from a federally declared disaster, or

    • for expenses incurred on account of a FEMA-declared disaster for which individual assistance is available.

  9. For purpose of deemed hardship distribution standards, a ‘‘primary beneficiary under the plan’’ means an individual who is named as a beneficiary under the plan and has an unconditional right, upon the death of the employee, to all or a portion of the employee’s account balance under the plan, Notice 2007-7, Q&A (5).

  10. The amount of the hardship distribution must not exceed the amount required to satisfy the financial need (including income taxes or penalties resulting from the distribution), 26 CFR 1.401(k)-1(d)(3)(iii).

  11. A distribution is not treated as necessary to satisfy an immediate and heavy financial need unless all of the following requirements are met:

    1. The employee must first obtain all other available distributions (other than hardship distributions) from the plan and all other plans of deferred compensation, both qualified and nonqualified, maintained by the employer.

    2. The employee must provide a representation to the plan administrator that he or she has insufficient cash or other liquid assets reasonably available to satisfy the need. The representation may be in writing or by an electronic medium such as e-mail, intranet or a recorded phone conversation. This representation is mandatory for distributions made on or after January 1, 2020.

      Note:

      Cash or other liquid assets that are earmarked for another expense in the future, such as rent, are not reasonably available to satisfy the financial need.

    3. The plan administrator does not have actual knowledge that is contrary to the representation. Without actual knowledge to the contrary, the plan sponsor may rely on the employee’s representation that a hardship can’t be satisfied by the employee’s other reasonably available means.

  12. For plan years beginning before January 1, 2019, a participant must have obtained a plan loan (if available) to offset his/her need for a hardship distribution unless taking a loan would disqualify the employee from getting other funds necessary to alleviate the hardship. For plan years beginning on or after January 1, 2019, a plan may optionally may impose additional conditions such as requiring an employee to obtain all nontaxable loans (determined at the time a loan is made) available under the plan and all other plans maintained by the employer as a condition of obtaining a hardship distribution.

  13. The six-month suspension on employee contributions after a hardship is prohibited for distributions on or after January 1, 2020, although the plan can optionally impose the six-month suspension for the 2019 plan year.

  14. Note that, beginning August 17, 2006, a 403(b) plan may treat a participant’s primary beneficiary under the plan in the same manner as the participant’s spouse or dependents for purposes of the hardship events relating to medical, tuition, and funeral expenses, Notice 2007-7, Q&A-5(a).

Distribution Requirements - Examination Steps

  1. Review the plan documents for the form and timing of distributions.

  2. Review the employer's internal controls; procedures and documentation of plan distributions. Verify the individuals responsible for plan administration and record keeping.

  3. Document any information that indicates non-compliance.

  4. Request written clarification for any oral statements that indicate non-compliance.

  5. Examine relevant records to corroborate oral testimony.

  6. Request participant account records, including hardship and loan requests, and Forms 1099-R.

  7. Examine payroll and personnel records to identify terminated individuals who have turned age 70 ½ or 72 depending on the year under exam.

  8. If it is found that RMDs have not been paid timely, consider any correction remedies under Rev. Proc. 2019-19.

  9. Obtain and examine the records used to justify distributions made on account of hardship, if any, and document the payments. Determine whether a hardship distribution occurred, and appropriate steps were taken to find out whether the payment was necessary considering other financial resources available to the participant.

    Note:

    Many vendors utilize web-based requests in lieu of paper requests, requiring a participant to self-certify their financial need and lack of other assets available to meet the financial need. Electronic records must be maintained in retrievable format per 26 CFR 1.401(a)-21(a)(3)(ii) which provides the requirements for a plan administrator/trustee to retain information for verification later. 29 CFR Part 2520 provides the DOL's requirements for retaining information.

  10. Obtain and examine the records used to justify distributions made on account of hardship, if any, and document the payments. Determine whether a hardship distribution occurred and appropriate steps were taken to find out whether the payment was necessary considering other financial resources available to the participant.

    Note:

    Many vendors utilize web-based requests in lieu of paper requests, requiring a participant to self-certify their financial need and lack of other assets available to meet the financial need. Electronic records must be maintained in retrievable format per 26 CFR 1.401(a)-21(a)(3)(ii) which provides the requirements for a plan administrator/trustee to retain information for verification later. 29 CFR Part 2520 provides the DOL's requirements for retaining information.

