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IRS Issues Final Regulations on QMACs and QNECs
Practical Law Legal Update w-015-8806 (Approx. 5 pages)
IRS Issues Final Regulations on QMACs and QNECs
by Practical Law Employee Benefits & Executive Compensation
| Published on 20 Jul 2018 • USA (National/Federal) |
The Internal Revenue Service (IRS) and Treasury Department issued final regulations that 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. The final regulations are substantively identical to the proposed regulations.
On July 19, 2018, the IRS and Treasury Department issued final regulations that 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 (83 Fed. Reg. 34469-01 (July 20, 2018)). The final regulations are substantively identical to the proposed regulations (82 Fed. Reg. 5477 (Jan. 18, 2017); see Legal Update, IRS Issues Proposed Regulations on QMACs and QNECs).
Background: Nondiscrimination Requirements for Defined Contribution Plans
Tax-qualified defined contribution plans may not discriminate in favor of highly compensated employees (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' (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.
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). 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). However, to do so, the QMACs and QNECs must satisfy nonforfeitability requirements (26 C.F.R. § 1.401(k)–1(c)) and distribution requirements (26 C.F.R. § 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) or (13)) (see Practice Note, Safe Harbor 401(k) Plans: Overview and Planning Opportunities and Standard Document, Safe Harbor Notice for Qualified Retirement Plans with Optional QACA Provisions).
Commenters 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. After considering the commenters' statements, the IRS and Treasury Department issued proposed regulations that would provide that the amounts used to fund QMACs and 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. (See Legal Update, IRS Issues Proposed Regulations on QMACs and QNECs.)
Final Regulations
The final regulations, which are substantively identical to the proposed regulations, amend the definitions of QMACs and QNECs under:
- 26 C.F.R. Section 1.401(k)-6 (26 C.F.R. § 1.401(k)-6) to provide that the amounts used to fund QNECs and QMACs must be nonforfeitable and meet the distribution limitations at the time they are allocated to plan participants' accounts, rather than when they are first contributed to a defined contribution plan. The final regulations differ slightly from the proposed regulations in that they replace "distribution requirements" with "distribution limitations" in each definition, because the applicable requirements in 26 C.F.R. Section 1.401(k)-1(d) are better characterized as limitations (26 C.F.R. § 1.401(k)-1(d)).
- 26 C.F.R. Section 1.401(m)-5 (26 C.F.R. § 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.
Public Comments
In response to the proposed regulations, the IRS and Treasury Department received comments asking about the application of the anti-cutback rule under Code Section 411(d)(6) (26 U.S.C. § 411(d)(6); see Practice Note, Protected Benefits Under Code Section 411(d)(6)) when plan sponsors seek to amend their plans to apply the regulations. The final regulations note that plan amendments would not implicate the anti-cutback rule if the plan amendments apply prospectively. In addition, the final regulations address the situation in which a plan provides that forfeitures will be used to pay plan expenses incurred during a plan year and that remaining forfeitures in the plan at the end of the plan year will be allocated to certain participants. In this situation, a plan amendment adopted before the plan year ends would not implicate the anti-cutback rule because one of the conditions for receiving an allocation (that plan expenses at the end of the year not exceed the forfeiture amounts) will not have been met at the time of the amendment.
Applicability Date
The final regulations apply to plan years beginning on or after July 20, 2018. Taxpayers may rely on the final regulations for periods preceding the applicability date.
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 final regulations help ensure that defined contribution plans can fund QMACs and QNECs with the amounts in plan forfeiture accounts.