[Federal Register: January 3, 2008 (Volume 73, Number 2)]
[Proposed Rules]
[Page 421-428]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr03ja08-12]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-136701-07]
RIN1545-BH04
Diversification Requirements for Certain Defined Contribution
Plans
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations under section
401(a)(35) of the Internal Revenue Code (Code) relating to
diversification requirements for certain defined contribution plans and
to publicly traded employer securities. These regulations will affect
administrators of, employers maintaining, participants in, and
beneficiaries of defined contribution plans that are invested in
employer securities.
DATES: Written or electronic comments and requests for a public hearing
must be received by April 2, 2008.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (Reg-136701-07), room
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station,
Washington DC 20044. Submissions may be hand-delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (Reg-
136701-07), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC, or sent electronically via the Federal
eRulemaking Portal at http://www.regulations.gov (IRS REG-136701-07).
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, R. Lisa
Mojiri-Azad or Dana Barry at (202) 622-6060; concerning submission of
comments or to request a public hearing, Kelly Banks at (202) 622-7180
(not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed regulations under section
401(a)(35) of the Code, which was added by section
[[Page 422]]
901 of the Pension Protection Act of 2006, Public Law 109-280, 120
Stat. 780 (PPA '06).\1\
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\1\ Section 901 of PPA '06 also added a parallel provision at
section 204(j) of the Employee Retirement Income Security Act of
1974, Public Law 93-406, 88 Stat. 829 (ERISA). Under section 101 of
Reorganization Plan No. 4 of 1978 (43 FR 47713), the Secretary of
Treasury has interpretative jurisdiction over the subject matter
addressed in these proposed regulations for purposes of section
204(j) of ERISA. Thus, the guidance provided in these proposed
regulations with respect to section 401(a)(35) of the Code also
applies for purposes of section 204(j) of ERISA.
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Section 401(a)(35)(A) provides that a trust which is part of an
applicable defined contribution plan is not a qualified trust under
section 401(a) unless the plan satisfies the diversification
requirements of sections 401(a)(35)(B), (C), and (D). Under section
401(a)(35)(B), each individual must have the right to direct the plan
to divest employer securities allocated to the individual's account
that are attributable to employee contributions or elective deferrals
and to reinvest an equivalent amount in other investment options
meeting the requirements of section 401(a)(35)(D).\2\
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\2\ Section 401(a)(28) provides certain diversification rights
to participants in an employee stock ownership plan within the
meaning of section 4975(e)(7) (ESOP). Section 401(a)(28)(B) also
generally requires that the plan offer at least three alternative
investment options. Section 401(a)(28)(B) permits a plan to satisfy
these diversification requirements by distributing, within 90 days
after the period during which the election may be made, the portion
of the participant's account that is subject to section
401(a)(28)(B). Section 401(a)(28)(B) was amended by section
901(a)(2)(A) of PPA '06 not to apply to a plan to which section
401(a)(35) applies.
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Under section 401(a)(35)(C), each individual who is a participant
who has completed at least three years of service, a beneficiary of a
participant who has completed at least three years of service, or a
beneficiary of a deceased participant must be permitted to elect to
direct the plan to divest employer securities allocated to the
individual's account and to reinvest an equivalent amount in other
investment options meeting the requirements of section 401(a)(35)(D).
Section 401(a)(35)(D)(i) requires an applicable defined
contribution plan to offer individuals not less than three investment
options, other than employer securities, to which the individuals may
direct the proceeds from the divestment of employer securities, each of
which is diversified and has materially different risk and return
characteristics.
Under section 401(a)(35)(D)(ii)(I), a plan does not fail to meet
the requirements of section 401(a)(35)(D) if it allows individuals to
divest employer securities and reinvest the proceeds at periodic,
reasonable opportunities occurring no less frequently than quarterly.
Under section 401(a)(35)(D)(ii)(II), a plan is not permitted to
impose restrictions or conditions with respect to the investment of
employer securities that are not imposed on the investment of other
assets of the plan. However, this rule does not apply to restrictions
or conditions imposed to comply with securities laws. The Secretary is
authorized to issue regulations providing additional exceptions to the
requirements of section 401(a)(35)(D)(ii)(II).
An applicable defined contribution plan under section 401(a)(35) is
a defined contribution plan that holds any publicly traded employer
securities. A publicly traded employer security is defined as an
employer security under section 407(d)(1) of the Employee Retirement
Income Security Act of 1974, Public Law 93-406, 88 Stat. 829 (ERISA)
which is readily tradable on an established securities market. Section
401(a)(35)(F)(i) provides that a plan that does not hold publicly
traded employer securities is nevertheless treated as holding publicly
traded employer securities if any employer corporation or any member of
a controlled group of corporations which includes the employer
(determined by applying section 1563(a), except substituting 50 percent
for 80 percent) has issued a class of stock that is a publicly traded
employer security. However, section 401(a)(35)(F) does not apply to a
plan if no employer corporation, or parent corporation (as defined in
section 424(e)) of an employer corporation, has issued any publicly
traded employer security and no employer or parent corporation has
issued any special class of stock which grants particular rights to, or
bears particular risks for, the holder or issuer with respect to any
corporation described in section 401(a)(35)(F)(i) which has issued any
publicly traded employer security.