  11. If the plan allows loans to participants:

    1. Verify and document that the loans comply with IRC 72(p).

    2. Verify the interest rate was reasonable considering similar loans available through financial institutions.

    3. Document whether the safe harbor requirements in IRC 72(p)(2) were satisfied, document and explain the facts and circumstances of the loan and determine whether the loan violates the distribution restrictions of IRC 403(b).

    4. Verify that loan repayments are timely as required under IRC 72(p), that any defaulted loans have been reported as deemed distributions, and that any subsequent loan following a default is paid through payroll reduction.

  12. Determine whether any disaster relief provisions found in notices, announcements or other guidance apply for purposes of loans and distributions.

  13. Determine whether any disaster relief provisions found in legislation, notices, announcements or other guidance apply for purposes of loans and distributions.

  14. If the plan allows for Roth contributions, verify distributions are in accordance with IRC 408A.

  15. IDRS research may be used to verify amounts paid were reported in gross income of the participant or beneficiary.

  16. Verify transactions involving the transfer of funds for the purchase of permissible service credits under a qualified defined benefit plan of a governmental employer are not more than the amount needed to purchase the service credit, IRC 403(b)(13) and IRC 415(n).

Hardship Distributions - Examination Steps
  1. Substantiation that a distribution is for one of the reasons listed in IRM 4.72.13.15.3.1 (7), Hardship Distributions, is required to determine that a hardship distribution is deemed to be on account of an immediate and heavy financial need.

  2. A summary of information provided by a participant to the employer or a third-party administrator may be used to substantiate a safe-harbor hardship distribution deemed to be on account of an immediate and heavy financial need.

  3. When reviewing distributions to determine whether they are made on account of a deemed immediate and heavy financial need, determine if the employer or third-party administrator obtained source documents (such as estimates, contracts, bills and statements from third parties) or a summary (in paper, electronic format, or telephone records) of the information contained in source documents, prior to making a distribution.

  4. If the employer or third-party administrator obtained source documents, review the documents to determine if they substantiate the hardship distribution.

  5. If a summary of information from source documents is used:

    1. Determine whether the employer or third-party administrator provided the required employee notifications listed in IRM 4.72.13.15.4.1.1 (1), Hardship Substantiation Information and Notification for Summary of Source Documents, prior to making a hardship distribution.

    2. Review the summary to determine whether it has the relevant items listed in IRM 4.72.13.15.4.1.1 (2) through IRM 4.72.13.15.4.1.1 (8), Hardship Substantiation Information and Notification for Summary of Source Documents, as applicable.

  6. If the notification provided to employees in IRM 4.72.13.15.4.1 (5)a), or the information reviewed in IRM 4.72.13.15.4.1 (5)b), is incomplete or inconsistent on its face, you may ask for source documents from the employer or third-party administrator to substantiate that a hardship distribution is deemed to be on account of an immediate and heavy financial need.

  7. If the summary of information reviewed in IRM 4.72.13.15.4.1 (5) b), is complete and consistent but you find employees who have received more than two hardship distributions in a plan year, then, in the absence of an adequate explanation for the multiple distributions and with managerial approval, you may ask for source documents from the employer or third-party administrator to substantiate the distributions.

    Note:

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

  8. If the third-party administrator obtained a summary of information contained in source documents, determine whether the third-party administrator provided a report or other access to data to the employer, at least annually, describing the hardship distributions made during the plan year.

  9. If you determine that all applicable requirements in IRM 4.72.13.15.4.1 (4) through IRM 4.72.13.15.4.1 (8) are satisfied, the plan should be treated as satisfying the substantiation requirement for making hardship distributions deemed to be on account of an immediate and heavy financial need.

  10. If hardship distributions were made for plan years beginning before January 1, 2019, you may also inspect the employee’s individual account statement for the six months following the hardship distribution to make sure the employee didn’t make elective deferrals (and after-tax employee contributions).

    Note:

    This six-month suspension rule is prohibited for hardship distributions made on or after January 1, 2020.

