This section lists the headings that appear in §1.197-2.

* * * * *

(g) * * *

(5) * * *

(ii) Determination of adjusted basis of amortizable section 197 intangible resulting from an assumption reinsurance transaction.

(A) In general.

(B) Amount paid or incurred by acquirer (reinsurer) under the assumption reinsurance transaction.

(C) Amount required to be capitalized under section 848 in connection with the transaction.

(1) In general.

(2) Required capitalization amount.

(3) General deductions allocable to the assumption reinsurance transaction.

(4) Treatment of a capitalization shortfall allocable to the reinsurance agreement.

(i) In general.

(ii) Treatment of additional capitalized amounts as the result of an election under §1.848-2(g)(8).

(5) Cross references and special rules.

(D) Examples.

(E) Effective/applicability date.

* * * * *

Par. 3. Section 1.197-2(g)(5)(ii) is revised to read as follows:

* * * * *

(g) * * *

(5) * * *

(ii) Determination of adjusted basis of amortizable section 197 intangible resulting from an assumption reinsurance transaction—(A) In general. Section 197(f)(5) determines the basis of an amortizable section 197 intangible for insurance or annuity contracts acquired in an assumption reinsurance transaction. The basis of such intangible is the excess, if any, of—

(1) The amount paid or incurred by the acquirer (reinsurer) under the assumption reinsurance transaction; over

(2) The amount, if any, required to be capitalized under section 848 in connection with such transaction.

(B) Amount paid or incurred by acquirer (reinsurer) under the assumption reinsurance transaction. The amount paid or incurred by the acquirer (reinsurer) under the assumption reinsurance transaction is—

(1) In a deemed asset sale resulting from an election under section 338, the amount of the adjusted grossed-up basis (AGUB) allocable thereto (see §§1.338-6 and 1.338-11(b)(2));

(2) In an applicable asset acquisition within the meaning of section 1060, the amount of the consideration allocable thereto (see §§1.338-6, 1.338-11(b)(2), and 1.1060-1(c)(5)); and

(3) In any other transaction, the excess of the increase in the reinsurer’s tax reserves resulting from the transaction (computed in accordance with sections 807, 832(b)(4)(B), and 846) over the value of the net assets received from the ceding company in the transaction.

(C) Amount required to be capitalized under section 848 in connection with the transaction—(1) In general. The amount required to be capitalized under section 848 for specified insurance contracts (as defined in section 848(e)) acquired in an assumption reinsurance transaction is the lesser of—

(i) The reinsurer’s required capitalization amount for the assumption reinsurance transaction; or

(ii) The reinsurer’s general deductions (as defined in section 848(c)(2)) allocable to the transaction.

(2) Required capitalization amount. The reinsurer determines the required capitalization amount for an assumption reinsurance transaction by multiplying the net positive or net negative consideration for the transaction by the applicable percentage set forth in section 848(c)(1) for the category of specified insurance contracts acquired in the transaction. See §1.848-2(g)(5). If more than one category of specified insurance contracts is acquired in an assumption reinsurance transaction, the required capitalization amount for each category is determined as if the transfer of the contracts in that category were made under a separate assumption reinsurance transaction. See §1.848-2(f)(7).

(3) General deductions allocable to the assumption reinsurance transaction. The reinsurer determines the general deductions allocable to the assumption reinsurance transaction in accordance with the procedure set forth in §1.848-2(g)(6). Accordingly, the reinsurer must allocate its general deductions to the amount required under section 848(c)(1) on specified insurance contracts that the reinsurer has issued directly before determining the general deductions allocable to the assumption reinsurance transaction. For purposes of allocating its general deductions under §1.848-2(g)(6), the reinsurer includes premiums received on the acquired specified insurance contracts after the assumption reinsurance transaction in determining the amount required under section 848(c)(1) on specified insurance contracts that the reinsurer has issued directly. If the reinsurer has entered into multiple reinsurance agreements during the taxable year, the reinsurer determines the general deductions allocable to each reinsurance agreement (including the assumption reinsurance transaction) by allocating the general deductions allocable to reinsurance agreements under §1.848-2(g)(6) to each reinsurance agreement with a positive required capitalization amount.