Section 401(a)(35)(E) provides that section 401(a)(35) does not
apply to an employee stock ownership plan within the meaning of section
4975(e)(7) (ESOP) that holds no contributions (or earnings thereunder)
that are subject to section 401(k) or (m) (generally relating to
elective deferrals and matching and employee after-tax contributions)
and the ESOP is a separate plan for purposes of section 414(l) with
respect to any other defined benefit plan or defined contribution plan
maintained by the same employer or employers. Section 401(a)(35)(E)
further provides that section 401(a)(35) does not apply to one-
participant retirement plans.
Section 401(a)(35) is generally effective for plan years beginning
after December 31, 2006. Section 401(a)(35)(H) generally provides a
three year phase-in rule with respect to an individual's right to
direct the divestment of employer securities attributable to employer
contributions, except with respect to certain participants who have
attained age 55. Section 901(c)(2) of PPA '06 includes a special rule
for a plan maintained pursuant to one or more collective bargaining
agreements between employee representatives and one or more employers
that was ratified on or before August 17, 2006. Under this rule,
section 401(a)(35) is not effective until plan years beginning after
the earlier of (1) the later of (a) December 31, 2007 or (b) the date
on which the last of such collective bargaining agreements terminates
(determined without regard to any extension thereof after August 17,
2006) or (2) December 31, 2008.
Notice 2006-107 (2006-2 CB 1114 (December 18, 2006)) (see Sec.
601.601(d)(2)(ii)(b) of this chapter), includes guidance and
transitional rules with respect to the diversification requirements of
section 401(a)(35).\3\ Notice 2006-107 provides that a plan (and an
investment option described in section 401(a)(35)(D)(i)) is not treated
as holding employer securities to which section 401(a)(35) applies with
respect to any securities held through either an investment company
registered under the Investment Company Act of 1940 or a similar pooled
investment vehicle that is regulated and subject to periodic
examination by a State or Federal agency and with respect to which
investment in securities is made both in accordance with the stated
investment objectives of the investment vehicle and independent of the
employer and any affiliate thereof, but only if the holdings of the
investment company or similar investment vehicle are diversified so as
to minimize the risk of large losses. Notice 2006-107 also provides
that investment options satisfy the requirement that investment options
be diversified and have materially different risk and return
characteristics under section 401(a)(35)(D)(i) if the investment
options satisfy the requirements of section 2550.404c-1(b)(3) of the
Department of Labor regulations.
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\3\ Notice 2006-107 also includes guidance regarding the related
notice requirements of section 101(m) of ERISA, including a model
notice.
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Notice 2006-107 further provides that, for purposes of section
401(a)(35), the date on which a participant completes three years of
service occurs immediately after the end of the third
[[Page 423]]
vesting computation period provided for under the plan that constitutes
the completion of a third year of service under section 411(a)(5). For
a plan using the elapsed time method of crediting service for vesting
purposes (or a plan that provides for immediate vesting without using a
vesting computation period or elapsed time method of determining
vesting), the date on which a participant completes three years of
service is the third anniversary of the participant's date of hire.
Notice 2006-107 includes special rules regarding restrictions or
conditions with respect to employer securities under section
401(a)(35)(D)(ii)(II). An impermissible restriction or condition is
either a restriction on an individual's right to divest an investment
in employer securities that is not imposed on an investment that is not
in employer securities or a benefit that is conditioned on an
investment in employer securities. Examples of restrictions or
conditions that are prohibited by section 401(a)(35)(D)(ii)(II) under
Notice 2006-107 include: (1) A plan allows an individual the right to
divest employer securities on a quarterly basis but permits divestiture
of another investment on a more frequent basis; (2) a plan provides
that a participant who divests his or her account of employer
securities receives less favorable treatment (such as a lower rate of
matching contributions) than a participant whose account remains
invested in employer securities; and (3) a plan that provides if a
participant divests his or her account balance with respect to
investment in a class of employer securities, the participant is not
permitted for a period of time to reinvest in that class of securities
where that restriction is not imposed on other investments. Notice
2006-107 also provided examples of restrictions or conditions that are
not prohibited by section 401(a)(35)(D)(ii)(II): (1) A provision that
limits the extent to which an individual's account balance can be
invested in employer securities; (2) a provision under which an
employer securities fund is closed; (3) a restriction imposed by reason
of application of securities laws or a restriction that is reasonably
designed to ensure compliance with such laws; (4) an imposition of fees
on other investment options under the plan but not on investments in
employer securities; and (5) a plan restriction on the availability of
otherwise applicable diversification rights under the plan for up to 90
days following an initial public offering of the employer's stock.
Notice 2006-107 provides certain transition rules. For example, for
the period prior to January 1, 2008, a plan does not impose a
restriction or condition prohibited by section 401(a)(35)(D)(ii)(II)
merely because the plan, as in effect on December 18, 2006, (1) does
not impose an otherwise applicable restriction on a stable value fund
or (2) allows individuals the right to divest employer securities on a
periodic basis (at least quarterly), but permits divestiture of another
investment on a more frequent basis, provided that the other investment
is not a generally available investment.