  11. Determine the amount of a hardship distribution does not exceed the amount required to satisfy the financial need (including income taxes or penalties resulting from the distribution).

  12. Make sure the employee provided to the plan administrator a representation that he/she has insufficient cash or other liquid assets reasonably available to satisfy the need (mandatory for hardship distributions made on or after January 1, 2020).

Hardship Substantiation Information and Notification for Summary of Source Documents
  1. Notifications that the employer/administrator must provide to the employee are:

    1. The hardship distribution is taxable and additional taxes could apply.

    2. The amount of the distribution cannot exceed the immediate and heavy financial need plus any taxes that are owed on the distribution.

    3. Hardship distributions cannot be made from earnings on elective deferral contributions.

    4. Hardship distributions can be made from amounts attributable to QNECs and QMACs in an annuity contract (if the plan so provides) and not a custodial account, 26 CFR 1.403(b)-6(b) and (c).

    5. The recipient agrees to preserve source documents and to make them available at any time, upon request, to the employer or administrator.

  2. Relevant general information needed for all hardship distribution requests are:

    1. Participant’s name

    2. Total cost of the event causing hardship (e.g., total cost of medical care, total cost of funeral/burial expenses, payment needed to avoid foreclosure or eviction)

    3. Amount of distribution requested

    4. Participant’s representation that he or she has insufficient cash or other liquid assets reasonably available to satisfy the financial need. This representation is mandatory for distributions made on or after January 1, 2020.

  3. Specific information needed for medical expenses:

    • Name of the person who incurred the medical expenses

    • The relationship to the participant of the person who incurred the medical expense (e.g., self, spouse, child, dependent, or primary beneficiary under the plan)

    • The purpose of the medical care

      Note:

      This refers to the general expense category and not the actual condition being treated (e.g., diagnosis, treatment, prevention, associated transportation, long-term care, etc.)

    • Name and address of the service provider (e.g., hospital, doctor/dentist/chiropractor/other, pharmacy)

    • Amount of medical expenses not covered by insurance

  4. Specific information needed for the purchase of a principal residence:

    • Confirmation that the property purchased is the participant’s principal residence

    • Address of the residence

    • Purchase price of the principal residence

    • Types of costs and expenses covered paid with the funds (e.g., down-payment, closing costs and/or title fees)

    • Name and address of the lender

    • Date of the purchase/sales agreement

    • Expected date of closing

  5. Specific information needed for educational payments:

    • Name of the person who incurred the educational expenses

    • The relationship to the participant of the person who incurred the educational expense (e.g., self, spouse, child, dependent, or primary beneficiary under the plan)

    • Name and address of the educational institution

    • The purpose of the educational payments (e.g., post-high school tuition, related fees, room and board, etc.)

    • Period covered by the educational payments (beginning/end dates of up to 12 months)

  6. Specific information needed for foreclosure/eviction from the participant’s principal residence:

    • Confirmation that the property is the participant’s principal residence

    • Address of the residence

    • Type of event (e.g., foreclosure or eviction)

    • Name and address of the party that issued the foreclosure or eviction notice

    • Date of the notice of foreclosure or eviction

    • Due date of the payment to avoid foreclosure or eviction

  7. Specific information needed for funeral or burial expenses:

    • Name of the deceased

    • Relationship to the participant (e.g., parent, spouse, child, dependent, or primary beneficiary under the plan)

    • Date of death

    • Name and address of the service provider (e.g., cemetery, funeral home, etc.)

  8. Specific information needed for repairs of damage to the participant’s principal residence relating to casualty loss:

    • Confirmation that the property is the participant’s principal residence

    • Address of the residence that sustained damage

    • A brief description of the cause of the casualty loss (e.g., fire, flood, type of weather-related damage, etc.), including the date of the casualty loss

    • A brief description of the repairs, including the date(s) of repair (in process or completed)

      Note:

      Expenses for the repair of damage to the participant’s principal residence must be expenses that would qualify for the casualty deduction under IRC 165, figured without regard to IRC 165(h) (federally declared disasters) and whether the loss exceeds 10 percent of adjusted gross income. (For taxable years beginning after December 31, 2017 and before January 1, 2026, any deduction for a personal casualty loss is available only to the extent that loss is attributable to a federally declared disaster.)

