Cash or Deferred Arrangements (Portfolio 358)

Tax Management Portfolio, Cash or Deferred Arrangements, No. 358-4th, discusses the rules of § 401(k) of the Internal Revenue Code relating to qualified cash or deferred arrangements.

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Tax Management Portfolio, Cash or Deferred Arrangements, No. 358-4th, discusses the rules of § 401(k) of the Internal Revenue Code relating to qualified cash or deferred arrangements. Part I of this Portfolio provides a brief overview of cash or deferred arrangements, their advantages, and the statutory requirements that apply to them. Part II discusses the background of cash or deferred arrangements and the evolution of the rules that apply to them. Part III includes a detailed analysis of the basic rules applicable to qualified cash or deferred arrangements. Part IV discusses the nondiscrimination rules that apply to a qualified CODA, and Part V discusses the special rules for design-based safe harbor plans. Part VI focuses on Roth contributions. Part VII deals with eligible automatic contribution arrangements. Part VIII discusses the §402(g) annual limit on elective deferrals and Part IX discusses catch-up contributions. Part X discusses the consequences of qualification or nonqualification under §401(k).
The Worksheets of this Portfolio contain a sample profit-sharing plan that includes a qualified cash or deferred arrangement, an eligible automatic contribution arrangement, and designated Roth contributions.


Jason K. Bortz

Jason K. Bortz, B.A., Hamilton College (1991); J.D., Cornell Law School (1997).

Kent A. Mason

Kent A. Mason, B.A., Amherst College (1976); J.D., University of Pennsylvania (1980).

David L. Raish

David L. Raish, B.A., Yale University (1969); J.D., Harvard Law School (1973).

Table of Contents

Detailed Analysis

I. Introduction

A. Scope of Discussion

B. General Description

C. Federal Income Tax Advantages of Contributions to the Trust

D. Summary of Statutory Requirements

1. Qualified Profit-Sharing or Stock Bonus Plan

2. Election by Employees

3. Coverage and Participation

4. Nondiscrimination

5. Restrictions on Distributions

6. Nonforfeitability

II. Background of Section 401(k)

A. CODAs Before 1974

1. Legal Issues Presented

a. Coverage and Discrimination

b. Constructive Receipt

2. Revenue Ruling 56-497

3. Subsequent Cases and Rulings

B. Enactment of § 401(k) and Former § 402(a)(8)

C. 1984 Amendments to § 401(k)

D. 1986 TRA Amendments to § 401(k)

E. 1996 Amendments

F. 2001 Amendments

G. 2006 Amendments

III. Requirements of a Qualified CODA

Introductory Material

A. Qualified Profit-Sharing or Stock Bonus Plan

1. Profit-Sharing Plans

2. Stock Bonus Plans

3. Exclusion of Most Pension Plans

4. Exclusion of Most Plans Maintained by State or Local Governments and, Before 1997, Other Tax- Exempt Employers

a. Background

b. Grandfathered Governmental Plans

c. Indian Tribal Governments

d. Special Considerations for Nongovernmental Tax-Exempt Employers

5. Contributions Other Than Those Subject to the Cash or Deferred Election

a. General

b. Thrift or Savings Plans

c. Other Contributory Plans

6. Section 401(a) Qualification Requirements

a. Limitation on Elective Deferrals

b. Section 415 Limit on Contributions

c. Section 401(a)(17) Limit on Compensation

d. Top-Heavy Rules of § 416

B. Election by Employee of Contributions to a Trust

1. Salary Reduction

2. Bonuses

3. Meaning of "Trust"

4. Self-Employed Individuals as "Employees"

5. Elective Deferrals Required to Be Invested in Employer Stock

a. 10% Limit

b. Diversification Rights

6. Roth Contribution Programs

7. Automatic Enrollment in a CODA

a. Definition

b. Requirements

8. Default Investment Elections

C. Nondiscrimination Rules Applicable to Elective CODA Contributions

1. General Approach of Statute and Regulations

2. Identifying, Aggregating and Disaggregating Plans and CODAs

a. Aggregation and Disaggregation of Plans

b. Aggregating CODAs Within a Plan

c. Restructuring Prohibited

d. Aggregation of CODAs in Computing Deferral Percentages for Highly Compensated Employees

e. Mergers, Acquisitions, Etc.

3. Coverage of Eligible Employee Group

4. 1.25 and 2.0 Tests of § 401(k)(3)(A)

a. Method of Applying the 1.25 and 2.0 Tests

b. Identifying Eligible Employees

c. Identifying Highly Compensated Employees for the Plan Year

(1) Meaning of 5% Owner

(2) Definition of Compensation

(3) Identifying the Top-Paid Group

d. Determining Compensation for the Plan Year

(1) Amounts Included

(2) Period in Which Compensation Measured

e. Contributions Taken into Account for the Plan Year

(1) General Timing Rules

(2) Counting Qualified Nonelective Contributions and Matching Contributions

f. Illustrations of the 1.25 and 2.0 Tests

(1) The 1.25 Test

(2) The 2.0 Test

g. Variables Affecting Compliance

h. Effects of the § 401(a)(17) Limit on Compensation

5. Measures to Help Assure Compliance with the 1.25 or 2.0 Test

a. Additional Nonelective Employer Contributions

(1) Compliance Contributions

(2) Matching Contributions

(3) Other Nonelective Employer Contributions

b. Limiting Amounts Subject to Deferral

c. Tracking the Elections During the Year

d. Nonqualified Deferred Compensation Plans for Management or Highly Compensated Employees

e. Refunding or Recharacterizing Excess Contributions

(1) Determining the Amount of Excess Contributions

(2) Determining the Income Allocable to Excess Contributions

(3) Distribution of Excess Contributions

(4) Recharacterization of Excess Contributions

(5) Year in Which Excess Contributions Are Included in Income

(6) Excise Tax of § 4979

(7) Effect on Matching Contributions

6. SIMPLE Plans Exempt from the 1.25 and 2.0 Tests

a. Eligible Employers

b. Contribution Requirements

c. Other Requirements

d. Model Amendment

7. Design-Based Safe Harbors

a. Matching Contribution Requirements

b. Nonelective Contribution Alternative

c. Other Contribution Rules

d. Notice Requirement

e. Other Requirements

(1) Timing of Plan Contributions

(2) Aggregation and Disaggregation of Plans

(3) Plan Provisions Relating to Safe Harbors

(4) Use of Safe Harbor Nonelective Contributions to Satisfy Other Nondiscrimination Requirements