Explanation of Provisions
Overview
The proposed regulations would provide guidance with respect to the
requirements of section 401(a)(35) that incorporate much of the
guidance provided under Notice 2006-107. The regulations would clarify
the scope of the rule in section 401(a)(35)(D)(ii)(II) that generally
prohibits restrictions and conditions on investment in employer
securities, but would specifically permit certain restrictions and
conditions on such investment that are consistent with the statute, and
would also define when employer securities are publicly traded on an
established securities market under section 401(a)(35)(D).
Basic Diversification Rights
The proposed regulations incorporate the guidance on the basic
diversification rights of section 401(a)(35) that is contained in
Notice 2006-107. Thus, if an applicable defined contribution plan holds
employee contributions (including rollover contributions) or elective
deferrals with respect to an individual that are invested in employer
securities, the plan must provide that the individual is given the
opportunity to divest the employer securities and reinvest an
equivalent amount in another investment. These rights must be provided
to each participant, to each alternate payee who has an account under
the plan, and to each beneficiary of a deceased participant.
If employer contributions (other than elective deferrals) are
invested in employer securities under the plan, the divestment right
must be provided to each participant who has completed at least three
years of service, to each alternate payee who has an account under the
plan with respect to a participant who has at least three years of
service, and to each beneficiary of a deceased participant (regardless
of whether the participant had completed at least three years of
service). For this purpose, the regulations would provide that a
participant has completed three years of service on the last day of the
vesting computation period as determined under the plan that
constitutes the completion of the third year of service (or the third
anniversary of hire for a plan that either uses the elapsed time method
or that does not define the vesting computation period because the plan
provides for full and immediate vesting).
The regulations would require a plan to provide individuals who
have section 401(a)(35) diversification rights the opportunity to
divest the employer securities and reinvest an equivalent amount in
another investment at least quarterly. The individuals must be
permitted to select among no less than three investment options, each
of which is diversified and has materially different risk and return
characteristics. For this purpose, investment options that constitute a
broad range of investment alternatives within the meaning of Department
of Labor Regulations section 2550.404c-1(b)(3) are treated as being
diversified and having materially different risk and return
characteristics.
Plans Subject to Section 401(a)(35)
Under the proposed regulations, a defined contribution plan, which
holds publicly traded employer securities (referred to as an applicable
defined contribution plan), is subject to the diversification
requirements of section 401(a)(35), unless it is exempted under section
401(a)(35)(E) as a stand-alone ESOP or as a one-participant retirement
plan. For this purpose, an employer security is defined by reference to
section 407(d)(1) of ERISA.
Under section 401(a)(35)(G)(v), an employer security is a publicly
traded employer security if it is readily tradable on an established
securities market. The regulations would provide separate rules for
securities traded on domestic securities exchanges and foreign
securities exchanges.
If a security is traded on a securities exchange that is registered
under section 6 of the Securities Exchange Act of 1934, then the
security would be deemed to be readily tradable on an established
securities market. This definition is consistent with the definition of
publicly traded found in Sec. 54.4975-7(b)(1)(iv), but deletes the
reference to a system sponsored by the National Association of
Securities Dealers (NASDAQ) registered under section 15A(b) of the Act
(15 U.S.C. 78o) because NASDAQ is now registered as
[[Page 424]]
a securities exchange under section 6 of the Securities Exchange Act of
1934. Thus, if a security is not traded on a national securities
exchange that is registered under section 6 of the Securities Exchange
Act of 1934, then the security would not be publicly traded for
purposes of section 401(a)(35) (unless it is traded on a foreign
securities exchange and has a ``ready market'' as described in the next
paragraph). This would apply to U.S. securities that are only traded on
the ``Over-The-Counter Bulletin Board'' and the ``pink sheets.''
Under the proposed regulations, if a security is not listed on a
securities exchange that is registered under section 6 of the
Securities Exchange Act of 1934, but is traded on a foreign national
securities exchange that is officially recognized, sanctioned, or
supervised by a governmental authority, then under the proposed
regulations, the security would be traded on an established securities
market. The proposed regulations would provide that such a security is
readily tradable if the security is deemed by the Securities and
Exchange Commission (SEC) as having a ``ready market'' under SEC Rule
15c3-1 (17 CFR 240.15c3-1).\4\
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\4\ Under the current SEC rules, a security is deemed to have a
ready market if it is included on the FTSE Group (FTSE) World Index.
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The proposed regulations would reflect section 401(a)(35)(F),
which, subject to certain exceptions, treats a plan holding employer
securities that are not publicly traded as nonetheless subject to the
rules of section 401(a)(35) if any employer sponsoring the plan, or any
member of the controlled group of corporations (determined by applying
section 1563(a), except substituting 50 percent for 80 percent) has
issued a class of stock which is publicly traded (as defined above).