  9. Specific information needed for expenses and losses (including loss of income) relating to a federally declared disaster:

    • Confirmation that the address of the participant’s principal residence or principal place of employment at the time of the disaster is located in an area designated by FEMA for individual assistance.

    • A brief description of the disaster losses and expenses, including any expenses for the repair of damage to the principal residence, any loss of income, and the date of the disaster.

Transfers and Contract Exchanges

  1. Within certain limits, funds may be moved by transfer to another IRC 403(b) plan or exchanged within the same plan without being includible in gross income in the taxable year of the transfer or exchange.

  2. Transfers of funds between IRC 403(b) plans are permitted under 26 CFR 1.403(b)-10(b)(3), which states that in order to carry out a plan-to-plan transfer the transferor and the transferee plan must:

    1. Both permit such a transfer;

    2. The participant must be an employee or former employee of the receiving plan;

    3. The transfer must not reduce the participant’s benefit; and

    4. The distribution restrictions of the plan that receives the funds are not less stringent than those under the transferor plan.

  3. There is no IRC requirement that a transfer from an IRC 403(b) plan or contract be permitted, or that an IRC 403(b) plan or contract have language to effect or accept a transfer (although an IRC 403(b) plan must provide a direct rollover for eligible rollover distributions).

  4. Transfers may also be made from an IRC 403(b) plan to a governmental defined benefit plan for the purchase of permissive service credit under IRC 415(n)(3) or a repayment of refunds under a governmental plan under IRC 415(k)(3). An IRC 403(b) plan is not required to provide for such transfers, 26 CFR 1.403(b)-10(b)(4).

    Note:

    If the state provides for the purchase of permissive service credit, language must be included in the defined benefit plan document permitting the purchase, and the funds transferred must be used specifically to purchase permissive service credit as defined in IRC 415(n)(3).

  5. 26 CFR 1.403(b)-10(b)(2) provides that funds may be exchanged between annuity contracts or custodial accounts within the same IRC 403(b) plan. In order to do such an exchange:

    1. The plan document must specifically permit such an exchange

    2. The exchange must not reduce the participant’s benefit

    3. The distribution restrictions of the contract or custodial account that receives the funds cannot be less stringent that those under the contract being exchanged, and

    4. The employer and the contract issuer must enter into an information sharing agreement, IRM 4.72.13.7.4, Written Provision for Information Sharing Agreements.

  6. Transfers per Rev. Proc. 90-24 are no longer permissible, 26 CFR 1.403(b)-9(b).

Rollovers

  1. In accordance with IRC 403(b)(8) and 26 CFR 1.403(b)-7(b), amounts may be distributed from an IRC 403(b) plan in an eligible rollover distribution (within the meaning of IRC 402(c)(4)), 26 CFR 1.403(b)-10(d) for rules relating to a IRC 403(b) plan accepting rollover distributions.

  2. Distributions from an IRC 403(b) plan or contract are not includible in the employee's gross income if they are properly rolled over.

  3. The rollover rules of IRC 402(c) and the direct rollover rules of IRC 401(a)(31) apply to distributions from IRC 403(b) plans.

    1. All or a portion of the balance to the credit of the distributee must be paid to the employee in an eligible rollover distribution.

    2. The employee may roll any portion of the property he or she receives in the distribution to an IRA, another IRC 403(b) plan, an IRC 403(a) annuity investment, a qualified plan or an eligible governmental 457 plan.

    3. If property other than money is distributed and the property transferred is the same as the property distributed, then the distribution (to the extent transferred) shall not be includible in gross income for the taxable year in which paid.

    4. A proper rollover must be completed within 60 days of the employee's receipt of the distribution. The 60-day period may be waived by the IRS under certain circumstances, Rev. Proc. 2003-16. A taxpayer may self-certify that he/she qualifies for a waiver of the 60-day requirement based on the conditions in Rev. Proc. 2016-47. Self-certification, however, is not a waiver.