D. Nondiscrimination Rules Applicable to Matching Contributions and Employee After-Tax Contributions

1. Definition of Matching Contributions

2. Definition of Employee Contributions

3. Nondiscrimination Tests

4. Eligible Employees

5. Aggregation of Plans and Contributions

6. Determination of Excess Aggregate Contributions

7. Distribution or Forfeiture of Excess Aggregate Contributions

8. Tax Treatment of Distributed Excess Aggregate Contributions

9. Multiple Use of the Alternative Limitation Removed

10. SIMPLE Plans Exempt from the ACP Tests

11. Design-Based Safe Harbors

E. Nonforfeitability of Elective Contributions (Vesting)

1. Exceptions of § 411(a)(3) Inapplicable

2. Applying Section 411(a) to Other Plan Contributions

3. Continuing Nonforfeitability

F. Restrictions on Distribution of Elective Contributions

1. General and Miscellaneous Rules

a. General Rule

b. Qualified Reservist Distributions

c. Qualified Military Service Benefits

d. Phased Retirement Distributions

e. Miscellaneous Rollover Distributions

2. Separation from Service/Severance from Employment and the Same Desk Rule

3. Disability

4. Termination of the Plan

5. Sale of a Business or Subsidiary - Repealed

6. Hardship

a. Immediate and Heavy Financial Need

b. Distributions Necessary to Satisfy Financial Need

7. Disaster Relief

8. Timing and Form of Distributions

G. Loans

H. Additional Requirements of § 401(k)

1. Separate Accounts

2. Service Requirement Limited to One Year

3. No Benefits May Be Contingent Upon Election to Defer

4. No Use of Elective Deferrals to Help Another Plan Satisfy § 401(a) or § 410(b)

5. Recordkeeping Requirement

I. Inclusion of a CODA in a Cafeteria Plan

J. Eligible Combined Plans

IV. Consequences of Qualification or Nonqualification Under § 401(k)

A. Consequences of Qualification Under § 401(k)

1. Qualified Status of the Plan Under § 401(a)

2. Elective Contributions Not Currently Included in Income

B. Consequences of Nonqualification Under § 401(k)

1. Elective Contributions Currently Included in Income

2. Elective Contributions Treated as Employer Contributions for All Other Purposes

3. Effect on Qualified Status of Plan

V. Section 402(g) Limit on Elective Deferrals

A. In General

1. Amount of the Limit

a. Catch-up Contributions

b. Increased Limit for Elective Deferrals Under § 403(b)

2. Elective Deferrals to Which § 402(g) Applies

3. Taxable Year for Which Deferrals Are Taken into Account

4. Reporting of Deferrals By Employer

B. Contributions in Excess of the § 402(g) Limit

1. Tax Treatment of Excess Deferrals

2. Return of Excess Deferrals

C. Designated Roth Contributions to § 401(k) Plans

1. Defined

2. Separate Accounting Requirement

3. Distributions

4. Rollovers

5. Investment in the Contract and Hardship Distributions

6. Multiple Contracts Under a Plan

7. Employer Securities

8. Plan Loan and Aggregation Rules

9. Excess Contributions

10. Reporting and Recordkeeping Requirements

VI. Effect of a Qualified CODA on Other Benefits

A. Social Security

B. Other Retirement Plans

C. Other Benefits

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 ABC Corporation Section 401(k) Plan

Worksheet 1A Automatic Enrollment of New Employees in § 401(k) Plan: Sample Plan Amendments

Worksheet 1B Automatic Rollover of Mandatory Distributions: Sample Plan Amendment

Worksheet 2 ABC Corporation Section 401(k) Trust Agreement. The ABC Corporation Section 401(k) Trust Agreement

Worksheet 3 Summary Plan Description of the ABC Corporation Section 401(k) Plan.

Worksheet 4 Labor Department Final Regulation on Participant-Directed Individual Account Plans (Preamble and Final Regulation)

Worksheet 5 Sample Employee Communications Material About Section 401(k) Plan; Salary Reduction Authorization Form; Form for Beneficiary Designation and for Selecting Alternative Form of Benefit Distribution.

Worksheet 5A IRS Sample Automatic Enrollment and Default Investment Notice

Worksheet 6 MEMORANDUM: Correcting the Excess: Methods for Adjusting Allocations to Comply With Section 401(k)

Worksheet 6A Rhodes, Kohn, and Waidmann, "To Test or Not to Test: IRS Issues Section 401(k) Safe Harbor Guidance," reprinted from 27 Tax Mgmt. Comp. Plan. J. No. 2, 39 (Feb. 5, 1999).

Worksheet 7 Pension Protection Act of 2006: Summary of Provisions and Agency Guidance Affecting § 401(k) Plans

Worksheet 8 [Reserved]

Worksheet 9 Cash or Deferred Arrangement Listing of Required Modifications and Information Package (1-2006)

Worksheet 10 Defined Contribution Listing of Required Modifications and Information Package (8-2005)




Legislative History:

Committee Reports:



Treasury Rulings:

Other IRS Releases: