IRS Revenue Ruling
2000-8

 Code Sec. 401

<<FULL TEXT>>

26 CFR 1.401(k)-1: Certain cash or deferred arrangements.

Cash or deferred arrangements; elective deferrals. This ruling
specifies the criteria to be met in order to automatically reduce an
employee's compensation by a certain amount and have that amount
contributed as an elective deferral to an employer's section 401(k) plan.


REV. RUL. 2000-8

ISSUE

Will employer contributions to a profit-sharing plan fail to be
considered elective contributions, within the meaning of section
1.401(k)-1(g)(3) of the Income Tax Regulations, made under a qualified
cash or deferred arrangement, within the meaning of section 401(k) of the
Internal Revenue Code, merely because they are made pursuant to an
arrangement under which a fixed percentage of an employee's compensation
is contributed to the plan unless the employee affirmatively elects to
receive the amount in cash?


FACTS

SITUATION 1

Employer X maintains Plan A, a profit-sharing plan intended to satisfy
the requirements of section 401(a), including sections 401(k) and 401(m),
and maintained on a calendar-year basis. Under Plan A, any employee of
Employer X, including a newly hired employee, may elect to have Employer X
make contributions on the employee's behalf to Plan A in lieu of receiving
that amount as cash compensation that would otherwise be payable to the
employee. The employee may designate the amount of these compensation
reduction contributions as a percentage of the employee's compensation,
subject to certain limitations set forth in the plan.

Under Plan A, if a newly hired employee does not affirmatively elect to
receive cash or have a specified amount contributed to Plan A, his or her
compensation is automatically reduced by 3 percent and this amount is
contributed to Plan A. An election by any employee not to make
compensation reduction contributions or to contribute a different
percentage of compensation can be made at any time. The election is
effective for the first pay period and subsequent pay periods (until
superseded by a subsequent election) if filed when the employee is hired
or if filed within a reasonable period thereafter ending before the
compensation for the first pay period is currently available. Thus, if an
employee files an election to receive cash in lieu of compensation
reduction contributions and the election is filed when the employee is
hired or within a reasonable period thereafter ending before the
compensation is currently available, then no compensation reduction
contributions for the first pay period or subsequent pay periods are made
on the employee's behalf to Plan A until the employee makes a subsequent
affirmative election to reduce his or her compensation. Elections filed at
a later date are effective for payroll periods beginning in the month next
following the date the election is filed.

At the time an employee is hired, the employee receives a notice that
explains the automatic compensation reduction election and the employee's
right to elect to have no such compensation reduction contributions made
to the plan or to alter the amount of those contributions, including the
procedure for exercising that right and the timing for implementation of
any such election. Each participant in Plan A is notified annually of his
or her compensation reduction percentage and the participant's right to
change the percentage, including the procedure for exercising that right
and the timing for implementation of any such election.

Plan A provides that compensation reduction contributions are
immediately nonforfeitable and, if the employee has not attained age 59
1/2, cannot be distributed prior to the employee's retirement, death, or
separation from service, except in the case of hardship (as defined in the
plan). Plan A also provides that, for each employee who has at least 1
year of service, Employer X will make matching contributions to Plan A on
account of the employee's compensation reduction contributions up to a
specified percentage of the employee's compensation. Plan A does not
permit after-tax employee contributions.

Plan A provides that both matching contributions and compensation
reduction contributions will be invested in accordance with the
participant's election among a broad range of investment funds held by the
trustee or, if no investment election is made by the participant, in the
trust's balanced fund which includes both diversified equity and fixed
income investments. <<ENDNOTE 1>>


SITUATION 2

The facts are the same as in Situation 1, except Plan A is amended,
effective the next January 1, to apply the same rule to both current and
newly hired employees. Thus, under Plan A as amended, if an employee hired
before January 1 who has not elected compensation reduction contributions
of at least 3 percent of compensation does not affirmatively elect during
a specified reasonable period ending on the January 1 effective date to
receive cash or have a specified amount contributed to Plan A, his or her
compensation is automatically reduced by 3 percent and this amount is
contributed to Plan A beginning the first pay period that begins after the
January 1 effective date.