    5. Effective January 1, 2018, the 60-day rollover period is extended for a plan loan offset that is due to plan termination or severance from employment. The participant has until the due date, including extensions, for filing the Federal income tax return for the taxable year in which the offset occurs, IRC 402(c)(3)(C).

    6. Distributions not properly rolled over are includable in the employee’s gross income and may be subject to additional tax under IRC 72(t).

    7. Unlike transfers, there must be a distribution event under the plan or contract to have an eligible rollover distribution.

  4. Under 26 CFR 1.403(b)-7(b), an eligible rollover distribution from an IRC 403(b) plan or contract is any distribution made to an employee of all or a portion of the balance to the credit of the employee, not including required minimum distributions, periodic distributions, or hardship distributions that occur after December 31, 1999.

    1. A direct rollover is an eligible rollover distribution from an IRC 403(b) plan or contract that is paid directly from the IRC 403(b) plan or contract to an IRA, another IRC 403(b) plan or contract, an IRC 403(a) annuity plan, a plan qualified under IRC 401(a), or an eligible governmental 457 plan.

    2. A direct rollover is both exempt from withholding and excludable from gross income, 26 CFR 1.403(b)-7(b)(4).

    3. Unless made in the form of a direct rollover, all eligible rollover distributions are subject to 20 percent mandatory income tax withholding, even if they are subsequently properly rolled over (and thus excludable from gross income), 26 CFR 1.403(b)-7(b)(4). The payor (i.e., insurer or custodian) is responsible for the withholding.

    4. If the amount distributed would be excluded from gross income if it were not rolled over, and such portion is to be rolled over to an eligible retirement plan that is not an IRA (i.e., a plan qualified under IRC 401(a) or another IRC 403(b) plan), the rollover must be done in a direct rollover and it must be maintained in a separate account, 26 CFR 1.403(b)-7(b)(1).

    Example 40: Employee X, age 59 1/2, received a $150,000 eligible rollover distribution from an IRC 403(b) plan on May 5, 2019. Twenty percent, or $30,000, was withheld by Payor. On June 20, 2019, Employee X rolled over $120,000 (the amount he actually received from Payor) to an IRA. The $30,000 withheld by Payor and not rolled over is subject to federal income tax for 2019. Employee X could have rolled over (within the 60-day period) the $30,000 withheld using other funds, in which case the entire $150,000 distribution would be excludible from gross income.

    Example 41: The same facts as Example 39, except that Employee X elected a direct rollover of the $150,000 eligible rollover distribution. The $150,000 is not subject to withholding and is excludable from Employee X's gross income in the year of the rollover.

  5. Under IRC 403(b)(10) and IRC 401(a)(31), an IRC 403(b) contract is required to permit an employee to elect a direct rollover to an eligible retirement plan, 26 CFR 1.403(b)-7(b)(2) and (3).

    1. The employee must also have a meaningful right to elect a direct rollover, 26 CFR 1.403(b)-7(b)(3).

    2. Within a reasonable period of time prior to making the eligible rollover distribution, the payor must provide an explanation to the employee of the employee’s right to elect a direct rollover and the income tax withholding consequences of not electing a direct rollover, 26 CFR 1.403(b)-7(b)(3).

  6. IRC 403(b) plans must be operated in compliance with the above rules. The contract and plan document must reflect the direct rollover requirements, IRC 403(b)(10), 26 CFR 1.403(b)-3(b)(3) and 26 CFR 1.403(b)-7(b)(2).

  7. Special rules relate to a rollover from a grandfathered IRC 403(b) annuity contract purchased by an Indian tribal government. A grandfathered IRC 403(b) contract is one that is purchased by an Indian tribal government in a plan year beginning prior to January 1, 1995.

  8. In accordance with IRC 403(b)(10), an IRC 403(b) plan is required to comply with IRC 401(a)(31) (including automatic rollover for certain mandatory distributions) in the same manner as a qualified plan, 26 CFR 1.403(b)-7(b)(5).

Transfers, Contract Exchanges and Rollovers - Examination Steps

  1. Review plan provisions regarding transfers, exchanges and rollovers.

  2. Request data regarding transfers and rollovers into or out of the plan.

  3. Examine distribution reports and Forms 1099-R.

    1. Form 1099-R is usually issued by the vendor or third-party administrator.

    2. Direct rollovers are reported on Form 1099-R.

    3. Transfers and exchanges are not reported on Form 1099-R.

  4. Distributions from the plan that are not direct rollovers should be researched on IDRS to determine if the reported distributions were taken into income.