Section 401(a)(35)(E)(ii) provides that an ESOP that is a separate
plan holding no contributions that are subject to section 401(k) or
section 401(m) is not an applicable defined contribution plan. (As
noted earlier in this preamble, such a plan is subject to the
diversification requirements of section 401(a)(28)(B).) The proposed
regulations would clarify that a plan does not lose this exemption
merely because it receives rollover contributions of amounts from
another plan that are held in a separate account, even if those amounts
were attributable to contributions that were subject to section 401(k)
or 401(m) in the other plan. In addition, the proposed regulations
would reflect the exemption for one-participant retirement plans under
section 401(a)(35)(E)(iv).
Notice 2006-107 provides that employer securities held by an
investment company registered under the Investment Company Act of 1940
or similar pooled investment vehicle are not treated as being held by
the plan. Some comments on Notice 2006-107 had recommended a broader
rule, under which a commingled fund that holds employer securities and
other securities would not be treated as holding employer securities
that are subject to the section 401(a)(35) diversification requirement.
The proposed regulations would not adopt this broad exemption from the
diversification rules.
The proposed regulations, however, clarify the types of pooled
investment vehicles that are exempt from the diversification
requirements. Under the proposed regulations, in order to be exempt
from the diversification requirements, the pooled investment vehicle
must be a common or collective trust fund or pooled investment fund
maintained by a bank or trust company supervised by a State or Federal
agency, a pooled investment fund of an insurance company that is
qualified to do business in a State, or an investment fund designated
by the Commissioner in revenue rulings, notices, or other guidance
published in the Internal Revenue Bulletin. As under Notice 2006-107,
the regulations would include the requirement that in order to be
exempt from the diversification requirements the pooled investment fund
that holds the employer securities must have stated investment
objectives and the investment must be independent of the employer and
any affiliate thereof. The proposed regulations would add a percentage
limitation rule to ensure that the investment in the employer
securities through a pooled fund is not an attempt to evade the rules
of section 401(a)(35). Under this rule, if the employer securities held
by such fund is more than 10 percent of the total value of all of the
fund's investment, then the fund is not considered to be independent of
the employer.
Prohibition on Restrictions or Conditions
The proposed regulations would provide that the section
401(a)(35)(D)(ii)(II) prohibition on restrictions or conditions with
respect to the investment of employer securities which are not imposed
on the investment of other assets of the plans applies to a direct or
indirect restriction on an individual's rights to divest an investment
in employer securities that is not imposed on an investment that is not
employer securities as well as a direct or indirect benefit that is
conditioned on investment in employer securities. However, like Notice
2006-107, the regulations would not apply this prohibition to
restrictions that are imposed by reason of the application of
securities laws and in certain other situations described below.
Like Notice 2006-107, the proposed regulations would allow a plan
to impose a restriction on divestiture that is reasonably designed to
comply with securities law, even if the restriction is broader than the
minimum restriction needed to comply with securities laws. The proposed
regulations incorporate the example of such a restriction from Notice
2006-107. This is merely an example and broader restrictions on
divestiture are permitted, provided they are reasonably designed to
comply with securities law. For example, in some smaller entities a
broad restriction allowing divestiture to occur only once a quarter
might be a restriction that is reasonably designed to comply with
securities law.
Notice 2006-107 includes a rule that permits a plan to restrict the
otherwise applicable diversification rights under section 401(a)(35)
for a period of up to 90 days following an initial public offering of
the employer's stock. The proposed regulations would extend this rule
to apply to the first 90 days after the plan becomes an applicable
defined contribution plan. This could happen, for example, when some
other entity in the controlled group first issues stock which is
publicly traded or when a stand-alone ESOP first provides for
contributions that are subject to section 401(k) or section 401(m).
Notice 2006-107 permits a plan to impose a restriction on an
investment in employer securities that is not imposed on a stable value
fund. The proposed regulations extend this rule to a fund that is
similar to a stable value fund. Specifically, the proposed regulations
would provide that in the case of a plan that has several investment
funds, including a fund invested in employer securities, a fund which
is a stable value or similar fund, and other funds which are not
invested in employer securities, the plan does not impose a restriction
prohibited under section 401(a)(35)(D)(ii)(II) merely because the plan
permits transfers to be made into the stable value or similar fund more
frequently than into the fund invested in employer securities (assuming
the plan does not impose a restriction on transfers to or from the
employer securities fund that it does not impose with respect to the
other funds).
While the proposed regulations would generally prohibit indirect
restrictions
[[Page 425]]
on an individual's exercise of diversification rights (such as a plan
provision that limits the right of an individual who diversifies out of
employer securities by providing that such a participant is not
permitted to reinvest in employer securities for a period of time), the
rules would permit certain indirect restrictions, as well as certain
indirect benefits that are conditioned on investment in employer
securities. Under the proposed regulations, a plan would be permitted
to limit the extent to which an individual's account balance can be
invested in employer securities. For example, a plan would not be
treated as imposing a restriction that violates section
401(a)(35)(D)(ii)(II) merely because the plan prohibits a participant
from investing additional amounts in employer securities if more than
10 percent of that participant's account balance is (or would be after
the change) invested in employer securities. In addition, an applicable
defined contribution plan does not violate a prohibition against
reinvestment in employer securities if the plan has terminated any
further investment in employer securities.