Under the terms of Plan A as amended, if a current employee files an
election to receive cash in lieu of compensation reduction contributions
and the election is filed during the reasonable period ending on the
January 1 effective date, then no compensation reduction contributions for
the first pay period beginning on or after the January 1 effective date or
for subsequent pay periods are made on the employee's behalf to Plan A
until the employee makes a subsequent affirmative election to reduce his
or her compensation. In the case of a current employee who has a
compensation reduction contribution election in effect for less than 3
percent, who does not make a new compensation reduction contribution
election during the reasonable period ending on the January 1 effective
date, and whose compensation is therefore automatically reduced by 3
percent beginning on that January 1, if that employee thereafter makes an
affirmative election to reduce his or her compensation by another amount
(or no amount), then that affirmative election will continue in effect
until the employee makes a subsequent affirmative election for a different
amount.

At the beginning of the reasonable period ending on the January 1
effective date, each current employee receives a notice that explains the
new automatic compensation reduction election and the employee's right to
elect to have no such compensation reduction contributions made to the
plan or to alter the amount of those contributions, including the
procedure for exercising that right and the timing for implementation of
any such election. Thereafter, each employee receives the annual notice
described above in Situation 1.


LAW AND ANALYSIS

Section 401(k) provides that a profit-sharing or stock bonus plan, a
pre-ERISA money purchase plan, or a rural cooperative plan can meet the
requirements of section 401(a) even if it includes a qualified cash or
deferred arrangement. Section 401(k) also sets forth the requirements that
a cash or deferred arrangement must satisfy in order to be a qualified
cash or deferred arrangement. Section 1.401(k)-1(a)(2)(i) defines a cash
or deferred arrangement as an arrangement under which an eligible employee
may make a cash or deferred election with respect to contributions to, or
accruals or other benefits under, a plan that is intended to satisfy the
requirements of section 401(a). Section 1.401(k)-1(a)(2)(ii) provides that
a cash or deferred arrangement does not include an arrangement under which
amounts contributed under a plan at an employee's election are designated
or treated at the time of contribution as after-tax employee
contributions.

Section 1.401(k)-1(a)(3)(i) defines a cash or deferred election as any
election (or modification of an earlier election) by an employee to have
the employer either provide an amount to the employee in the form of cash
(or some other taxable benefit) that is not currently available or
contribute an amount to a trust (or provide an accrual or other benefit)
under a plan deferring the receipt of compensation. Section
1.401(k)-1(a)(3)(iv) provides that a cash or deferred election does not
include a one-time irrevocable election, made at the time an employee
commences employment with the employer or upon the employee's first
becoming eligible under any plan of the employer, to have contributions
made by the employer on the employee's behalf to the plan (or to any other
plan of the employer) equal to a specified amount or percentage of the
employee's compensation.

Section 1.401(k)-1(e)(2) provides generally that a qualified cash or
deferred arrangement must provide that the amount that each eligible
employee may defer as an elective contribution is available to the
employee in cash.

Section 1.401(k)-1(g)(3) defines elective contributions as employer
contributions made to a plan that were subject to a cash or deferred
election under a cash or deferred arrangement. Such contributions are
elective contributions without regard to whether the cash or deferred
arrangement is a qualified cash or deferred arrangement.

The definition of a cash or deferred election in section
1.401(k)-1(a)(3)(i) requires that the employee have an election between
the employer paying cash (or some other taxable benefit) to the employee
or making a contribution to a trust on behalf of the employee. The
regulation does not require that the employee receive an amount in cash in
any case in which the employee does not make an affirmative election to
have that amount contributed to the trust. Thus, a cash or deferred
election will not fail to be made under a qualified cash or deferred
arrangement merely because, when an employee fails to make an affirmative
election with respect to an amount of compensation, that amount is
contributed on the employee's behalf to a trust, provided that the
employee had an effective opportunity to elect to receive that amount in
cash. The employee has an effective opportunity to elect to receive an
amount in cash as required under section 1.401(k)-1(a)(3)(i) if the
employee receives notice of the availability of the election and the
employee has a reasonable period before the cash is currently available to
make the election.

If Plan A were to permit after-tax employee contributions, then the
amounts contributed to the plan would have to be designated or treated, at
the time of the contribution, as pre-tax compensation reduction
contributions or after-tax employee contributions.

