Anchors Away: IRS Finalizes Safe Harbor Reduction Regulations

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By Brenna Clark, Esq., Atlanta, and Adam Cohen,
Esq
 

Sutherland Asbill & Brennan LLP, Atlanta and Washington,
DC

On November 14, 2013, the Internal Revenue Service (IRS) issued
final regulations that permit employers to suspend or reduce safe
harbor nonelective contributions under a 401(k), 401(m), or 403(b)
plan during the plan year. The final regulations also revise the
requirements that apply to mid-year suspensions or reductions of
safe harbor matching contributions. The final regulations are
generally effective for plan amendments adopted after May 18, 2009,
while the new requirements that apply to safe harbor matching
contributions are effective for plan years beginning on or after
January 1, 2015.

Background  

Plans maintained under §401(k) and (m) and certain contributions
under §403(b) plans must meet nondiscrimination and other
requirements to keep their tax-favored status. This usually
requires yearly testing to establish that the benefits provided
under a plan do not discriminate disproportionately in favor of
highly compensated employees, often referred to as the "ADP test"
and the "ACP test." Plans that meet certain safe harbor
requirements, however, are not required to perform these
nondiscrimination tests. To satisfy the IRC nondiscrimination safe
harbors, an employer must, among other requirements, make either
safe harbor matching or safe harbor nonelective contributions to
the plan each year on behalf of its non-highly compensated
employees. Generally, an employer must adopt a safe harbor
contribution before the plan year begins and make these
contributions for the entire year, subject to certain
exceptions.

Under the originally issued final regulations, employers could
terminate a safe harbor plan mid-year, or they could suspend or
reduce safe harbor matching contributions mid-year
for any reason if certain other conditions were met. However,
employers were not permitted to suspend or reduce safe harbor
nonelective contributions during a plan year. In
2009, the IRS issued proposed regulations allowing employers to
suspend or reduce safe harbor nonelective contributions if the
employer experienced a "substantial business hardship." For this
purpose, a "substantial business hardship" was comparable to a
substantial business hardship under the §412 funding rules. Factors
used to determine whether an employer had suffered a "substantial
business hardship" included (i) whether the employer was operating
at an economic loss, (ii) whether there was substantial
unemployment or underemployment in the employer's trade or
business, (iii) whether the sales and profits of the employer's
industry were depressed or declining, and (iv) whether it was
reasonable to expect that the plan would only be continued if
relief was granted.

The final regulations modify the proposed regulations by
loosening the standards under which nonelective contributions may
be suspended or reduced, and by imposing new, similar restrictions
on the suspension or reduction of safe harbor matching
contributions.

Summary of New Guidance  

The final regulations modify the "substantial business hardship"
standard for suspending or reducing safe harbor nonelective
contributions, replacing that standard with an "operating at an
economic loss" standard. The economic loss standard is intended to
be more objective and avoid the factual uncertainty of some of the
"substantial business hardship" requirements.  The final
regulations also allow an employer to suspend or reduce safe harbor
nonelective contributions for any reason if the employer provides
participants with notice before the beginning of the plan year that
discloses the possibility that contributions may be suspended or
reduced during the plan year. This notice must explain that
participants will receive a supplemental notice if the suspension
or reduction does occur, and that the suspension or reduction will
not apply until at least 30 days after the supplemental notice is
provided. The following additional conditions, which remain
unchanged from the conditions that applied to safe harbor matching
contributions in the original final regulations, must also be
met:

  •   Employees are given a supplemental notice describing the
    suspension or reduction;
  •   The suspension or reduction becomes effective no earlier
    than the later of (i) 30 days after the supplemental notice is
    provided, or (ii) the date the amendment is adopted;
  •   Employees are given a reasonable opportunity and period
    of time before the suspension or reduction takes effect to adjust
    their deferral elections;
  •   The plan is amended to provide that it will satisfy the
    ADP and/or the ACP test, using the current year testing method, for
    the full plan year; and
  •   The plan satisfies the safe harbor contribution
    requirement through the amendment's effective date.

 

In order to achieve uniformity between the rules that apply to a
mid-year suspension or reduction of safe harbor matching
contributions and a mid-year suspension or reduction of safe harbor
nonelective contributions, the final regulations also modify the
rules that apply to mid-year suspensions or reductions of safe
harbor matching contributions. Safe harbor matching contributions
can still be suspended or reduced for any reason, but effective
January 1, 2015, the employer must provide participants with notice
before the beginning of the plan year which discloses the
possibility that contributions may be suspended or reduced
mid-year. Suspensions or reductions as a result of operating at an
economic loss are also permitted. The additional requirements
described above will continue to apply to a suspension or reduction
of matching contributions.

The chart below highlights the main differences before and after
the new final regulations:

Provision  

Before New Final
Regulations
 

After New Final
Regulations
 

Mid-year changes to nonelective contributions

 Permitted if the employer incurs a substantial business
hardship, as described under § 412(c)(2). Mid-year changes for
other reasons not permitted.

 Permitted if the employer is operating at an economic
loss, as described under §412(c)(2)(A). Permitted for any reason,
provided participants receive notice before the beginning of the
plan year disclosing the possibility that contributions may be
suspended or reduced. Effective for amendments adopted on or after
May 18, 2009.

Mid-year changes to matching contributions

 Permitted for any reason, including economic hardship (no
requirement to provide participants notice before the beginning of
the plan year).

 Permitted if the employer is operating at an economic
loss, as described under §412(c)(2)(A). Permitted for any reason,
provided participants receive notice before the beginning of the
plan year disclosing the possibility that contributions may be
suspended or reduced. Effective for plan years beginning on or
after January 1, 2015.

For more information, in the Tax Management Portfolios, see
Bortz, Mason, and Raish, 358 T.M.
, Cash or Deferred
Arrangements xx,  and in Tax Practice Series, see ¶5560,
Cash or Deferred Arrangements.

© 2013 Sutherland Asbill & Brennan LLP.