The proposed regulations would provide that a plan is not providing
an indirect benefit that is conditioned on investment in employer
securities merely because the plan imposes fees on other investment
options that are not imposed on the investment in employer securities.
In addition, a plan is not providing a restriction on the right to
divest an investment in employer securities merely because the plan
imposes a reasonable fee for the divestment of employer securities.
The proposed regulations would permit a restriction on the
frequency of investment elections that was not in Notice 2006-107.
Under this rule, a plan would be permitted to impose reasonable
restrictions on the timing and number of investment elections that an
individual can make to invest in employer securities, provided that the
restrictions are designed to limit short-term trading in the employer
securities. For example, a fund could limit the purchase of employer
securities if there has been a sale within a short period of time, such
as 7 days. The regulations, however, would not permit a plan to limit
an individual's right to divest employer securities.
Proposed Effective Date
Section 401(a)(35) is applicable to plan years beginning on or
after January 1, 2007, subject to certain deferred effective dates and
transition rules. The proposed regulations would provide guidance on
these effective dates and transition rules. In particular, the
regulations would provide that a plan is eligible for the deferred
effective date applicable to collectively bargained plans only if at
least 25 percent of the participants in the plan are members of
collective bargaining units for which the contributions under the plan
are specified under a collective bargaining agreement.
The regulations under section 401(a)(35) are proposed to be
effective for plan years beginning on or after January 1, 2009. Until
the regulations go into effect, Notice 2006-107 will continue to apply.
For this purpose, the transitional relief provided for the period prior
to January 1, 2008, in paragraph 4 of Section III.D. of Notice 2006-107
will continue to apply after 2007 until the regulations go into
effect.\5\ In addition, plans are also permitted to apply the proposed
regulations for plan years before the regulations go into effect.
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\5\ The Treasury and IRS are issuing a notice to reflect this
extension. The notice is expected to be published as Notice 2008-7
in the 2008-3 issue of the IRB on january 22, 2008 (see Sec.
601.601(d)(2)(ii)(b) of this chapter).
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Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations, and, because
Sec. 1.401(a)(35)-1 would not impose a collection of information on
small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Pursuant to section 7805(f) of the Code, this notice of
proposed rulemaking will be submitted to the Chief Counsel for Advocacy
of the Small Business Administration for comment on its impact on small
business.
Comments and Requests for Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written (one signed and eight (8)
copies) or electronic comments that are submitted timely to the IRS.
The IRS and the Treasury Department specifically request comments on
the clarity of the proposed regulations and how they can be made easier
to understand.
In particular, the IRS and the Treasury Department request comments
on whether the determination of when an employer security is readily
tradable on an established securities market under these proposed
regulations should also be applied for purposes of determining whether
an employer security is readily tradable on an established securities
market in applying other provisions relating to qualified plans, given
that the same words used in interrelated provisions of the Code are
presumed to have the same meaning. These interrelated provisions
include section 401(a)(28)(C) (requiring the use of an independent
appraiser for valuation of employer securities that are not readily
tradable on an established securities market), section 409(h)(1)(B)
(relating to put options for employer securities that are not readily
tradable on an established market), the definition of employer
securities under section 409(l)(1) (including regulations under section
4975), and the special rules under section 1042 (providing
nonrecognition treatment for certain sales to an ESOP).
All comments will be available for public inspection and copying. A
public hearing will be scheduled if requested in writing by any person
who timely submits written comments. If a public hearing is scheduled,
notice of the date, time, and place of the public hearing will be
published in the Federal Register.
Drafting Information
The principal authors of these regulations are Dana A. Barry and
Lisa Mojiri-Azad, Office of Division Counsel/Associate Chief Counsel
(Tax Exempt and Government Entities). However, other personnel from the
IRS and the Treasury participated in the development of these
regulations.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.401(a)(35)-1 is also issued under 26 U.S.C.
401(a)(35).* * *
Par. 2. Section 1.401(a)(35)-1 is added to read as follows:
[[Page 426]]
Sec. 1.401(a)(35)-1 Diversification Requirements for Certain Defined
Contribution Plans.
(a) General rule--(1) Diversification requirements. Section
401(a)(35) imposes diversification requirements on applicable defined
contribution plans. A trust that is part of an applicable defined
contribution plan is not a qualified trust under section 401(a) unless
the plan--
(i) Satisfies the diversification election requirements for
elective deferrals and employee contributions set forth in paragraph
(b) of this section;
(ii) Satisfies the diversification election requirements for
employer nonelective contributions set forth in paragraph (c) of this
section;
(iii) Satisfies the investment option requirement set forth in
paragraph (d) of this section; and
(iv) Does not apply any restrictions or conditions on investments
in employer securities that violate the requirements of paragraph (e)
of this section.