  5. Verify that amounts received into the plan as rollover contributions are accounted for separately.

  6. Determine whether plan-to-plan transfers comply with 26 CFR 1.403(b)-10(b)(3).

  7. Request, review and verify information sharing agreements on contract exchanges.

  8. Verify compliance with direct rollover requirements of IRC 401(a)(31).

  9. Document whether the withholding and reporting requirements are met.

Plan Terminations

  1. An IRC 403(b) plan may contain provisions allowing the plan sponsor to terminate the plan and make distributions on plan termination, 26 CFR 1.403(b)-10(a) and Rev. Rul. 2011-7.

  2. Termination of an IRC 403(b) plan involves the distribution of each participant’s accumulated benefit for plan termination purposes . Delivery of a fully paid individual insurance annuity contract is treated as a distribution, Rev. Rul. 2011-7.

  3. In the case of an IRC 403(b) contract that is subject to the distribution restrictions relating to custodial accounts and elective deferrals, termination of the IRC 403(b) plan and the distribution of accumulated benefits is permitted only if the employer does not make contributions to any IRC 403(b) contract that is not part of the plan during the period beginning on the date of plan termination and ending 12 months after distribution of all assets from the terminated plan, 26 CFR 1.403(b)-10(a)(1).

  4. There is an exception to the general rule as stated in IRM 4.72.13.17 (3). If for the period beginning 12 months before the date of the plan termination and 12 months after the date of the distribution of all assets from the plan, less than 2 percent of eligible employees are eligible under the alternative IRC 403(b) plan, the alternative IRC 403(b) contract is disregarded, 26 CFR 1.403(b)-10(a)(1).

  5. Alternatively, an IRC 403(b) plan may contain provisions allowing the sponsor to freeze the plan by eliminating future contributions or by limiting participation to existing participants and employees, 26 CFR 1.403(b)-10(a)(1).

    Note:

    The frozen plan is not terminated and is still required to meet the nondiscrimination requirements for IRC 403(b) plans, 26 CFR 1.403(b)-10(a)(1) and 26 CFR 1.403(b)-5.

  6. Section 110 of the SECURE Act provides that future guidance will provide that, if an employer terminates a plan under which amounts are contributed to a custodial account under IRC 403(b)(7), the plan administrator or custodian may distribute an individual custodial account (ICA) in kind to a participant or beneficiary of the plan. It also provides that the distributed custodial account will be maintained by the custodian on a tax-deferred basis as an IRC 403(b)(7) custodian account, similar to the treatment of fully paid individual annuity contracts under Rev. Rul 2011-7, until amounts are actually paid to the participant or beneficiary.

    Rev. Rul. 2020-23 provides that “[d]istribution of an ICA in kind to a participant or beneficiary is not includible in gross income until amounts are actually paid to the participant or beneficiary out of the ICA, so long as the ICA maintains its status as a 403(b)(7) custodial account. Any other amount distributed from a custodial account to a participant or beneficiary to effectuate plan termination is includable in gross income., except to the extent the amount is rolled over to an IRA or other eligible retirement plan by a direct rollover or by a transfer made within 60 days.”

Plan Termination - Examination Steps

  1. Review the plan document.

    1. Determine whether it has provisions allowing for termination of the plan.

    2. Review all amendments to determine if an amendment terminating the plan has been adopted.

    3. Review the plan’s terms regarding the form of distribution.

  2. Document whether distributions have been made to all participants as soon as is administratively practicable (generally within one year) following the date of termination.

  3. Document whether distribution of all accumulated benefits has been made to all the participants in accordance with the plan’s terms. Depending on the plan’s terms and funding vehicles, distributions from a terminating plan may be made in cash, or in kind by distribution of an individual custodial account or by the delivery of fully paid individual insurance annuity contracts to the participant.

    Note:

    If all benefits are not distributed, the plan is not terminated, and Form 5500 filing requirements may apply.

