4.72.13 IRC 403(b) Plans

Manual Transmittal

August 11, 2017

Purpose

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

Material Changes

(1) IRM 4.72.13.1, Program, Scope and Objectives, and the subsections thereunder, were added to meet the new internal controls requirements.

(2) IRM 4.72.13.15.4.1, Hardship Distributions - Examination Steps, and IRM 4.72.13.15.4.1.1, Hardship Substantiation Information and Notification for Summary of Source Documents, were added to incorporate the March 7, 2017 memorandum from the Acting Director, EP Examinations entitled, Substantiation Guidelines for Safe-Harbor Hardship Distributions from Section 403(b) Plans.

(3) Minor editorial changes, including updates to links to other websites, were made throughout the document.

Effect on Other Documents

This supersedes IRM 4.72.13 dated July 18, 2016.

Audience

Tax Exempt and Government Entities
Employee Plans

Effective Date

(08-11-2017)


Robert S. Choi
Director, Employee Plans
Tax Exempt and Government Entities

Program, Scope and Objectives

  1. Purpose: IRM 4.72.13, Employee Plans Technical Guidance, IRC 403(b) Plans, provides technical guidance as well as examination steps to be taken by an Employee Plans (EP) agent when auditing an IRC 403(b) plan. This section will also aid group managers in their review of the agent’s case file and to provide assistance to the agent as needed.

  2. Audience: This IRM provides procedures for agents, their group managers and support staff in EP Exam.

  3. Policy Owner: Director, EP Examination.

  4. Program Owner: EP Examination.

  5. Program Authority: EP Examination’s authority to resolve issues is derived from its authority to make determinations of tax liability under IRC 6201.

  6. Program Goals: The information contained in this IRM is designed to promote quality 403(b) examinations. To achieve this objective, the format of this IRM is laid out by each area of qualification and taxation. For each area, the applicable law is discussed and followed by the examination steps the agent should take to verify compliance with the law. This section will also aid group managers in their review 403(b) cases, in providing technical assistance to their agents and in resolving 403(b)issues with the taxpayer.

Background

  1. EP Examination is the division designated to determine whether a 403(b) plan is in compliance with current law. As part of EP Examination’s responsibilities, a determination of tax liability must be made for non-complaint 403(b) plans. EP Examination should seek to resolve the tax liability discovered during examination under the authority provided under IRC 6201.

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

    1. IRC 403(b) was first added to the Code in 1958.

    2. In 1974, pre-Employee Retirement Income Security Act of 1974 (ERISA) regulations were issued detailing some of the basic statutory provisions of IRC 403(b). These regulations were later amended as new provisions were added to IRC 403(b).

    3. 26 CFR 1.401(a)(31)-1, Q&A-1 provides that the direct rollover requirements apply to IRC 403(b) annuities, effective for years beginning after 1992.

    4. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) amended various sections of IRC 403(b) effective for years beginning after 2001, with respect to compensation, deferral limitations, age 50 catch-up contributions, rollovers, and distributions.

    5. Effective for years beginning on and after January 1, 2003, 26 CFR 1.401(a)(9) was issued pertaining to the minimum distribution requirements under IRC 401(a)(9).

    6. On November 16, 2004, proposed regulations were issued which constituted a comprehensive update of the IRC 403(b) regulations.

    7. Effective for years beginning after 2005, EGTRRA provides that IRC 403(b) plans may allow for Roth contributions. See IRC 402A.

    8. The Pension Protection Act of 2006 (PPA '06) amended various provisions of IRC 403(b) by making certain EGTRRA provisions permanent and by making changes with respect to hardship distributions.

    9. On April 4, 2007, Treas. Regs. were issued under IRC 415, effective for limitation years beginning after June 30, 2007, which provided changes to the definition of 415 compensation to include certain types of post-severance compensation.

    10. On July 26, 2007, final IRC 403(b) regulations were issued, generally effective on January 1, 2009. These final regulations reflect the amendments made to IRC 403(b) by PPA ’06, and require that all IRC 403(b) plans adopt a written plan document effective as of January 1, 2009.

    11. Rev. Proc. 2007-71 provides model plan language that may be used by public schools to comply with the written plan requirement. Other IRC 403(b) plan sponsors may rely on the language to the extent it is applicable for their organization.

    12. The Heroes Earning Assistance and Relief Tax Act of 2008 (HEART), passed on June 17, 2008, added death benefits for qualified active military service under Uniform Services Employment and Re-employment Rights Act of 1994 (USERRA) as required under IRC 401(a)(37), effective for years beginning on or after January 1, 2010.

    13. Effective with plan years beginning after December 31, 2009, the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) added provisions to allow a rollover of benefits by a nonspouse beneficiary, generally subject to the same rules as other eligible rollovers.

    14. Notice 2009-3 delays the written plan requirement to December 31, 2009, if certain requirements are met.

    15. Rev. Rul. 2009-18 makes obsolete certain IRC 403(b) guidance that no longer applies.

    16. Announcement 2009-34 includes a draft revenue procedure for an IRC 403(b) pre-approved program. Along with Announcement 2009-34, the IRS issued a Listing of Required Modifications (LRMs) for IRC 403(b) plans

    17. Announcement 2009-89 announces an initial remedial amendment period 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.

    18. Rev. Rul. 2011–7 provides guidance on the termination of an IRC 403(b) plan.

    19. Rev. Proc. 2013-12 expanded the Employee Plans Correction Resolution System (EPCRS) to resolve matters arising from a failure to comply with new requirements imposed by the final IRC 403(b) regulations. This includes written plans not timely adopted or failure to follow the written plan in 2009 and later plan years.

    20. Rev. Proc. 2013-22 sets forth the procedures for issuing opinion and advisory letters for pre-approved IRC 403(b) prototype plans and IRC 403(b) volume submitter plans. Rev. Proc. 2013-22 also modifies the remedial amendment period in Announcement 2009-89 and provides that it is not anticipated that determination letters will be issued for individually designed IRC 403(b) plans. In connection with Rev. Proc. 2013-22, the IRS issued sample plan language in the form of LRMs for IRC 403(b) plans.

    21. Rev. Proc. 2014-28, issued on March 25, 2014, amended the program for pre-approved plans and extended the deadline to April 30, 2015.

Program Controls

  1. Tax Exempt Quality Measurement System (TEQMS) is the quality control system used to oversee the entire examination program. For more information on TEQMS, see IRM 4.71.15.1.3, Program Controls and Program Reports - TEQMS.

  2. All examinations will be done in accordance with the Taxpayer Bill of Rights as listed in IRC 7803(a)(3).

    Note:

    Additional information may be found on the irs.gov website at www.irs.gov/taxpayer-bill-of-rights.

Acronyms, Forms and Pubs

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

    Acronyms

    Acronym Definition
    ACP Average Contribution Percentage
    ADP Average Deferral Percentage
    Audit CAP Audit Closing Agreement Program
    CAS Computer Audit Specialist
    CODA Cash or Deferred Arrangement
    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 Correction 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
    FUTA Federal Unemployment Tax Act
    HEART Heroes Earning Assistance and Relief Tax Act of 2008
    IDR Information Document Requests
    IRA Individual Retirement Arrangement
    IRC Internal Revenue Code (or 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
    RBD Required Beginning Date
    SCP Self Correction Program
    SEP Simplified Employee Pension
    SIMPLE Savings Incentive Match Plan for Employees
    SPD Summary Plan Description
    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 Year of Service

    Forms and Pubs

    Form 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 of Your Organization

Overview

  1. Guidance is provided on how to examine a plan described in IRC 403(b).

  2. The guidance contained in this section is designed primarily to assist EP agents in identifying relevant issues relating to IRC 403(b) plans.

  3. In examining IRC 403(b) plans, agents must ensure that the issues under consideration satisfy the applicable requirements of the Treasury Regulations (Treas. Regs. or 26 CFR) in both form and operation.

  4. An agent should consult the Code, Treasury Regulations and other relevant guidance for further development of a particular issue. Accordingly, cites are provided where appropriate.

    .

  5. The issues discussed in this IRM may not be relevant for every examination.

  6. Examination steps and techniques identified should be modified based on the actual examination issue encountered.

  7. These guidelines cannot be, nor are they intended to be a precedent or comprehensive statement of the legal position of the IRS.