(2) Definitions, effective dates, and transition rules. The
definitions of applicable defined contribution plan, employer security,
parent corporation, and publicly traded are set forth in paragraph (f)
of this section. Effective/applicability dates and transition rules are
set forth in paragraph (g) of this section.
(b) Diversification requirements for elective deferrals and
employee contributions invested in employer securities--(1) General
rule. With respect to any individual described in paragraph (b)(2) of
this section, if any portion of the individual's account under an
applicable defined contribution plan attributable to elective deferrals
(as described in section 402(g)(3)(A)), after-tax employee
contributions, or rollover contributions is invested in employer
securities, then the plan satisfies the requirements of this paragraph
(b) if the individual may elect to divest those employer securities and
reinvest an equivalent amount in other investment options. The plan may
limit the time for divestment and reinvestment to periodic, reasonable
opportunities occurring no less frequently than quarterly.
(2) Applicable individual with respect to elective deferrals and
employee contributions. An individual is described in this paragraph
(b)(2) if the individual is--
(i) A participant;
(ii) An alternate payee who has an account under the plan; or
(iii) A beneficiary of a deceased participant.
(c) Diversification requirements for employer nonelective
contributions invested in employer securities--(1) General rule. With
respect to any individual described in paragraph (c)(2) of this
section, if a portion of the individual's account under an applicable
defined contribution plan attributable to employer nonelective
contributions, other than elective deferrals, is invested in employer
securities, then the plan satisfies the requirements of this paragraph
(c) if the individual may elect to divest those employer securities and
reinvest an equivalent amount in other investment options. The plan may
limit the time for divestment and reinvestment to periodic, reasonable
opportunities occurring no less frequently than quarterly.
(2) Applicable individual with respect to employer nonelective
contributions. An individual is described in this paragraph (c)(2) if
the individual is--
(i) A participant who has completed at least three years of
service;
(ii) An alternate payee who has an account under the plan with
respect to a participant who has completed at least three years of
service; or
(iii) A beneficiary of a deceased participant.
(3) Completion of 3 years of service. For purposes of paragraph
(c)(2) of this section, a participant completes three years of service
on the last day of the vesting computation period provided for under
the plan that constitutes the completion of the third year of service
under section 411(a)(5). However, for a plan that uses the elapsed time
method of crediting service for vesting purposes (or a plan that
provides for immediate vesting without using a vesting computation
period or the elapsed time method of determining vesting), a
participant completes three years of service on the day immediately
preceding the third anniversary of the participant's date of hire.
(d) Investment option. An applicable defined contribution plan must
offer not less than three investment options, other than employer
securities, to which an individual who has the right to divest under
paragraph (b)(1) or (c)(1) of this section may direct the proceeds from
the divestment of employer securities. Each of the three investment
options must be diversified and have materially different risk and
return characteristics. For this purpose, investment options that
constitute a broad range of investment alternatives within the meaning
of Department of Labor Regulation section 2550.404c-1(b)(3) are treated
as being diversified and having materially different risk and return
characteristics.
(e) Restrictions or conditions on investments in employer
securities--(1) Impermissible restrictions or conditions--(i) General
rule. Except as provided in paragraph (e)(2) of this section, an
applicable defined contribution plan violates the requirements of this
paragraph (e) if the plan imposes restrictions or conditions with
respect to the investment of employer securities that are not imposed
on the investment of other assets of the plan. A restriction or
condition with respect to employer securities means--
(A) A restriction on an individual's right to divest an investment
in employer securities that is not imposed on an investment that is not
employer securities; and
(B) A benefit that is conditioned on investment in employer
securities.
(ii) Indirect restrictions or conditions. Except as provided in
paragraph (e)(3) of this section, a plan violates the requirements of
this paragraph (e) if the plan imposes a restriction or condition in
paragraph (e)(1)(i)(A) or (B) of this section either directly or
indirectly. For example, a plan imposes an indirect restriction on an
individual's right to divest an investment in employer securities if
the plan provides that a participant who divests his or her account
balance with respect to investment in employer securities is not
permitted for a period of time thereafter to reinvest in employer
securities.
(2) Permitted restrictions or conditions--(i) In general. An
applicable defined contribution plan does not violate the requirements
of this paragraph (e) merely because it imposes a restriction or a
condition set forth in paragraph (e)(2)(ii) or (e)(2)(iii) of this
section.
(ii) Securities laws. A plan is permitted to impose a restriction
or condition on the divestiture of employer securities that is either
required in order to ensure compliance with applicable securities laws
or is reasonably designed to ensure compliance with applicable
securities laws. For example, it is permissible for a plan to limit
divestiture rights for participants who are subject to section 16(b) of
the Securities Exchange Act of 1934 to a reasonable period (such as 3
to 12 days) following publication of the employer's quarterly earnings
statements because it is reasonably designed to ensure compliance with
Rule 10b-5 of the Securities and Exchange Commission.
(iii) Deferred application of the diversification requirements. An
applicable defined contribution plan is permitted to restrict the
application of the diversification requirements of
[[Page 427]]
section 401(a)(35) and this section for up to 90 days after the plan
becomes an applicable defined contribution plan (for example, the date
on which the employer securities held under the plan become publicly
traded).