(4) Treatment of a capitalization shortfall allocable to the reinsurance agreement—(i) In general. The reinsurer determines any capitalization shortfall allocable to the assumption reinsurance transaction in the manner provided in §§1.848-2(g)(4) and 1.848-2(g)(7). If the reinsurer has a capitalization shortfall allocable to the assumption reinsurance transaction, the ceding company must reduce the net negative consideration (as determined under §1.848-2(f)(2)) for the transaction by the amount described in §1.848-2(g)(3) unless the parties make the election provided in §1.848-2(g)(8) to determine the amounts capitalized under section 848 in connection with the transaction without regard to the general deductions limitation of section 848(c)(2).

(ii) Treatment of additional capitalized amounts as the result of an election under §1.848-2(g)(8). The additional amounts capitalized by the reinsurer as the result of the election under §1.848-2(g)(8) reduce the adjusted basis of any amortizable section 197 intangible with respect to specified insurance contracts acquired in the assumption reinsurance transaction. If the additional capitalized amounts exceed the adjusted basis of the amortizable section 197 intangible, the reinsurer must reduce its deductions under section 805 or section 832 by the amount of such excess. The additional capitalized amounts are treated as specified policy acquisition expenses attributable to the premiums and other consideration on the assumption reinsurance transaction and are deducted ratably over a 120-month period as provided under section 848(a)(2).

(5) Cross references and special rules. In general, for rules applicable to the determination of specified policy acquisition expenses, net premiums, and net consideration, see section 848(c) and (d), and §1.848-2(a) and (f). However, the following special rules apply for purposes of this paragraph (g)(5)(ii)(C)—

(i) The amount required to be capitalized under section 848 in connection with the assumption reinsurance transaction cannot be less than zero;

(ii) For purposes of determining the company’s general deductions under section 848(c)(2) for the taxable year of the assumption reinsurance transaction, the reinsurer takes into account a tentative amortization deduction under section 197(a) as if the entire amount paid or incurred by the reinsurer for the specified insurance contracts were allocated to an amortizable section 197 intangible with respect to insurance contracts acquired in an assumption reinsurance transaction; and

(iii) Any reduction of specified policy acquisition expenses pursuant to an election under §1.848-2(i)(4) (relating to an assumption reinsurance transaction with an insolvent insurance company) is disregarded.

(D) Examples. The following examples illustrate the principles of this paragraph (g)(5)(ii):

Example 1. (i) Facts. On January 15, 2006, P acquires all of the stock of T, an insurance company, in a qualified stock purchase and makes a section 338 election for T. T issues individual life insurance contracts which are specified insurance contracts as defined in section 848(e)(1). P and new T are calendar year taxpayers. Under §§1.338-6 and 1.338-11(b)(2), the amount of AGUB allocated to old T’s individual life insurance contracts is $300,000. On the acquisition date, the tax reserves for old T’s individual life insurance contracts are $2,000,000. After the acquisition date, new T receives $1,000,000 of net premiums with respect to new and renewal individual life insurance contracts and incurs $100,000 of general deductions under section 848(c)(2) through December 31, 2006. New T engages in no other reinsurance transactions other than the assumption reinsurance transaction treated as occurring by reason of the section 338 election.