  8. These guidelines are not to be relied on or cited as authority by either taxpayers or IRS agents.

  9. These guidelines are subject to future change in accordance with developments in the law governing IRC 403(b).

  10. Examination procedures for IRC 403(b) plans are found 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 behalf of and on a tax-deferred basis for an employee. Over the years IRC 403(b) plans became more like qualified retirement plans. Accordingly, effective January 1, 2009, IRC 403(b) plans must, in part:

    1. Be maintained pursuant to a written plan that satisfies the requirements of IRC 403(b) in form and operation. 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 applicable to the plan

    2. Comply with 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 do not exceed the IRC 402(g) limit

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

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

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

    7. Not exceed the applicable limitations of IRC 415(c)

    8. Not be transferable

    9. Have rights of the employees under the annuity contract be 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 multiple documents, including documents that are incorporated by reference, rather than a single written plan document. This is acceptable under IRC 403(b).
    Example 2: Employer A is an organization described in IRC 501(c)(3) and exempt from tax under IRC 501(a). Employer A maintains an IRC 403(b) plan for its employees. The IRC 403(b) plan consists of a lengthy plan document, and employees are informed of plan features through annual summary plan descriptions.

  2. The plans in Examples 1 and 2 are subject to the requirements of IRC 403(b).

    1. An IRC 403(b) plan is subject to Title II of ERISA (relating to the IRC) but may not be subject to Title I of ERISA.

    2. For example, the plan described in Example 1 may not be an employee pension benefit plan under DOL Reg. 2510.3-2(f), but the plan is nevertheless subject to the requirements of IRC 403(b).

  3. At the outset of the examination of an IRC 403(b) plan, the agent should determine if the plan is subject to Title I of ERISA. See IRM 4.72.13.1.9, IRC 403(b) Filing Requirements.

General Characteristics

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

  2. IRC 403(b) plans are exempt from the requirements applicable 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 one-time irrevocable elections and condition of employment)

    3. After-tax employee contributions

    4. Rollover contributions

  5. In an IRC 403(b) plan that consists of 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 permit contributions to be treated as Roth contributions, in which case the contributions are includible for income tax purposes in the participants’ gross income when made.

  7. Earnings on non-Roth contributions are also tax deferred until distributed, while Roth earnings are not taxed if made under a qualified distribution.

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

  9. Generally, salary reduction contributions to an IRC 403(b) plan, as defined in IRC 3121(a)(5)(D) (including elective deferrals, one-time elections and condition 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. See 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, however, is responsible for paying the employer share of FICA, and withholding income and FICA taxes, if applicable.

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

    Example 3: Hospital M maintains an annuity plan intended to be an IRC 403(b) plan (Plan). Hospital M is not exempt from FICA and the Plan does not permit Roth contributions. The Plan provides only for employer contributions that are not elective deferrals and is funded through annuity contracts. It is discovered on examination that the Plan is not an IRC 403(b) plan. Unless Hospital M can correct under EPCRS, the tax ramifications for all open years under the statute of limitations, are as follows:

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

    2. Employees are responsible for FICA taxes, and

    3. The employer is responsible for income tax and FICA withholding.

    Example 4: Assume the same facts as in Example 3, except that the Plan is an IRC 403(b) plan and it provides both elective deferrals and employer contributions that are not elective deferrals. The tax ramifications would also include:

    1. The elective deferrals are subject to FICA tax at the time of contribution.

    2. Hospital M is responsible for withholding income taxes and the employees' portion of FICA.

    3. Elective deferrals and employer contributions are not subject to income tax until distributed.

Aggregated Annuity Contracts

  1. All annuity contracts (including custodial accounts and retirement income accounts) purchased by an employer on behalf of an employee are treated as a single annuity contract for purposes of applying the requirements of IRC 403(b). See 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 tax-exempt employers, governments and ministers may sponsor an IRC 403(b) plan.

    2. Funding vehicles for an IRC 403(b) plan are limited to annuity contracts and custodial accounts (and retirement income accounts for churches, a convention or association of churches, or an organization described in IRC 414(e)(3)(A)).

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

    4. There is no special 10-year averaging for purposes of calculating the taxable portion of a lump sum distribution for IRC 403(b) plans.

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

    6. Compensation under IRC 415 is defined as includible compensation under IRC 403(b).

    7. Certain nonelective employer contributions may be made for former employees for up to five years. See 26 CFR 1.403(b)(3)-4(d).

IRC 403(b) Filing Requirements

  1. With some exceptions, IRC 403(b) plans are required to file Form 5500. The following types of plans are exempt from filing (see instructions to Form 5500):

    • Church plans, as defined in IRC 414(e), that have not made an election under IRC 410(d)

      Reminder:

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

    • Governmental plans

    • IRC 403(b) plans that are not employee pension benefit plans under Title I of ERISA

  2. In general, an IRC 403(b) plan is not subject to Title I of ERISA if:

    1. The plan provides only elective deferrals, and

    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 http://www.dol.gov/ebsa/403b.html. These FABs discuss types of employer involvement (including, for example, authorizing plan distributions, hardship withdrawals, or loans) that can trigger ERISA coverage.

  3. Employee Benefits Security Administration (EBSA) of the DOL, has issued the following guidance related to filing requirements for IRC 403(b) plans:

    1. FAB 2007-02 addressed the effect of the final IRC 403(b) regulations on the DOL safe harbor regulations in DOL Reg. 2510.3-2(f) regarding circumstances under which an employer remains outside the coverage of ERISA.

    2. FAB 2009-2 provided transitional relief from requirements for IRC 403(b) plans for Form 5500 annual reporting.

    3. FAB 2010-01 supplements FAB 2009-02 with respect to the scope and conditions required for transitional relief provided in FAB 2009-02. In addition, FAB 2010-01 addressed questions relating to the scope of the DOL’s safe harbor regulation in DOL Reg. 2510.3-2(f).

      Note:

      For additional information related to these FABs and other DOL guidance see http://www.dol.gov/ebsa/403b.html

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

    1. Form 8955-SSA, is a stand-alone reporting form filed 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.

    3. Governmental plans and church plans, as defined in IRC 414(e), that have not made an election under IRC 410(d) are generally excluded from coverage under Title I of ERISA. See FAB 2009-2.

Scope of the Examination

  1. The focused examination methodology is the standard approach to conducting IRC 403(b) examinations.

  2. Focused examinations require the examiner to review a variety of information to determine the scope of the examination and which specific issues will be examined.

  3. Under focused examinations for IRC 403(b) plans, three issues will be identified by EP Classification that the examiner must address in the examination.

    1. Based on the pre-audit review, an agent may determine additional issues to be addressed.

    2. Managerial approval is required if the total number of issues exceeds five.

  4. See IRM 4.71.1.5, Scope of the Examination for a more detailed description of the focused examination methodology.

Pre-audit Analysis

  1. A comprehensive pre-audit analysis is important to organize the examination and to identify potential issues prior to sending out an appointment letter. See IRM 4.71.1.6, Pre-audit Analysis for a discussion of pre-audit responsibilities.

  2. IRC 403(b) plans that are not subject to Title I of ERISA are not required to file a Form 5500. Filed Forms 5500 can be found on DOL's "Form 5500/Form 5500-SF Search" at: https://www.efast.dol.gov/welcome.html

  3. Other information should be reviewed in order to identify potentially significant issues. These sources include, but are not limited to the Internet, Form 990, W-2 data, 5500 returns for related plans, and IDRS.

    1. In addition to the normal review of IDRS information, the Employment Code shown on the INOLES is useful to determine the type of employer being examined. These codes can be found in Document 6379.

      Note:

      See IRM 4.71.2, Overview of IDRS Transcripts, 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 whether the plan sponsor is under examination by EO or FSLG, and if EO or FSLG has already begun an examination, contact and coordinate with the EO or FSLG specialist. Any conflicts should be resolved through the group managers.

  4. Determine whether assistance is needed from specialists such as Computer Audit Specialists (CAS), EO, and FSLG. See IRM 4.10.2.6.5.1, Referral Criteria, for a discussion of the procedures to request specialist assistance.

  5. Upon completion of the pre-audit analysis, prepare Letter 1346-D, Form 5464 and appropriate Information Document Requests (IDRs) for the various types of records needed to conduct the examination.

    Note:

    Initial IDRs have been developed for use by all 403(b) agents to follow.

  6. Request a copy of the written plan prior to the initial appointment. The review of the plan will provide valuable information on how the plan should operate.

Package Audit

  1. Package Audits include an assessment of the employer’s various filing requirements.

  2. The types of returns that fall within the EP Package Audit requirements include the following:

    • 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 audit in an examination of an IRC 403(b) plan.