(3) Permitted indirect restrictions or conditions--(i) In general.
An applicable defined contribution plan does not violate the
requirements of this paragraph (e) merely because it imposes an
indirect restriction or condition set forth in paragraphs (e)(3)(ii)
through (e)(3)(v) of this section.
(ii) Limitation on investment in employer securities. The plan is
permitted to limit the extent to which an individual's account balance
can be invested in employer securities, provided the limitation applies
without regard to a prior exercise of rights to divest employer
securities. For example, a plan does not impose a restriction that
violates this paragraph (e) merely because the plan prohibits a
participant from investing additional amounts in employer securities if
more than 10 percent of that participant's account balance is invested
in employer securities.
(iii) Trading frequency. A plan is permitted to impose reasonable
restrictions on the timing and number of investment elections that an
individual can make to invest in employer securities, provided that the
restrictions are designed to limit short-term trading in the employer
securities. For example, a plan could provide that a participant may
not elect to invest in employer securities if the employee has elected
to divest employer securities within a short period of time, such as
seven days.
(iv) Frozen funds. A plan is permitted to prohibit any further
investment in employer securities.
(v) Fees. The plan has not provided an indirect benefit that is
conditioned on investment in employer securities merely because the
plan imposes fees on other investment options that are not imposed on
the investment in employer securities. In addition, the plan has not
provided a restriction on the right to divest an investment in employer
securities merely because the plan imposes a reasonable fee for the
divestment of employer securities.
(vi) Transfers to stable value fund. In the case of a plan that has
several investment funds, including one or more funds invested in
employer securities, a fund which is a stable value or similar fund,
and other funds which are not invested in employer securities, the plan
does not impose a restriction prohibited under this paragraph (e)
merely because the plan permits transfers to be made into the stable
value or similar fund more frequently than other funds (including funds
invested in employer securities).
(f) Definitions--(1) Application of definitions. This paragraph (f)
contains definitions that are applicable for purposes of this section.
(2) Applicable defined contribution plan--(i) General rule. Except
as provided in this paragraph (f)(2), an applicable defined
contribution plan means any defined contribution plan which holds
employer securities that are publicly traded. See paragraph (f)(2)(iv)
of this section for a special rule that treats certain plans that hold
employer securities that are not publicly traded as applicable defined
contribution plans and paragraph (f)(3)(ii) of this section for a
special rule that treats certain plans as not holding publicly traded
employer securities for purposes of this section.
(ii) Exception for certain ESOPs. An employee stock ownership plan
(ESOP), as defined in section 4975(e)(7), is not an applicable defined
contribution plan if the plan is a separate plan for purposes of
section 414(l) with respect to any other defined benefit plan or
defined contribution plan maintained by the same employer or employers
and holds no contributions (or earnings thereunder) that are (or were
ever) subject to section 401(k) or 401(m). Thus, an employee stock
ownership plan is an applicable defined contribution plan if that ESOP
is a portion of a larger plan (whether or not that larger plan includes
contributions that are subject to section 401(k) or 401(m)). For
purposes of this paragraph (f)(2)(ii), a plan is not considered to hold
amounts ever subject to section 401(k) or 401(m) merely because the
plan holds amounts attributable to rollover amounts in a separate
account that were previously subject to section 401(k) or 401(m).
(iii) Exception for one-participant plans. A one-participant plan,
as defined in section 401(a)(35)(E)(iv), is not an applicable defined
contribution plan.
(iv) Certain defined contribution plans treated as holding publicly
traded employer securities--(A) General rule. A defined contribution
plan holding employer securities that are not publicly traded is
treated as an applicable defined contribution plan if any employer
maintaining the plan or any member of a controlled group of
corporations that includes such employer has issued a class of stock
which is publicly traded. For purposes of this paragraph (f)(2)(iv), a
controlled group of corporation has the meaning given such term by
section 1563(a), except that ``50 percent'' is substituted for ``80
percent'' each place it appears.
(B) Exception for certain plans. Paragraph (f)(2)(iv)(A) of this
section does not apply to a plan if--
(1) No employer maintaining the plan (or a parent corporation with
respect to such employer) has issued stock that is publicly traded; and
(2) No employer maintaining the plan (or parent corporation with
respect to such employer) has issued any special class of stock which
grants to the holder or issuer particular rights, or bears particular
risks for the holder or issuer, with respect to any employer
maintaining the plan (or any member of a controlled group of
corporations that includes such employer) which has issued any stock
that is publicly traded.
(3) Employer security--(i) General rule. Employer security has the
meaning given such term by section 407(d)(1) of the Employee Retirement
Income Security Act of 1974, as amended.
(ii) Certain defined contribution plans or investment funds not
treated as holding employer securities--(A) Exception for certain flow-
through investments. Subject to paragraph (f)(3)(ii)(B) and (C) of this
section, a plan (and an investment option described in paragraph (d) of
this section) is not treated as holding employer securities for
purposes of this section to the extent the employer securities are held
indirectly through--
(1) An investment company registered under the Investment Company
Act of 1940;
(2) A common or collective trust fund or pooled investment fund
maintained by a bank or trust company supervised by a State or a
Federal agency;
(3) A pooled investment fund of an insurance company that is
qualified to do business in a State; or
(4) Any other investment fund designated by the Commissioner in
revenue rulings, notices, or other guidance published in the Internal
Revenue Bulletin.
(B) Investment must be independent. The exception set forth in
paragraph (f)(3)(ii)(A) of this section applies only if the investment
in the employer securities are held in a fund under which--
(1) There are stated investment objectives of the fund; and
(2) The investment is independent of the employer and any affiliate
thereof.
(C) Percentage limitation rule. For purposes of paragraph
(f)(3)(ii)(B)(2) of this section, an investment in employer securities
in a fund is considered to be independent of the employer and any
affiliate thereof only if the aggregate value of the employer
securities held in
[[Page 428]]
the fund is not in excess of 10 percent of the total value of all of
the fund's investments.
(4) Parent corporation. Parent corporation has the meaning given
such term by section 424(e).
(5) Publicly traded--(i) In general. A security is publicly traded
if it is readily tradable on an established securities market.
(ii) Established securities market. For purposes of this paragraph
(f)(5), a security is traded on an established securities market if--
(A) The security is traded on a national securities exchange that
is registered under section 6 of the Securities and Exchange Act of
1934 (15 U.S.C. 78f); or
(B) The security is traded on a foreign national securities
exchange that is officially recognized, sanctioned, or supervised by a
governmental authority.
(iii) Readily tradable. For purposes of this paragraph (f)(5),
except as provided by the Commissioner in revenue rulings, notices, or
other guidance published in the Internal Revenue Bulletin, a security
is readily tradable if--
(A) The security is traded on a securities exchange that is
described in paragraph (f)(5)(ii)(A) of this section; or
(B) The security is traded on a securities exchange that is
described in paragraph (f)(5)(ii)(B) of this section and the security
is deemed by the Securities and Exchange Commission (SEC) as having a
``ready market'' under SEC Rule 15c3-1 (17 CFR 240.15c3-1).
(g) Effective date and transition rules--(1) Statutory effective
date--(i) General rule. Except as otherwise provided in this paragraph
(g), section 401(a)(35) is effective for plan years beginning after
December 31, 2006.
(ii) Collectively bargained plans--(A) Delayed effective date. In
the case of a plan maintained pursuant to one or more collective
bargaining agreements between employee representatives and one or more
employers ratified on or before August 17, 2006, section 401(a)(35) is
effective for plan years beginning after the earlier of
(1) the later of--
(i) December 31, 2007; or
(ii) the date on which the last such collective bargaining
agreement terminates (determined without regard to any extension
thereof); or
(2) December 31, 2008.
(B) Definition of collectively bargained plans. For purposes of
this paragraph (g)(1)(ii), in the case of a plan for which one or more
collective bargaining agreements apply to some, but not all, of the
plan participants, the plan is considered a collectively bargained plan
if at least 25 percent of the participants in the plan are members of
collective bargaining units for which the contributions under the plan
are specified under a collective bargaining agreement.
(iii) Special rule for certain employer securities held in an ESOP.
Section 901(c)(3)(A) and (B) of the Pension Protection Act of 2006,
Public Law 109-280, 120 Stat. 780 (PPA '06), provides a special
effective date for an employee stock ownership plan that holds a class
of preferred stock with a guaranteed minimum value, as described in
that section.
(2) Statutory transition rules--(i) General rule. Pursuant to
section 401(a)(35)(H), in the case of the portion of an account to
which paragraph (c) of this section applies and that consists of
employer securities acquired in a plan year beginning before January 1,
2007, the requirements of paragraph (c) of this section only apply to
the applicable percentage of such securities.
(ii) Applicable percentage--(A) Phase-in percentage. For purposes
of this paragraph (g)(2), the applicable percentage is determined as
follows--
------------------------------------------------------------------------
The
applicable
Plan year to which paragraph (c) of this section applies: percentage
is:
------------------------------------------------------------------------
1st......................................................... 33
2nd......................................................... 66
3rd and following........................................... 100
------------------------------------------------------------------------
(B) Special rule. For a plan described in paragraph (g)(1)(iii) of
this section for which the special effective date under section
901(c)(3) of PPA '06 applies, the applicable percentage under this
paragraph (g)(2)(ii) is determined without regard to the delayed
effective date in section 901(c)(3)(A) and (B) of PPA '06.
(iii) Nonapplication for participants age 55 with three years of
service. Paragraph (g)(2)(i) of this section does not apply to an
individual who is a participant who attained age 55 and had completed
at least three years of service (as defined in paragraph (c)(3) of this
section) before the first day of the first plan year beginning after
December 31, 2005.
(iv) Separate application by class of securities. This paragraph
(g)(2) applies separately with respect to each class of securities.
(3) Regulatory effective date. This section is effective for plan
years beginning on or after January 1, 2009.
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E7-25533 Filed 1-2-08; 8:45 am]
BILLING CODE 4830-01-P