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401(k) Plans – IRS Issues Relief for Employers Suffering Business Hardship

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June 2, 2009

Employers may rely on proposed regulations recently issued by the IRS to suspend nonelective contributions to safe harbor 401(k) plans as an alternative to terminating such plans if the employer is suffering a business hardship (Prop. Reg., §1.401(k)-3(g); Prop. Reg., §1.401(m)-3(h)). These regulations extend existing rules that permit the reduction or suspension of 401(k) safe harbor matching contributions when the employer incurs a "substantial business hardship" to now also apply to safe harbor nonelective contributions. A "substantial business hardship" as it is defined in Section 412(c) of the Internal Revenue Code, includes (but is not limited to) whether or not:

  • the employer is operating at a loss;
  • there is substantial unemployment in the employer's industry;
  • the sales and profits of the industry are depressed or declining; and
  • the plan is reasonably expected to continue after the reduction or suspension.

A plan that reduces or suspends safe harbor nonelective contributions under the proposed regulations will not fail the ADP test, provided that:

  • a supplemental notice* of the reduction or suspension is distributed;
  • employees are given a reasonable opportunity to change their cash or deferred elections, and their employee contribution elections, if any;
  • the reduction or suspension is effective after the later of (a) 30 days following the distribution of the supplemental notice, and (b) the date the plan amendment is adopted;
  • the plan provides that the ADP test will be satisfied for the plan year of the reduction or suspension pursuant to the current year testing method; and
  • the plan satisfies the requirement with respect to safe harbor compensation paid through the effective date of the plan amendment.

    *The supplemental notice requirement is satisfied if each eligible employee is given a notice explaining:
    • the consequences of the reduction or suspension;
    • the procedures for changing cash or deferred elections and employee contribution elections, if any; and
    • the amendment's effective date.

A suspension or reduction cannot be implemented at the end of the plan year because (i) the reduction or suspension cannot be effective until the later of (a) 30 days after the notice is provided, and (b) the date the amendment is adopted, and (ii) plans that reduce or suspend these contributions must prorate the compensation limit of Code Section 401(a)(17). Further, plans that are so amended are no longer exempt from the top-heavy rules for the remaining of the plan year.

Effective date. The proposed regulations are effective immediately and taxpayers may rely on them for guidance pending the issuance of final regulations. However, if the final regulations are more restrictive than the proposed version, the more restrictive provisions of the final regulations will not apply retroactively.

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