  3. IDRS research should be conducted to determine filing requirements and whether returns have been timely filed.

  4. See IRM 4.71.1.14, Package Audit Requirements.

Initial Interview

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

  2. It is important to hold the initial interview with persons who are familiar with the organization of the employer, 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 provide an understanding of the employer’s history, operations, and accounting records.

  4. Detailed questions should be prepared in advance of the initial interview. Make sure to consider the type and structure of the employer and the types of deferred compensation plans maintained. In addition, detailed questions should be asked concerning the day to day operation of each aspect of the plan being examined. This is an important step in the preparation of a focused audit plan.

  5. Some important things to consider when preparing for an initial interview:

    1. Know what you want to accomplish.

    2. Develop a strategy.

    3. Utilize a questionnaire as an aid, but remain flexible.

    4. Conduct interviews with persons who can best answer your questions.

    5. Listen to answers.

    6. Follow up immediately if responses are ambiguous.

    7. Document responses.

  6. See IRM 4.71.1.12, Initial Interview.

Evaluation of Internal Controls

  1. Internal controls are the procedures and practices of the plan administrator 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 with the pre-audit analysis.

  3. Most of the information regarding the plan’s internal controls will likely be obtained during the initial interview.

  4. Adequacy of internal controls will determine the sample size utilized and will set parameters for the depth of review required.

  5. It is important to evaluate internal controls for each aspect of plan administration.

  6. A well-designed questionnaire will assist in the evaluation of internal controls and provide an understanding of the administrative and accounting systems that pertain to the plan. The questionnaire should be directed to those employees who are directly responsible for the administration of the plan and may be combined with initial interview questionnaires.

  7. Plan records and persons responsible for maintaining them are usually located at the employer’s place of business; therefore, the initial interview and the assessment of internal controls should be conducted at the plan sponsor's place of business. See 26 CFR 301.7605-1(d) and IRM 4.10.3.4, Evaluating the Taxpayer's Internal Controls.

Written Plan Requirement Overview

  1. 26 CFR 1.403(b)-3(b) introduced a new IRC based written plan requirement for IRC 403(b) plans. It provides that an IRC 403(b) program must be maintained pursuant to a written defined contribution plan, and must satisfy all of the requirements of IRC 403(b) and the related Treas. Regs. in form and must operate in compliance with the form.

  2. The written plan requirement provides employers with a central location for determining benefits and administrative responsibilities under the IRC 403(b) program, and will improve the administration and coordination of the various legal requirements.

  3. Originally the written plan was to be in place by January 1, 2009, the effective date of the IRC 403(b) Treas. Regs. However, in Notice 2009-3 the IRS extended the deadline to December 31, 2009, as long as certain conditions were met. See IRM 4.72.13.7.5, Notice 2009-3 - Transitional Relief Regarding the Written Plan Requirement.

  4. A plan that did not adopt a written plan document by December 31, 2009, may still do so by complying with the procedures set forth in Rev. Proc. 2013-12. See sections 2.03, 5.02 and 6.10 of Rev. Proc. 2013-12.

  5. An IRC 403(b) written plan may incorporate other documents by reference, however, in the event of a conflict with another document, the plan governs.

Written Plan Requirement

  1. The IRC 403(b) written plan requirement does not require that there must be a single plan document. Instead, the written plan may consist of multiple documents, including documents that are incorporated by reference. All of those documents, 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 in order to satisfy the written plan requirement in 26 CFR 1.403(b)-3(b)(3).

  3. A plan may contain certain optional features that are consistent with but not required under IRC 403(b), such as hardship withdrawal distributions and loans. If a plan contains any optional provisions, the optional provisions must also meet, in both form and operation, the relevant requirement under IRC 403(b) and the Treasury Regulations for IRC 403(b). See 26 CFR 1.403(b)-3(b)(3).

  4. The plan may allocate responsibility for performing administrative functions, but must identify responsibility for compliance with the IRC requirements that apply on the basis of aggregated contracts for a participant (such as loan limits).

Written Plan Exclusions

  1. In general, a contract will not 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 does not 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).

  3. Section 8 of Rev. Proc. 2007-71, provides guidance on contracts to which contributions have ceased that may be excluded from the written plan requirement depending on when such contributions ceased.

    1. Contracts that stopped receiving contributions after December 31, 2004, are excluded from the written plan document requirement. Therefore, if a plan sponsor stopped making all IRC 403(b) contributions prior to December 31, 2004, the plan sponsor does not need a written plan document.

    2. Contracts issued on or between January 1, 2005, and December 31, 2008, by an issuer that does not receive contributions under the plan in a year after the contract was issued is 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 by 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 5: Organization A provided employees with 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 an IRC 403(b) arrangement and instead adopted an IRC 401(k) plan. Organization A does not have to comply with the written plan requirement.

Sample Plan Language

  1. Model plan language that public schools can use to comply with the written document requirement is in Rev. Proc. 2007-71.

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

    2. Public schools that use the language in Rev. Proc. 2007-71 have reliance that their plan documents comply with the written plan requirement in the Treas. Regs. See section 4 of Rev. Proc. 2007-71.

    Note:

    Rev. Proc. 2007-71 includes additional guidance that is applicable to all IRC 403(b) plans.

  2. The LRMs issued in conjunction with Rev. Proc. 2013-12 also include sample plan language for IRC 403(b) plans. The draft LRMs are available on the IRS web site 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 is not an approved vendor (for example, a payroll slot vendor) under the plan. See 26 CFR 1.403(b)-10(b)(2)(i)(C).

  2. Section 8.01 of Rev. Proc. 2007-71 imposes an information sharing requirement for certain contracts that were not required to be brought under an employer’s written IRC 403(b) plan.

    1. Section 8.01 of Rev. Proc. 2007-71 provides that contracts which received contributions on or between January 1, 2005, and December 31, 2008, by an issuer that does not receive contributions under the plan in a year after the contract was issued, are not 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 for purposes of coordinating information necessary to satisfy IRC 403(b).

    3. Section 8.01 of Rev. Proc. 2007-71 also provides that as an alternative to the actions described in b) above, a reasonable, good faith effort to include a contract as part of the employer’s plan also includes the issuer taking action before making any distribution or loan to the participant or beneficiary which constitutes a reasonable, good faith effort to contact the employer and exchange any information that may be needed in order to satisfy IRC 403(b) with the person in charge of administering the employer’s plan.

  3. If the employer’s IRC 403(b) plan allows for contract exchanges, the employer is required to 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 section 8.04 of Rev. Proc. 2007-71 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 provide 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 if the withdrawal results in a six month suspension of the participant’s right to make elective deferrals under the plan.

    3. The vendor must provide information to the employer or other vendors to enable a vendor to determine the amount of any plan loan that is outstanding to the participant in order for a vendor to determine whether an additional plan loan is not a deemed distribution under IRC 72(p)(1).

    4. Information necessary in order 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 plan loan that is outstanding to the participant in order for a vendor to determine whether an additional plan loan satisfies the limitation in IRC 72(p); and
      (ii) information concerning 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. Notice 2009-3 provides transition relief during 2009 for sponsors of IRC 403(b) plans with respect to the requirement to have a written plan in place by January 1, 2009. Notice 2009-3 provides that the IRS will not treat the IRC 403(b) plan as failing to satisfy the requirements of IRC 403(b) during the 2009 calendar year provided that:

    1. A written plan that is intended to satisfy IRC 403(b) and the related Treas. Regs. is adopted on or before December 31, 2009;

    2. During 2009, the plan is operated in accordance with a reasonable interpretation of IRC 403(b), taking into account the Treas. Regs., and

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

  2. The relief in Notice 2009-3 applies solely with respect to the 2009 calendar year and may not be relied on with respect to the operation of an IRC 403(b) plan or correction of operational defects in any prior or subsequent year.

  3. An IRC 403(b) plan sponsor that did not take the necessary actions as described in Notice 2009-3 by December 31, 2009, should be offered the opportunity to resolve the plan document qualification issue through Audit Closing Agreement procedures. See Rev. Proc. 2013-22.

IRC 403(b) Remedial Amendment Period

  1. The remedial amendment period (RAP) for IRC 403(b) plans was announced in Announcement 2009-89 and modified in Rev. Proc. 2013-22. See sections 4.01(11), 4.02(3), and 21 of Rev. Proc. 2013-22.

  2. The RAP is intended to allow employers to correct plan document defects retroactive to the first day of the plan’s remedial amendment period by timely adopting an IRC 403(b) pre-approved plan or by otherwise timely amending its plan.

    1. For this purpose, the "first day of the plan’s remedial amendment period" means the later of January 1, 2010, or the effective date of the plan.