(ii) Analysis. The transfer of insurance contracts and the assumption of related liabilities deemed to occur by reason of the election under section 338 is treated as an assumption reinsurance transaction. New T determines the adjusted basis under section 197(f)(5) for the life insurance contracts acquired in the assumption reinsurance transaction as follows. The amount paid or incurred for the individual life insurance contracts is $300,000. To determine the amount required to be capitalized under section 848 in connection with the assumption reinsurance transaction, new T compares the required capitalization amount for the assumption reinsurance transaction with the general deductions allocable to the transaction. The required capitalization amount for the assumption reinsurance transaction is $130,900, which is determined by multiplying the $1,700,000 net positive consideration for the transaction ($2,000,000 reinsurance premium less $300,000 ceding commission) by the applicable percentage under section 848(c)(1) for the acquired individual life insurance contracts (7.7 percent). To determine its general deductions, new T takes into account a tentative amortization deduction under section 197(a) as if the entire amount paid or incurred for old T’s individual life insurance contracts ($300,000) were allocable to an amortizable section 197 intangible with respect to insurance contracts acquired in the assumption reinsurance transaction. Accordingly, for the year of the assumption reinsurance transaction, new T is treated as having general deductions under section 848(c)(2) of $120,000 ($100,000 + $300,000/15). Under §1.848-2(g)(6), these general deductions are first allocated to the $77,000 capitalization requirement for new T’s directly written business ($1,000,000 x .077). Thus, $43,000 ($120,000 - $77,000) of the general deductions are allocable to the assumption reinsurance transaction. Because the general deductions allocable to the assumption reinsurance transaction ($43,000) are less than the required capitalization amount for the transaction ($130,900), new T has a capitalization shortfall of $87,900 ($130,900 - $43,000) with regard to the transaction. Under §1.848-2(g), this capitalization shortfall would cause old T to reduce the net negative consideration taken into account with respect to the assumption reinsurance transaction by $1,141,558 ($87,900 ÷ .077) unless the parties make the election under §1.848-2(g)(8) to capitalize specified policy acquisition expenses in connection with the assumption reinsurance transaction without regard to the general deductions limitation. If the parties make the election, the amount capitalized by new T under section 848 in connection with the assumption reinsurance transaction would be $130,900. The $130,900 capitalized by new T under section 848 would reduce new T’s adjusted basis of the amortizable section 197 intangible with respect to the specified insurance contracts acquired in the assumption reinsurance transaction. Accordingly, new T would have an adjusted basis under section 197(f)(5) with respect to the individual life insurance contracts acquired from old T of $169,100 ($300,000 - $130,900). New T’s actual amortization deduction under section 197(a) with respect to the amortizable section 197 intangible for insurance contracts acquired in the assumption reinsurance transaction would be $11,273 ($169,100 ÷15).

Example 2. (i) Facts. The facts are the same as Example 1, except that T only issues accident and health insurance contracts that are qualified long-term care contracts under section 7702B. Under section 7702B(a)(5), T’s qualified long-term care insurance contracts are treated as guaranteed renewable accident and health insurance contracts, and, therefore, are considered specified insurance contracts under section 848(e)(1). Under §§1.338-6 and 1.338-11(b)(2), the amount of AGUB allocable to T’s qualified long-term care insurance contracts is $250,000. The amount of T’s tax reserves for the qualified long-term care contracts on the acquisition date is $7,750,000. Following the acquisition, new T receives net premiums of $500,000 with respect to qualified long-term care contracts and incurs general deductions of $75,000 through December 31, 2006.

(ii) Analysis. The transfer of insurance contracts and the assumption of related liabilities deemed to occur by reason of the election under section 338 is treated as an assumption reinsurance transaction. New T determines the adjusted basis under section 197(f)(5) for the insurance contracts acquired in the assumption reinsurance transaction as follows. The amount paid or incurred for the insurance contracts is $250,000. To determine the amount required to be capitalized under section 848 in connection with the assumption reinsurance transaction, new T compares the required capitalization amount for the assumption reinsurance transaction with the general deductions allocable to the transaction. The required capitalization amount for the assumption reinsurance transaction is $577,500, which is determined by multiplying the $7,500,000 net positive consideration for the transaction ($7,750,000 reinsurance premium less $250,000 ceding commission) by the applicable percentage under section 848(c)(1) for the acquired insurance contracts (7.7 percent). To determine its general deductions, new T takes into account a tentative amortization deduction under section 197(a) as if the entire amount paid or incurred for old T’s insurance contracts ($250,000) were allocable to an amortizable section 197 intangible with respect to insurance contracts acquired in the assumption reinsurance transaction. Accordingly, for the year of the assumption reinsurance transaction, new T is treated as having general deductions under section 848(c)(2) of $91,667 ($75,000 + $250,000/15). Under §1.848-2(g)(6), these general deductions are first allocated to the $38,500 capitalization requirement for new T’s directly written business ($500,000 x .077). Thus, $53,167 ($91,667 - $38,500) of general deductions are allocable to the assumption reinsurance transaction. Because the general deductions allocable to the assumption reinsurance transaction ($53,167) are less than the required capitalization amount for the transaction ($577,500), new T has a capitalization shortfall of $524,333 ($577,500 - $53,167) with regard to the transaction. Under §1.848-2(g), this capitalization shortfall would cause old T to reduce the net negative consideration taken into account with respect to the assumption reinsurance transaction by $6,809,519 ($524,333 ÷ .077) unless the parties make the election under §1.848-2(g)(8) to capitalize specified policy acquisition expenses in connection with the assumption reinsurance transaction without regard to the general deductions limitation. If the parties make the election, the amount capitalized by new T under section 848 in connection with the assumption reinsurance transaction would increase from $53,167 to $577,500. Pursuant to paragraph (g)(5)(ii)(C)(4) of this section, the additional $524,333 ($577,500 - $53,167) capitalized by new T under section 848 would reduce new T’s adjusted basis of the amortizable section 197 intangible with respect to the insurance contracts acquired in the assumption reinsurance transaction. Accordingly, new T’s adjusted basis of the section 197 intangible with regard to the insurance contracts is reduced from $196,833 ($250,000 - $53,167) to $0. Because the additional $524,333 capitalized pursuant to the §1.848-2(g)(8) election exceeds the $196,833 adjusted basis of the section 197 intangible before the reduction, new T is required to reduce its deductions under section 805 by the $327,500 ($524,333 - $196,833).