  4. Document whether the employer continues to be an eligible employer under IRC 403(b).

  5. If an employer is no longer eligible to maintain an IRC 403(b) plan and has not terminated the plan, correction under EPCRS should be considered.

Correction Programs

  1. An IRC 403(b) plan may be eligible to correct one or more failures to comply with the requirements of IRC 403(b) or the final IRC 403(b) regulations as outlined in Rev. Proc. 2019-19. Rev. Proc. 2019-19 provides the following correction programs:

    1. SCP

    2. VCP

    3. Audit CAP

  2. For 2009 and later years, the following IRC 403(b) errors may be corrected under EPCRS:

    1. Plan Document Failure

    2. Demographic failure

    3. Operational failure

    4. Employer Eligibility Failure

  3. Rev. Proc. 2019-19 provides guidance and information regarding correction principles through SCP, VCP and Audit CAP, along with fee schedules and guidance on sanction fees, http://www.irs.gov/Retirement-Plans/Correcting-Plan-Errors.

  4. More information can be obtained from the IRS web site at: http://www.irs.gov/Retirement-Plans/403(b)-Plan-Fix-It-Guide.

Self-Correction Program (SCP)

  1. SCP allows an employer to self-correct certain insignificant operational errors at any time. Significant operational errors may be able to be self-corrected if action is taken within the time frame set forth in Section 9 of Rev. Proc. 2019-19.

Voluntary Correction Program (VCP)

  1. Voluntary Compliance Program (VCP) allows an employer who has established compliance practices and procedures to correct a failure with IRS approval. Some failures must be corrected through VCP and are not eligible for self-correction.

  2. An employer cannot apply for VCP once the plan is under examination, as defined in Section 5.08 of Rev. Proc. 2019-19.

Correction on Audit (Audit CAP)

  1. Audit CAP for IRC 403(b) plans is available to correct all failures discovered on examination other than a failure that has been corrected under SCP or VCP or is eligible for correction under SCP. SCP is available for certain failures while the plan if under examination as defined in Section 5.08 of Rev. Proc. 2019-19.

  2. Under Audit CAP, an employer and the IRS enter into a closing agreement specifying the form of correction and the sanction amount.

Effect of Correction under EPCRS

  1. If the employer corrects a failure in accordance with the applicable requirements of SCP, VCP, or Audit CAP, the IRS will not treat the plan as failing to meet the requirements of IRC 403(b) because of the failure. For example, if the employer corrects a failure in accordance with the requirements of Rev. Proc. 2019-19, the plan will not be treated as failing to satisfy IRC 403(b) for purposes of applying FICA and FUTA taxes.

  2. In appropriate cases, certain excise taxes may be waived under EPCRS, Section 6.09 of Rev. Proc. 2019-19.

  3. The issuance of a compliance statement or closing agreement under EPCRS for the failure to adopt a written IRC 403(b) plan timely will result in the written IRC 403(b) plan being treated as if it had been adopted timely for the purpose of making available the extended RAP set forth in Rev. Proc. 2017-18. However, the issuance of a compliance statement or closing agreement is not a determination as to whether the written plan, as drafted, complies with the requirements of IRC 403(b) and the final IRC 403(b) regulations, Section 6.10(3) of Rev. Proc. 2019-19.

Examination Use of EPCRS

  1. Issues found during an examination should be corrected using the guidance under Rev. Proc. 2019-19.

  2. If, during an examination, it is found that the plan sponsor has corrected a failure through EPCRS:

    1. If the employer has made self-correction through SCP, verify that the method of correction was proper and timely

    2. If a failure has been corrected through VCP, review the compliance statement and verify that the correction was properly and timely made. Review and verify the accuracy of the correction if it applies to the year under examination. For example, if a failure is corrected through VCP, the correction must be implemented within 150 days of the date of the compliance statement, unless more time was provided under the compliance statement.

    3. Check to see if there are any failures or years that fall outside of the scope of the compliance statement or closing agreement.

    4. If a written plan has been adopted through EPCRS, confirm that the written plan, as drafted, complies with the requirements of IRC 403(b)and the final IRC 403(b) Regulations.

    5. Secure Form 5330 and payment of any excise taxes, if applicable.