    2. For this purpose, a defect in the form of a plan 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.

  3. The form of a plan will be treated as satisfying the Treas. Reg. as of the first day of the plan’s remedial amendment period 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 remedial amendment period, 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 remedial amendment period.

  4. The amendment requirement under IRM 4.72.13.7.6 (3) b) is automatically satisfied (except to the extent any documents incorporated by reference into the plan must be amended) if the employer retroactively adopts an IRC 403(b) pre-approved plan with an opinion or advisory letter on or before the last day of the amendment period.

    1. For purposes of this section, an IRC 403(b) pre-approved plan with an opinion or advisory letter means a plan for which an opinion or advisory letter is issued pursuant to a timely filed application under section 21.04 of Rev. Proc. 2013-22, as amended by Rev. Proc. 2014-28.

  5. The IRS will announce, in subsequent guidance, the date that will be the last day of the remedial amendment period for all employers. See section 21 of Rev. Proc. 2013-22 for additional information on the remedial amendment period for IRC 403(b) plans.

Written Plan Examination Steps

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

    Note:

    If a plan incorporates other documents by reference and it is determined that there is a conflict between the written plan and another document, the plan document will govern.

  2. If the plan sponsor does not have a single written plan document, request all documents pertaining to 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:

    It is not unusual to find that an IRC 403(b) plan sponsor does not have a separate SPD, so ask for any written policies, procedures regarding eligibility, etc.

  3. Verify timely adoption and good faith efforts to comply by December 31, 2009, with IRC 403(b), including any changes in the applicable law and regulations.

    1. Consider whether the employer is under the remedial amendment period as outlined in Rev. Proc. 2013-22.

    2. If a review of the written plan indicates that amendments are necessary, discuss whether the employer would like to adopt amendments to prevent operational issues. If employer does not wish to make amendments then consider follow up action to insure they adopt the necessary documents as set forth in Rev. Proc. 2013–22 during the remedial amendment period.

      Note:

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

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

  5. Review information provided to employees regarding the plan and verify that it is in agreement with the plan. Any discrepancies should be noted and corrected by the plan sponsor. Information may be provided through various methods, including:

    1. The plan sponsor’s Employee Benefits Package/Handbook

    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 web page

      Note:

      This supports the requirement that the plan complies with the universal availability requirement of 26 CFR 1.403(b)-5(b)(2), reflecting effective notice. See also IRM 4.72.13.14.1, Elective Deferrals —Universal Availability.

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

  7. In the case of a plan that is funded through multiple vendors, and the employer has adopted a separate document from each vendor, each vendor’s document must be reviewed for compliance and to determine if any conflicting provisions exist.

  8. Verify the plan operates under the terms of the plan document.

    1. Consider the Self-Correction Program (SCP) and the Audit Closing Agreement Program (Audit CAP) under Rev. Proc. 2013-12 for any failures found.

IRC 403(b) Eligibility

  1. Not all non-profit or tax-exempt organizations are eligible to maintain an IRC 403(b) plan. There are only four types of employers eligible to maintain an IRC 403(b) plan:

    1. A State, but only with respect to an employee of the State performing services for a public school.

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

    3. Any 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. See 26 CFR 1.403(b)-2(b)(8).

  2. Pursuant to CFR 1.403(b)-2(b)(8)(ii), 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, 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, see IRC 403(c) and IRC 72.

  5. Issues involving an ineligible employer may be resolved through Audit CAP in a manner that limits or prevents unfavorable tax treatment. See section 6.03 of Rev. Proc. 2013-12 and IRM 4.71.3.3.1, 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. See 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 (e.g., 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 (e.g., a member of the school board, university regent or trustee may not be eligible). See CFR 1.403(b)-2(b)(10).

    Example 6:Public High School Y maintains an IRC 403(b) plan for its employees. Employee A is employed by Public High School Y and performs timekeeping and payroll services for Public High School Y. Employee A may participate because Employee A performs services for a public school. In contrast see Rev. Rul. 72-390.

    Example 7: Employee B, a state employee, provides in-home teaching services. 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 the following purposes:

    1. Religious

    2. Charitable

    3. Scientific

    4. Public safety testing

    5. Literary or educational

    6. To encourage national or international amateur sports competition

    7. For the prevention of cruelty to children or animals

  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. In order 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 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). See 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. See 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). See 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. See 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)). See 26 CFR 1.403(b)-2(b)(8)(i)(D).

  2. Employee status under IRC 403(b) is generally determined 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. See 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. See Rev. Rul. 87-41.

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

    3. To utilize SRS, search on the IRS intranet home page for the Specialist Referral System, or go to http://lmsb.irs.gov/hq/fs/InformationResources/srs/FS_referral.asp.

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, its status can be verified in the following ways:

    1. Request a copy of any determination letter issued by the IRS regarding the organization’s tax exempt status under IRC 501(a) and whether the entity is an IRC 501(c)(3) organization.

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

    3. "Exempt Organizations Select Check" is an on-line search tool that allows users to select an exempt organization and check certain information about its federal tax status and filings. The link can be accessed by entering Exempt Organizations Select Check in the Search box on www.irs.gov.

    4. Guide Star®, provides a searchable database of IRC 501(c)(3) charitable organizations, including online copies of Forms 990, Forms 990-EZ and Forms 990-PF and other information. The link is: www.guidestar.org.

    5. Foundation Center is another source that can be used to find information about exempt organizations. The link is: www.foundationcenter.org.

    6. Prior to 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 the Exempt Organizations division. The organization cannot be a State, political subdivision or integral part. See Rev. Rul. 60-384; 1960-2 C.B. 172. A referral to the Exempt Organizations division may be necessary for them to make a determination of the employer’s status.

  4. If an IRC 403(b) plan examination is conducted in connection with an Exempt Organizations audit, 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 not eligible. Under such circumstances, consider a closing agreement under Rev. Proc. 2013-12.

  5. If the IRC 403(b) plan examination is not initiated by the Exempt Organizations division, any question regarding the IRC 501(c)(3) status of the employer must be referred to Exempt Organizations by the Employee Plans agent.

    1. The Specialist Referral System (SRS) should be used to request assistance from EO or to make a referral.

    2. To utilize SRS, go to https://srs.web.irs.gov.

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

    Note:

    An IRC 403(b) plan document may allow non-elective employer contributions for former employees for up to five years after the severance of employment under 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 assets of the plan. See 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, a convention or association of churches, or an organization described in IRC 414(e)(3)(A)

    4. Any combination of these

      Note:

      See 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 applicable to IRC 403(b) annuity contracts (in addition to their own special requirements). 26 CFR 1.403(b)-8(d)&(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 is not longer than is reasonable for the proper administration of the plan. This requirement is generally satisfied if IRC 403(b) elective deferrals are contributed within 15 business days following the month in which these amounts would have otherwise been paid to the participant. See 26 CFR 1.403(b)-8(b).

    Note:

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

  5. Under IRC 403(b)(5), for any taxable year in which two or more annuity contracts are purchased by the employer for the employee, such contracts will be treated as one contract. See 26 CFR 1.403(b)-3(b)(1).

    Note:

    Failure to aggregate contracts will result in the loss of IRC 403(b) status of the annuity contracts.

  6. Under IRC 403(b)(1)(E), a contract purchased by an employer must comply with the requirements of IRC 401(a)(30) which states that the amount of elective deferrals under the plan of the employer must not exceed the limit under IRC 402(g). Thus, in order to be a valid contract under IRC 403(b), the contract by its terms must preclude the making of excess deferrals and must reflect the IRC 402(g) limit.

    Note:

    IRC 402A(a)(1) provides that designated Roth contributions are treated as elective deferrals, except that they are not excludable from gross income.

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. See 26 CFR 1.403(b)-3(a)(5).

    1. Loans may be made from an annuity contract and amounts held under the contract may be transferred or rolled over to another IRC 403(b) plan under certain conditions.

    2. 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.

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

    4. 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. See 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. See 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. See 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 comply with the terms of the written plan, if subject to the written plan requirement. See 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. See Rev. Rul. 68-87, 1968-2 C.B. 187.

    Example 8: ABC Foundation, an IRC 501(c)(3) organization, maintains an annuity plan intended to be an IRC 403(b) plan. 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. Foundation purchases annuity contracts for employees at their retirement. The arrangement is not an IRC 403(b) plan.

    Example 9: 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). See IRC 403(b)(7) and 26 CFR 1.403(b)-8(d)(i).

  2. The assets of a custodial account must be held by a bank or an approved non-bank trustee or custodian under IRC 401(f)(2). See 26 CFR 1.403(b)-8(d)(2).

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

  4. The distribution restrictions of IRC 403(b)(7) must be met with respect to amounts held in the custodial account. See 26 CFR 1.403(b)-6(c).

  5. The assets are used only for the exclusive benefit of plan participants or their beneficiaries. See 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.

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

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

  8. Unlike contributions to annuity contracts, excess contributions to a custodial account are subject to the excise tax under IRC 4973. See IRC 4973(a)(3).

  9. The custodial account must comply with the terms of the written plan. See IRM 4.72.13.7.1, Written Plan Requirement.

Retirement Income Accounts

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

  2. The funding vehicles for retirement income accounts can be varied. See 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. See 26 CFR 1.403(b)-2(b)(5), (6), & (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. See 26 CFR 1.403(b)-9(a)(2)(i)(A).

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

  4. A retirement income account must be maintained pursuant to a written plan, which must state the intent to constitute a retirement income account. See 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. See 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. See 26 CFR 1.403(b)-9(a)(4). The distribution rules of IRC 403(b)(11) would apply rather than IRC 403(b)(7). See 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 in the event that a payment is due that exceeds the participant’s or beneficiary’s accumulated benefit. See 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 grandfathered. A defined benefit plan which is established by a church or a convention or association of churches and is in effect on September 3, 1982, is not treated as failing to satisfy the requirements of IRC 403(b) merely because it is a defined benefit arrangement. See 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. See 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) & (d).

  3. Verify that the language in the custodial account 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. Inquire 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 differs under IRC 403(b). This subsection focuses on requirements applicable only to elective deferral contributions.

  2. Elective deferrals are contributions made by an employer as a result of a salary reduction agreement with an employee to take a reduction in salary or forego 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. However, see the effective opportunity requirement of universal availability under 26 CFR 1.403(b)-5(b)(2).

  4. An IRC 403(b) salary reduction agreement applies to compensation that is not yet paid or currently 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 (See IRM 4.72.13.11, Contribution Limitations.)

    2. Nondiscrimination rules (universal availability) (See IRM 4.72.13.14, Nondiscrimination and Coverage.)

    3. Withdrawal restrictions (See IRM 4.72.13.15, Distribution Requirements.)

Elective Deferrals - Examination Steps

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

  2. Determine whether contributions are elective deferrals, and closely analyze one-time irrevocable and condition of employment contributions and to verify they are not considered elective deferrals subject to IRC 402(g). See IRM 4.72.13.11.1, Salary Reduction Contributions other than Elective Deferrals.

  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 shown in Box 14 of Form W-2 but are not required to be shown there. See Rev. Rul. 2006-43, Rev. Rul. 77-462, Rev. Rul. 81-25, Rev. Proc. 82-36 and Rev. Rul. 87-10 for additional reporting information.

    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 currently available to the employee at the time the agreement is effective.

    Note:

    Separate agreements may be necessary for some forms of compensation, such as unused sick or vacation pay.

  6. Verify that election forms properly limit elective deferrals to the IRC 402(g) limit.

  7. Verify that elective deferrals are limited to 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. See 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.

  3. All elective deferrals made by a participant to a Simplified Employee Pension (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 the amount of 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 $52,000 (for 2014) or 100% of includible compensation on the maximum amount that may be contributed to an IRC 403(b) plan for the year. See IRM 4.72.13.12, IRC 415 Limit.

  5. Under IRC 414(u), contributions by an employer or employee pursuant to 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.

  6. Under IRC 414(v), contributions made pursuant to 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. See 26 CFR 1.403(b)-2(b)(7) and IRC 402(g)(3).

  2. Elective deferrals do not include:

    1. Salary reduction contributions made pursuant to a one-time irrevocable election that is made when an employee is initially eligible to participate in the salary reduction agreement (See 26 CFR 1.402(g)-1(c)(1)), or

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

  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 10: 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 three percent 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 11: Assume the same facts as in Example 10, except that the Plan further provides that an 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 11 points out that if an employee may terminate his election to participate in a plan, the election is not considered to be irrevocable. Irrevocability relates to the election to participate rather than an election to terminate participation in a plan.

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. See 26 CFR 1.403(b)-2(b)(7), IRC 402(g)(3), 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:

    1. Qualified CODA

    2. Salary reduction simplified employee pension plan

    3. IRC 403(b) plan

    4. SIMPLE plan

      Note:

      See IRC 402(g)(3).

  4. Elective deferrals, one-time elections made at the time of initial eligibility, and mandatory contributions as condition of employment are subject to FICA. See 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. See 26 CFR 1.403(b)-4(c)(i) and 26 CFR 1.403(b)-3(a)(4).

    Example 12: An employee participating in two salary reduction IRC 403(b) plans with separate employers must count 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 retirement account under IRC 408(p), elective deferrals under those plans are also counted. See 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), which requires the contract terms to provide that elective deferrals will not 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. See IRM 4.72.13.9, Funding Vehicles.

  8. The IRC 402(g) limit must always be considered in examining an IRC 403(b) plan with elective deferrals. For example, when considering the contribution limits in 2014, even if the limitation under IRC 415 is $ 52,000, IRC 402(g) further limits elective deferrals to $17,500 (or a maximum of $20,500 ($17,500 plus $3,000 if the full IRC 402(g)(7) 15-year catch-up limit applies)).

  9. The IRC 402(g) limits are adjusted periodically pursuant to IRC 402(g)(4). Recent limits are as follows:

    1. 2016: $18,000

    2. 2015: $18,000

    3. 2014: $17,500

    4. 2013: $17,500

    5. 2012: $17,000

    6. 2011: $16,500

    7. 2010: $16,500

    8. 2009: $16,500

    9. 2008: $15,500

Catch-Up Contributions

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

  2. 26 CFR 1.403(b)-4(c)(3) provides that the election is available only to an employee who has completed at least 15 years of service (as defined in IRC 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 a church related organization, years with different employers cannot be added together for purposes of satisfying the 15-year requirement. See 26 CFR 1.403(b)-4(c)(3)(ii)(B), and 26 CFR 1.403(b)-4(e)(3).

    Example 13: Employee A is a teacher with the County W school system. She has been employed by County W for 6 years, but worked for County V for 10 years, prior to 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. Only the years that are worked while a teacher for County W may be counted for purposes of using the 15 year catch-up.

  4. Under the IRC 402(g)(7) election, the IRC 402(g)(1) dollar limitation is increased by the smallest of:

    1. $ 3,000,

    2. $ 15,000 minus any elective deferrals previously excluded under this catch-up election, plus any amount of 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 c), years of service (YOS) are calculated through the end of the year for which the calculation is being made. For example, to determine limit for 2014, count YOS through 2014.

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

  6. In addition to the 15 year catch-up, IRC 414(v) allows an individual who attains age 50 prior to the end of the year to make an additional catch-up of $5,500 (2009 though 2014).

  7. For an employee eligible to use both the fifteen year catch-up and the age 50 catch-up, the 15 year catch-up must be applied first. Then 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. See 26 CFR 1.403(b)-4(c)(3)(iv).

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

    Example 14: In 2014, Employee A, age 45, has taxable compensation of $70,000 prior to IRC 403(b) elective deferrals, and 12 years of service (YOS) with the County W school system. Employee A has made no other elective deferrals under any other IRC 403(b) or IRC 401(k) plans in 2014.
    For 2014, the maximum elective deferral that Employee A may contribute to the IRC 403(b) plan is determined as follows:

    1. The general limit under IRC 402(g)(1) is $17,500.

    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.

    Employee A is not eligible for any catch-up contributions, so the maximum Employee A can defer is $17,500.

    Example 15: In 2014, Employee B, age 45, has taxable compensation of $70,000 prior to IRC 403(b) elective deferrals, and 15 YOS with the County W school system, and has made no other elective deferrals under any other IRC 403(b) or IRC 401(k) plans in 2014. Employee B has not made any contributions to the IRC 403(b) plan prior to 2014.
    For 2014, the maximum elective deferral that Employee B may contribute to the IRC 403(b) plan is determined as follows:

    1. The general limit under IRC 402(g)(1) is $17,500.

    2. Employee B has 15 YOS, 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 had not attained age 50, therefore not eligible for the age 50 catch-up.

    The maximum amount Employee B can defer is $20,500 ($17,500 plus $3,000 15 YOS catch-up).

