IRS Issues Proposed Regulations on QMACs and QNECs

The Internal Revenue Service (IRS) issued proposed regulations that would provide that the amounts used to fund qualified matching contributions (QMACs) and qualified non-elective contributions (QNECs) must be nonforfeitable and subject to distribution restrictions at the time they are allocated to plan participants' accounts, rather than when they are first contributed to the plan.

Practical Law Employee Benefits & Executive Compensation

On January 17, 2017, the Internal Revenue Service (IRS) issued proposed regulations that would change the definition of qualified matching contributions (QMACs) and qualified non-elective contributions (QNECs) to provide that employer contributions to a plan are able to qualify as QNECs and QMACs if they are nonforfeitable and subject to distribution restrictions when they are allocated to plan participants' accounts, rather than when they are first contributed to a defined contribution plan ( www.practicallaw.com/2-502-2755) (82 Fed. Reg. 5477 (Jan. 18, 2017)).

 

Background: Nondiscrimination Requirements for Defined Contribution Plans

Tax-qualified ( www.practicallaw.com/9-502-1856) defined contribution plans may not discriminate in favor of highly compensated employees ( www.practicallaw.com/9-501-8255) (HCEs). There are two nondiscrimination tests that specifically apply to 401(k) plans:

  • The Actual Deferral Percentage (ADP) Test. The ADP test applies to employee salary deferrals made under the plan. This test measures whether the average rate of HCEs' pre-tax contributions exceeds the average rate of non-highly compensated employees' ( www.practicallaw.com/2-502-0228) (NHCEs) pre-tax contributions by an amount calculated under several available formulas.

  • The Actual Contribution Percentage (ACP) Test. The ACP test also compares average rates of contributions, but applies to employer matching contributions, if any, and employee after-tax contributions, if any, made to the plan.

(See Practice Note, Safe Harbor 401(k) Plans: Overview and Planning Opportunities: Nondiscrimination Rules ( www.practicallaw.com/9-501-1089) .)

The mechanics of nondiscrimination testing can be quite complicated. To help ensure that their matching contributions pass nondiscrimination testing, plan sponsors can designate a matching contribution as a QMAC. The entire contribution or part of it can be designated as a QMAC (for more information on QMACs, see Practice Note, Contributions to a Defined Contribution Plan: Overview: Employer Contributions: QMACs ( www.practicallaw.com/0-608-6785) ). Plan sponsors may also make QNECs to pass nondiscrimination testing (for more information on QNECs, see Practice Note, Contributions to a Defined Contribution Plan: Overview: Employer Contributions: Non-Elective Contributions: QNECs ( www.practicallaw.com/0-608-6785) ). However, to do so, the QMACs and QNECs must satisfy the nonforfeitability requirements of 26 C.F.R. Section 1.401(k)–1(c) and the distribution requirements of 26 C.F.R. Section 1.401(k)–1(d) "when they are contributed to the plan."

To avoid dealing with complicated nondiscrimination testing rules, 401(k) plans may also provide non-highly compensated employees with "safe harbor" contributions under Sections 401(k)(12) or 401(k)(13) of the Internal Revenue Code (Code) (26 U.S.C. § 401(k)(12)) (see Practice Note, Safe Harbor 401(k) Plans: Overview and Planning Opportunities ( www.practicallaw.com/9-501-1089) and Standard Document, Safe Harbor Notice for Qualified Retirement Plans with Optional QACA Provisions ( www.practicallaw.com/9-519-6097) ).

Commenters have argued that requiring QMACs and QNECs to meet the applicable nonforfeitability and distribution requirements at the time the amounts are first contributed to the plan would prevent plan sponsors from using plan forfeitures to fund QMACs and QNECs. Specifically, the amounts would have been allocated to the forfeiture accounts only after a participant incurred a forfeiture of benefits and generally would have been subject to a vesting schedule when they were first contributed to the plan. To ensure that plan sponsors can use plan forfeitures to fund QMACs and QNECs, commenters have requested that the QMAC and QNEC requirements be satisfied when they are allocated to participants' accounts, not when first contributed to the plan.

 

Proposed Regulations

After considering the commenters' statements, Treasury and the IRS issued the proposed regulations, which amend the definitions of QMACs and QNECs under:

  • 26 C.F.R. Section 1.401(k)-6 to provide that the amounts used to fund QNECs and QMACs must be nonforfeitable and meet the distribution requirements at the time they are allocated to plan participants' accounts, rather than when they are first contributed to a defined contribution plan. The proposed regulations also replace the word "vesting" with "nonforfeitability" in each definition, because the applicable requirements are better characterized as nonforfeitability requirements under Code Section 401(k)(2)(C) (26 U.S.C. § 401(k)(2)(C)) and 26 C.F.R. Section 1.401(k)-1(c). The preamble to the proposed regulations states that use of the word "nonforfeitability" is not otherwise intended to have any substantive impact on the regulations.

  • 26 C.F.R. Section 1.401(m)-5 to cross-reference the definition of QMACs and QNECs under 26 C.F.R. Section 1.401(k)-6 to provide consistency in the definitions. The preamble to the proposed regulations states that these changes are not otherwise intended to have any substantive impact on this or any other section of the regulations.

Applicability Date

The proposed regulations would apply to taxable years beginning on or after the date of publication of the Treasury decision adopting the proposed regulations as final regulations in the Federal Register. The preamble to the proposed regulations notes that taxpayers may rely on the proposed regulations for periods preceding the proposed applicability date. If the final regulations are more restrictive than the proposed regulations, the final regulations will apply without retroactive effect.

The IRS will consider comments on the proposed regulations and hold a public hearing if requested.

 

Practical Implications

By providing that the amounts used to fund QNECs and QMACs must be nonforfeitable and subject to the applicable distribution restrictions when they are allocated to plan participants' accounts, rather than when they are first contributed to a defined contribution plan, the proposed regulations would help ensure that defined contribution plans could fund QMACs and QNECs with the amounts in plan forfeiture accounts.

 
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