In Situation 1, compensation reduction contributions made by Employer X
to Plan A, including those made on behalf of a newly hired employee who
has not filed an election to the contrary, are amounts contributed
pursuant to a procedure under which the employee receives a notice
explaining his or her rights to have no compensation reduction
contributions made and, after receiving the notice, the employee has a
reasonable period before the cash is currently available to elect to
receive the cash in lieu of having it contributed to the plan. Similarly,
in Situation 2, compensation reduction contributions made by Employer X to
Plan A, including those made on behalf of a newly hired employee who has
not filed an election to the contrary and those made on behalf of a
current employee who has elected less than 3 percent compensation
reduction contributions, are amounts contributed pursuant to a procedure
under which the employee receives a notice explaining his or her rights to
have no compensation reduction contributions made and, after receiving the
notice, the employee has a reasonable period before the cash is currently
available to elect to receive the cash in lieu of having it contributed to
the plan. Thus, in Situation 1 and Situation 2, an eligible employee has
an effective opportunity to elect to receive cash or have a contribution
made to the plan on the employee's behalf. In addition, compensation
reduction contributions made under the plan are not contributions made
pursuant to a one-time irrevocable election because the employee can
change the election in the future. Consequently, the compensation
reduction contributions described in Situation 1 and Situation 2 are made
pursuant to cash or deferred elections and satisfy the requirement in
section 1.401(k)-1(a)(3)(i) that the amount that each eligible employee
may defer as an elective contribution be available to the employee in
cash. The result would be the same if the plan required a period of
service (permitted under section 401(k)(2)(D)) before an employee became
eligible for elective contributions.


HOLDING

Where, as in Situation 1 and Situation 2, a newly hired or a current
employee has an effective opportunity to elect to receive an amount in
cash or have that amount contributed by the employer to a profit-sharing
plan, those employer contributions made on the employee's behalf to the
plan in lieu of receipt of cash compensation will not fail to be
considered elective contributions within the meaning of section
1.401(k)-1(g)(3) made under a qualified cash or deferred arrangement
within the meaning of section 401(k) merely because they are made pursuant
to an arrangement under which, in any case in which an employee does not
affirmatively elect to receive cash, the employee's compensation is
reduced by a fixed percentage and that amount is contributed on the
employee's behalf to the plan.


EFFECT ON OTHER DOCUMENTS

Rev. Rul. 98-30, 1998-25 I.R.B. 8, is amplified and superseded.


PAPERWORK REDUCTION ACT

The collection of information contained in this revenue ruling has been
reviewed and approved by the Office of Management and Budget (OMB) in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control
number 1545-1605.

An agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless the collection of
information displays a valid OMB control number.

The collections of information in this revenue ruling are in the third,
sixth, and last paragraphs in the section headed "FACTS" and in the sixth
paragraph in the section headed "LAW AND ANALYSIS." The collections of
information are required to enable personnel in the Tax Exempt and
Government Entities Division of the Internal Revenue Service to determine
if an employer's retirement plan satisfies the requirements to obtain
favorable tax treatment and to enable certain employee elections to meet
the requirements of section 401(k). The collections of information are
required to obtain a benefit. The likely respondents are businesses or
other for-profit institutions, and not-for-profit institutions.

The estimated total annual reporting burden is 1,750 hours. The
estimated average annual burden per respondent is 1 hour and 10 minutes.
The estimated number of respondents is 1,500. The estimated annual
frequency of responses is on occasion.

Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any Internal Revenue law. Generally, tax returns and tax
return information are confidential, as required by 26 U.S.C. 6103.


DRAFTING INFORMATION

The principal author of this revenue ruling is Roger Kuehnle of the Tax
Exempt and Government Entities Division. For further information regarding
this revenue ruling, call the Employee Plans' taxpayer assistance
telephone service at (202) 622-6074/6075 (not toll-free numbers) between
1:30 and 3:30 p.m. Eastern Time, Monday through Thursday.


<<ENDNOTES>>

1/ The Department of Labor has advised Treasury and the Service that,
under Title I of the Employee Retirement Income Security Act of 1974
(ERISA), fiduciaries of a plan must ensure that the plan is administered
prudently and solely in the interest of plan participants and
beneficiaries. While ERISA section 404(c) may serve to relieve certain
fiduciaries from liability when participants or beneficiaries exercise
control over the assets in their individual accounts, the Department of
Labor has taken the position that a participant or beneficiary will not be
considered to have exercised control when the participant or beneficiary
is merely apprised of investments that will be made on his or her behalf
in the absence of instructions to the contrary. See 29 CFR section
2550.404c-1 and 57 F.R. 46924.

<<END RULING>>

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