    Example 16: In 2014, Employee C, age 50, has taxable compensation of $70,000 prior to IRC 403(b) elective deferrals, 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 2014.
    For 2014, the maximum elective deferral that maybe contributed to the IRC 403(b) plan is determined as follows:

    1. The general limit under IRC 402(g)(1) is $17,500.

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

    3. Employee C has attained age 50, therefore eligible for the age 50 catch-up of $5,500.

    The maximum amount Employee C can elect to defer is $23,000 ($17,500 plus $5,500 age 50 catch-up).

    Note:

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

    Example 17: In 2014, Employee D, age 50, has taxable compensation of $70,000 prior to IRC 403(b) elective deferrals, and 15 YOS with Hospital H. Employee D has made no other elective deferrals under IRC 403(b) or IRC 401(k) in 2014 and this is the first year Employee D has contributed to the IRC 403(b) plan.
    For 2014, the maximum elective deferral that Employee D may defer under the IRC 403(b) plan is determined as follows:

    1. The general limit under IRC 402(g)(1) is $17,500.

    2. Employee D has 15 YOS, 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 attained age 50, therefore is eligible for the age 50 catch-up of $5,500.

    The maximum amount Employee D can elect to defer is $26,000 ($17,500 plus $3,000 plus $5,500), because Employee D is eligible for both the 15 YOS catch-up and the age 50 catch-up. If Employee D defers only $23,000, 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 $2,500 will count as the age 50 catch-up.

    Example 18: In 2014, Employee E, age 45, has taxable compensation of $70,000 prior to IRC 403(b) elective deferrals, and 15 YOS under the Teachers Retirement System in the state he teaches in. Employee E worked 5 years at City College X and has 10 YOS with State University Y. Employee E has made no other contributions under any other IRC 403(b) or IRC 401(k) in 2014 and this is the first year Employee E has contributed to the IRC 403(b) plan sponsored by State University Y.
    For 2014, the maximum elective deferral that maybe contributed to the IRC 403(b) plan is determined as follows.

    1. The general limit under IRC 402(g)(1) is $17,500.

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

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

    The maximum amount Employee E can elect to defer is $17,500 because Employee E is not eligible for any catch-up.

    Example 19: In 2014, Employee F, age 50, has taxable compensation of $70,000 prior to IRC 403(b) elective deferrals, and 20 YOS with Hospital H. Employee F has made no other elective deferrals under any other IRC 403(b) or IRC 401(k) plans in 2014. Employee F has made elective deferrals in prior years under the IRC 403(b) equal to $175,000.
    For 2014, the maximum amount that Employee F can elect to defer is determined as follows:

    1. The general limit under IRC 402(g)(1) is $17,500.

    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: thus 20 YOS x $5,000 = $100,000. Employee F had prior deferrals of $175,000 which exceed $100,000, therefore the 15 YOS catch-up limit is $0

    3. Employee F has attained age 50, therefore is eligible for IRC 414(v) age 50 catch-up limit of $5,500.

    The maximum amount Employee F can elect to defer is $23,000 ($17,500 plus $5,500 under the age 50 catch-up).

Effect of Contributions in Excess of 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 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 thereon, 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. See 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.

  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 and they are not timely corrected, the excess is taxed both in the year contributed and again on distribution, unless the excess deferrals and the earnings thereon are timely distributed by the IRC 403(b) contract(s).

    Example 20: Association, a IRC 501(c)(3) organization, maintains an IRC 403(b) plan (Plan) with a calendar plan year. In 2014, each of the highly compensated employees elects to make a contribution of $50,000 on the mistaken assumption that the contributions are not elective deferrals limited by IRC 402(g). The excess deferrals of $32,500 ($50,000 - $17,500) are not timely corrected by April 15, 2015. All contributions made to the affected annuity contracts are includible in the employees' gross income for taxable year 2014 and are subject to FICA. See 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 held by a participant exceeding 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 21:The same facts as Example 20, except that $20,000 of the $50,000 contributed to the Plan in 2014 consists of non-elective employer contributions. The excess deferrals are timely corrected by being distributed with income to the employees by April 15, 2015. The excess elective deferrals of $12,500 ($30,000 - $17,500) are includible in gross income for tax year 2014.

    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 contributions are properly limited to IRC 402(g). Review the plan for Roth provisions.

  2. Determine if 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 compliance with its terms. Plans subject to ERISA may need to be referred to the DOL.

  4. Analyze participants whose deferrals exceed the basic limit to determine whether they are entitled to use the 15 year catch-up and/or age 50 catch-up.

    1. Verify age and years of service through personnel records.

    2. Prior year allocation reports, W-2s, salary deferral election forms, and related plan documents may also be needed to establish the facts necessary to determine entitlement for catch-up contributions and the proper limit.

  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. See 26 CFR 1.403(b)-4(c)(3)(iv).

  6. Determine if the employer has any other plan covering the same employees, to verify that the combined amount of elective salary deferrals are 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 appropriate enforcement and corrective action under EPCRS. Document whether there is compliance with the withholding and reporting requirements in 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 memorandum or other communications to employees.

    Note:

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

  11. If contributions are found not to be condition of employment contributions or valid 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 (See IRM 4.72.13.12.1, Includible Compensation) or the dollar limits identified in IRC 415(c) (adjusted pursuant to IRC 415(d)) in the limitation year. See 26 CFR 1.403(b)-4(b). The dollar limitations are as follows:

    1. 2016: $53,000

    2. 2015: $53,000

    3. 2014: $52,000

    4. 2013: $51,000

    5. 2012: $50,000

    6. 2011: $49,000

    7. 2010: $49,000

    8. 2009: $49,000

    9. 2008: $46,000

  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. See 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. See 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 pursuant to 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. Under IRC 414(u), contributions by an employer or employee pursuant to 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.

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

Includible Compensation

  1. Includible compensation is generally all salary 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. See 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). See 26 CFR 1.403(b)-2(b)(11).

  3. Includible compensation does not include:

    1. 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. See 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. See 26 CFR 1.403(b)-2(b)(11).

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

  4. For 2014, the maximum amount of compensation that may be taken into account is $260,000. See 26 CFR 1.403(b)-5(a)(ii).

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 (See 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) (See 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. IRC 403(b)(3) allows for certain amounts to be excludable from gross income for post-severance contributions to an IRC 403(b) plan for up to five years after an employee has a severance from employment. See 26 CFR 1.403(b)-4(d).

    1. Only non-elective employer contributions may be excluded 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. See 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 school teacher, 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 pursuant to 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 pursuant to plan terms over a period of five years following severance of employment pursuant to 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. See 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 for 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 annual includible compensation is $72,000 (so that 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 additional contributions would exceed Individual C’s includible compensation for purposes of IRC 415(c).

IRC 415 Aggregation

  1. Under IRC 415, a participant is considered to exclusively control and maintain his or her own an IRC 403(b) plan. See 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. In this situation, the IRC 403(b) plan is treated as a defined contribution plan maintained by both the employer and the participant. See 26 CFR 1.415(f)-1(f)(2).

  3. Where a participant controls any employer (this may be the employer contributing to the IRC 403(b) plan or another employer) for a limitation year, the contributions to the IRC 403(b) plan are combined with contributions to a qualified plan by the controlled employer or any affiliated employer under IRC 415.

  4. Excess deferrals are attributed to the IRC 403(b) plan.

  5. The following examples illustrate that 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 $52,000 (in 2014) 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.

    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.

    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.

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. See 26 CFR 1.403(b)-4(a).

    Example 28: 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 $70,000. Contributions to the Plan on behalf of Employee A equal $55,000 (all are non-elective employer contributions) in the limitation year ending December 31, 2014, $3,000 above the allowable IRC 415 limit. The $3,000 excess is includible in Employee A's gross income for the 2014 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 which constitutes a separate account for the purposes of IRC 72.

  3. 26 CFR 1.415(a)-1(b)(2) provides the separate account must be maintained for the excess IRC 415(c) contributions or all contracts fail to be IRC 403(b) contracts. See Rev. Proc. 2013-12 for correction methods available under EPCRS.

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. See IRC 4973(a).

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

  3. To the extent contributions are in excess of the IRC 415 limit, the contributions are taxable. See 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 is not applicable to an IRC 403(b)(1) annuity contract or IRC 403(b)(9) retirement income account. See 26 CFR 1.403(b)-8(d).

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

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

    Example 29: 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, 2014, 50 employees receive contributions in excess of the IRC 415 limit. The excess contributions are includible in employees' gross income in taxable year 2014. Any portion of the excess IRC 415 amounts invested in the custodial accounts are subject to the excise tax under IRC 4973. See IRC 4973(c) to calculate the applicable tax.

Examination Steps for IRC 415

  1. Review the plan documents, plan amendments and SPD to determine the types of contributions allowed under the plan and that plan language properly limits contributions. See IRC 415.

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

  3. Determine if the employer is part of a controlled group or affiliated service group and if so, whether contributions have been aggregated.

  4. Sample contributions allocated and compare 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 to what extent 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. See 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 the combined plans exceed the IRC 415(c) limits.

    Example 30: Doctor A is employed by a non-profit 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 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) and 26 CFR 1.415(c)-1.

  8. Determine if any participant has excess contributions and to what extent the funds are invested through a custodial account. Secure and process Form 5330 for the excise taxes due under IRC 4973. See IRM 4.71.5, Employee Plans Examination of Returns - Form 5330 Examinations.

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 (called "deemed IRAs" ) are subject to the same requirements that apply to IRAs that are not deemed IRAs. See 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) & (3).

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

    3. The deemed IRAs and the IRC 403(b) plan are treated as separate entities: the separately applicable rules apply to deemed IRAs and the IRC 403(b) plan. See 26 CFR 1.408(q)-1(d).

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

  2. Since the IRA rules apply to the deemed IRAs, the required beginning date for distributions from a deemed IRA is April 1st following the year the employee attains age 70½, even if the employee is still working. See 26 CFR 1.408(q)-1(e).

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. See 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). See IRC 403(b)(12)(A)(i)and 26 CFR 1.403(b)-5(a).

  3. In general, nondiscrimination and coverage requirements with respect to contributions other than elective deferrals do not apply to governmental IRC 403(b) plans. See 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. See IRC 403(b)(12)(C) and 26 CFR 1.403(b)-5(a)(5).

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

  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 pursuant to veterans' reemployment rights under USERRA.

Elective Deferrals —Universal Availability

  1. Elective deferrals are tested separately from non-elective employer contributions for nondiscrimination. See 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. See IRC 403(b)(12)(A)(ii). This test is referred to as universal availability. See 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. See 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 (9) below. See 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. See 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. See 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. 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. See 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 contributions. See 26 CFR 1.403(b)-5(b)(4). These include:

    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. Once an employee can no longer be excluded under b), the employee always remains eligible to participate thereafter (i.e., once-in-always-in). See 26 CFR 1.403(b)-5(b)(4)(iii)(B).

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

      Note:

      Some full-time students may not meet this requirement. See 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 b) and 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. See 26 CFR 1.403(b)-5(b)(4)(i). So 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 31: 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 commenced, 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 commenced (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.

      Note:

      In operation, 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. See 26 CFR 1.403(b)- 5(b)(4)(i).

    Example 32: The same facts apply as in Example 31. The school system does not treat substitute teachers as employees who are eligible for other 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 for universal availability on the basis of classification or hours worked, 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. See 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) for employees who work less than 20 hours per week. See 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.

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

  14. Examples 33-35 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 33: 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 34: 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 excluded from making elective deferrals excludable, the plan does not satisfy the requirements of IRC 403(b)(12)(A)(ii).

    Example 35: 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 attainment of age 21. 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. 2013-12 for remedies under EPCRS.

Elective Deferrals - Examination Steps
  1. Review the plan document for the eligibility requirements for the 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) & (E) to make deferrals, then no other employees may be excluded under that provision. See 26 CFR 1.403(b)-5(b)(4)(i).

  3. Verify that employees are provided meaningful communication about the plan through review of information 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

    Note:

    This supports the requirements that the plan meets the universal availability requirement of 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 if employees 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 by January 1 of the following year.

  6. Review excluded employees to determine if they were properly excluded from making an elective deferral. 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 a IRC 403(b) plan.

    2. Visiting professors for up to one year and employees affiliated with a religious order who take a vow of poverty.

    3. 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 they have 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 made pursuant to 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. See 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) for non-salary reduction contributions

  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.

  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.

    Note:

    Notice 89-23 is obsolete pursuant to Rev. Rul. 2009-18 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 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 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, 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 and which of these employees 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. If the plan has contributions other than elective deferrals, 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 under 26 CFR 1.403(b)-6 to each of the following:

    1. Contracts (including retirement income accounts) other than custodial accounts and except to the extent of IRC 403(b) elective deferrals,

    2. Custodial accounts except to the extent of IRC 403(b) elective deferrals, and

    3. IRC 403(b) elective deferrals.

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) annuity contract.

    1. These restrictions are based on distribution events and relate to the earliest date at which distributions from an IRC 403(b) annuity contract 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 there is compliance with the minimum distribution rules, incidental death benefit distribution rules and direct rollover rules).

    4. These early distribution restrictions do not apply to after-tax employee contributions or amounts held in a separate account for eligible rollover distributions received by the IRC 403(b) plan. See 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), both Roth and non-Roth elective deferral contributions (and income on such contributions), are not permitted to be distributed earlier than (except for in the case of a plan termination or the correction of excess deferrals):

    1. Attainment of age 59 ½,

    2. Death,

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

    4. Severance of employment, or

    5. Hardship of the employee (limited to the amount of elective deferrals necessary to satisfy the hardship and subject to the rules of 26 CFR 1.401(k)-1(d)(3)).

    Note:

    These distribution restrictions are not applicable to elective deferrals made before January 1, 1989 (not including income on such contributions). See 26 CFR 1.403(b)-6(d)(1)(ii).

  3. Under 26 CFR 1.403(b)-6(b), amounts (other than elective deferrals) distributed from an annuity contract (not including a custodial account, but including a retirement income account) may not be distributed earlier than:

    1. Severance from employment,

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

    3. Disability.

      Note:

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

  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, or

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

    Example 36: Employee A is a participant in an IRC 403(b) plan (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 and is not disabled. Employee A withdraws $5,000 from his elective deferrals. 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 requirements of 26 CFR 1.403(b)-3(b)(3).

    Example 37: 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. A's distribution violates 26 CFR 1.403(b)-6(c).

  5. Certain loans may also 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), a plan termination is permitted to be a distribution triggering event. Generally, this provision is effective January 1, 2009. See IRM 4.72.13.18, Correction Programs.

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 the attainment of age 59 ½,

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

    3. Made upon the 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.

    Note:

    In Examples 36 and 37, 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 commence.

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

    1. The rules in 26 CFR 1.408-8 apply to IRC 403(b) plans.

    2. The rules applicable to IRAs are generally the same as those applicable 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. See 26 CFR 1.403(b)-6(e)(1).

    4. Under 26 CFR 1.408-8, 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. See 26 CFR 1.403(b)-6(e)(4).

  4. The required beginning date (RBD) or the date at which distributions must commence from a participant's IRC 403(b) annuity contract is April 1 of the calendar year following the later of the calendar year in which the employee attains age 70 ½ or the calendar year in which the employee retires from the employer maintaining the plan. See 26 CFR 1.403(b)-6(e)(3).

    Example 38: Participant Q is a participant in an IRC 403(b) plan that is sponsored by an IRC 501(c)(3) organization, is not a five percent owner, has not retired, and attains age 70 ½ in 2010. 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 applies and is April 1 following the calendar year in which the five percent owner attains age 70 ½. See 26 CFR 1.403(b)-6(e)(3).

    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 having complied with IRC 401(a)(9) if the governmental plan applies a reasonable and good faith interpretation of IRC 401(a)(9). See 26 CFR 1.403(b)-6(e)(8). This rule also applies to a IRC 403(b) contract that is part of a governmental plan. See 26 CFR 1.401(a)(9)-1 Q&A-2(d).

  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. See 26 CFR 1.403(b)-6(e)(7). Similarly, the employee 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. See 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 commencement requirements apply only to benefits that accrue after December 31, 1986, including the income on pre-1987 contributions. See 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 attains age 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). See 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). See 26 CFR 1.403(b)-6(e)(6).

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

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

  11. Before assessing the tax, the agent should determine if reasonable cause exists. See 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

    • Hardship withdrawal distributions

    • Loans

    • Plan-to-plan or annuity contract-to-annuity contract transfers, and

    • Acceptance of rollovers to the plan

  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. See also 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 (See 26 CFR 1.403(b)-6(f)),

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

    3. Is subject to the requirements of IRC 72(p) (See 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. A hardship distribution :

    • Has the same meaning as under 26 CFR 1.401(k)-1(d)(3)

    • Requires that the participant must stop making elective deferrals for six months after receipt of a hardship distribution.

    • Is limited to the amount of the participant's IRC 403(b) elective deferrals, not including any income thereon.

      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 pursuant to a QDRO is treated in the same manner as a distribution from a plan to which IRC 401(a)(13) applies. 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 determined to be a qualified domestic relations order.

Hardship Distributions
  1. IRC 403(b) plans may provide that an employee can receive a distribution from the plan on account of hardship.

  2. A distribution is made on account of hardship only if the distribution is made on account of an immediate and heavy financial need of the employee and is necessary to satisfy the financial need.

  3. 26 CFR 1.403(b)-6(d)(2) provides that a hardship distribution for purposes of a section 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).

  4. 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. Expenses for medical care deductible under IRC 213(d) for the employee or the employee’s spouse, children or dependents (as defined in IRC 152) or primary beneficiary under the plan;

    2. Costs directly related to the purchase of a principal residence;

    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 primary beneficiary under the plan;

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

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

    6. Expenses for the repair of damages to the employee’s principal residence that would qualify for the casualty deduction under IRC 165.

  5. Substantiation that a distribution is for one of the items listed in IRM 4.72.13.15.3.1 (4) is required to determine that a hardship distribution is deemed to be on account of an immediate and heavy financial need.

  6. 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.

  7. If during an examination, you are reviewing distributions to determine whether they are made on account of a deemed immediate and heavy financial need, you should take the steps described below

Distribution Requirements - Examination Steps

  1. Review the plan documents for 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 may reveal substantial non-compliance.

  4. Request written clarification for any oral statements that appear to reveal areas of substantial 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 and those who are age 70 ½ or older.

  8. Identify any terminated participants who are age 70 ½ or older who did not receive a distribution.

  9. If it is determined that RMDs have not been paid timely, consider any correction remedies under Rev. Proc. 2013-12.

  10. Obtain and examine the records used to justify distributions made on account of hardship distributions, if any, and document the payments. Determine whether a hardship distribution occurred and that appropriate steps were taken to ascertain 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 2520 provides the DOL's requirements for retaining information.

  11. If the plan allows loans to participants:

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

  12. Verify all other distributions are in accord with plan provisions.

  13. Verify Form 1099-Rs have been properly issued to report distributions, hardships and defaulted loans.

  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. See 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 (4), 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 whether 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 contains 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.

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

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

    • The amount of the distribution cannot exceed the immediate and heavy financial need.

    • Hardship distributions cannot be made from earnings on elective contributions or from QNEC or QMAC accounts, if applicable.

    • 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:

    • Participant’s name

    • 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)

    • Amount of distribution requested

    • Certification by the participant that the information provided is true and accurate

  3. Specific information that is needed for deemed hardship distributions for medical care:

    • 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 that is needed for deemed hardship distributions 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 that is needed for deemed hardship distributions 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 that is needed for deemed hardship distributions 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 that is needed for deemed hardship distributions 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 that is needed for deemed hardship distributions for repairs for damage to the participant’s principal residence

    • 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)

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 accomplish 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 (unlike direct 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 credits under IRC 415(n)(3) or repayments of cashouts under a governmental plan under IRC 415(k)(3). Although permissible, these plan sponsors are not required to provide for this. See IRC 403(b)(13) and 26 CFR 1.403(b)-10(b)(4).

    Note:

    If the State provides for the purchase of permissive service credits, language must be included in the plan document permitting this purchase, and the funds transferred must be used specifically to purchase permissive service credits that fall within the definition of Form 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 accomplish such 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. See IRM 4.72.13.7.4, Written Provision for Information Sharing Agreements.

  6. Transfers pursuant to Rev. Proc. 90-24 are no longer permissible under the IRC 403(b) Treasury Regulations.

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)). See 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 currently 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) investment, an IRC 403(a) annuity plan, 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. See Rev. Proc. 2003-16.

    5. Distributions not properly rolled over are currently includible in the employee's gross income and may be subject to additional tax under IRC 72(t).

    6. 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. See 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). See 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 accomplished in a direct rollover and it must be maintained in a separate account. See 26 CFR 1.403(b)-7(b)(1).

    Example 39: Employee X, age 59 1/2, received a $150,000 eligible rollover distribution from an IRC 403(b) plan on May 5, 2013. Twenty percent, or $30,000, was withheld by Payor. On June 20, 2013, 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 2013. Employee X could have avoided income tax by making a direct rollover or rolling over the additional $30,000 from other funds.

    Example 40: 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. See 26 CFR 1.403(b)-7(b)(2)&(3).

    1. The employee must also have a meaningful right to elect a direct rollover. See 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 his right to elect a direct rollover and the income tax withholding consequences of not electing a direct rollover. See 26 CFR 1.403(b)-7(b)(3).

  6. IRC 403(b) plans must be operated in compliance with the above rules. The plan document must reflect the direct rollover requirements. See 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 IRC 401(a)(31) (including automatic rollover for certain mandatory distributions) in the same manner as a qualified plan. See 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.

    • Form 1099-R is usually issued by the vendor or third party administrator.

    • Transfers, exchanges and direct rollovers 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. See 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. Delivery of a fully paid individual insurance annuity contract is treated as a distribution. See Rev. Rul. 2011-7.

  3. 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. See 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 one year before the date of the plan termination and one year 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. See 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. See 26 CFR 1.403(b)-10(a)(1).

    Note:

    The frozen plan is still required to meet the nondiscrimination requirements for IRC 403(b) plans. See 26 CFR 1.403(b)-10(a)(1) and 26 CFR 1.403(b)-5.

Plan Termination - Examination Steps

  1. Review the plan document.

    1. Determine whether it contains provisions allowing for termination of the plan.

    2. Review all amendments to determine if an amendment terminating the plan has been adopted.

  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 have been made to all the participants. In lieu of a distribution of cash, the termination may be accomplished by the delivery of a fully paid individual insurance annuity contract to the participant.

    Note:

    If distribution does not occur to all participants, the plan is not terminated and Form 5500 filing requirements may be applicable.

  4. Document whether the employer continues to be an eligible employer under IRC 403(b).

  5. In the case of an employer no longer eligible to maintain an IRC 403(b) plan, and where the plan has not been terminated, consider the ineligible employer remedy under EPCRS.

Correction Programs

  1. When a determination is made that an IRC 403(b) plan is not in compliance with IRC 403(b) or the IRC 403(b) Treas. Regs., correction may be available through the correction programs outlined in Rev. Proc. 2013-12. These programs include:

    • Self Correction Program (SCP)

    • Voluntary Correction Program with IRS approval (VCP)

    • Correction on Audit (Audit CAP)

  2. For 2009 and later years, the following IRC 403(b) errors may be corrected under EPCRS:

    • Plan Document Failure

    • Demographic Failure

    • Operational Failure

    • Employer Eligibility Failure

    Note:

    Rev. Proc. 2008-50 applies to plan years prior to 2009 for correction of IRC 403(b) operational errors. A failure to follow the terms of an IRC 403(b) plan document that occurred prior to January 1, 2009, cannot be addressed unless the failure meets one of the operational failures outlined in Rev. Proc. 2008-50.

  3. Rev. Proc. 2013-12 provides guidance and information regarding correction principles through SCP, VCP and Audit CAP, along with fee schedules and guidance on sanction fees. At IRS website: http://www.irs.gov/Retirement-Plans/Correcting-Plan-Errors. The Rev. Proc., Topical Index, and Chart of Significant changes are available.

  4. Additional 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. 2013-12.

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 the VCP program once the plan is under examination, as defined in section 5.09 of Rev. Proc. 2013-12.

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 5.09 of Rev. Proc. 2013-12. See section 4.02 of Rev. Proc. 2013-22.

  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. 2013-12, the plan will not be treated as failing to satisfy IRC 403(b), as applicable, for purposes of applying FICA and FUTA taxes.

  2. In appropriate cases, certain excise taxes may be waived under EPCRS. See Section 6.09 of Rev. Proc. 2013-12.

  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 remedial amendment period set forth in Rev. Proc. 2013-22. However, the issuance of a compliance statement or closing agreement does not constitute a determination as to whether the written plan, as drafted, complies with the applicable requirements of IRC 403(b) and the IRC 403(b) Treas. Regs. See sections 2.03, 5.02 and 6.10 of Rev. Proc. 2013-12.

Examination Use of EPCRS

  1. Each area has an IRC 403 and IRC 457 Area Coordinator who can assist with development of issues and correction methods.

  2. Issues found during an audit should be corrected using the guidance under Rev. Proc. 2013-12.

  3. 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 appropriate and timely

    2. If a failure has been corrected through VCP, review the compliance statement and verify that the correction was properly and timely. 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 additional 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 applicable requirements of IRC 403(b) and the Final IRC 403(b) Regulations.

    5. Secure any Forms 5330 due and the payment of any excise taxes, if applicable.