(E) Effective/applicability date. This section applies to acquisitions and dispositions of insurance contracts on or after April 10, 2006.

* * * * *

* * * * *

(d) Reserve increases by new target after the deemed asset sale.

(1) In general.

(2) Exceptions.

(3) Amount of additional premium.

(i) In general.

(ii) Increases in unpaid loss reserves.

(iii) Increases in other reserves.

(4) Limitation on additional premium.

(5) Treatment of additional premium under section 848.

(6) Examples.

(7) Effective/applicability date.

(i) In general.

(ii) Application to pre-effective date increases to reserves.

(e) Effect of section 338 election on section 846(e) election.

(1) In general.

(2) Revocation of existing section 846(e) election.

* * * * *

Par. 6. Section 1.338-1 is amended by adding paragraph (b)(2)(vii) to read as follows:

* * * * *

(b) * * *

(2) * * *

(vii) Section 846(e) (relating to an election to use an insurance company’s historical loss payment pattern).

* * * * *

* * * * *

(d) Reserve increases by new target after the deemed asset sale—(1) In general. If in new target’s first taxable year or any subsequent year, new target increases its reserves for any acquired contracts, new target is treated as receiving an additional premium, which is computed under paragraph (d)(3) of this section, in the assumption reinsurance transaction described in paragraph (c)(1) of this section. New target includes the additional premium in gross income for the taxable year in which new target increases its reserves for acquired contracts. New target’s increase in reserves for the insurance contracts acquired in the deemed asset sale is a liability of new target not originally taken into account in determining AGUB that is subsequently taken into account. Thus, AGUB is increased by the amount of the additional premium included in new target’s gross income. See §§1.338-5(b)(2)(ii) and 1.338-7. Old target has no deduction under this paragraph (d) and makes no adjustments under §§1.338-4(b)(2)(ii) and 1.338-7.

(2) Exceptions. New target is not treated as receiving additional premium under paragraph (d)(1) of this section if—

(i) It is under state receivership as of the close of the taxable year for which the increase in reserves occurs; or

(ii) It is required by section 807(f) to spread the reserve increase over the 10 succeeding taxable years.

(3) Amount of additional premium—(i) In general. The additional premium taken into account under this paragraph (d) is an amount equal to the sum of the positive amounts described in paragraphs (d)(3)(ii) and (d)(3)(iii) of this section. However, the additional premium cannot exceed the limitation described in paragraph (d)(4) of this section.

(ii) Increases in unpaid loss reserves. The positive amount with respect to unpaid loss reserves is computed using the formula A/B x (C - [D + E]) where—

(A) A equals old target’s discounted unpaid losses (determined under section 846) included in AGUB under paragraph 11(b)(1) of this section;

(B) B equals old target’s undiscounted unpaid losses (determined under section 846(b)(1)) as of the close of the acquisition date;

(C) C equals new target’s undiscounted unpaid losses (determined under section 846(b)(1)) at the end of the taxable year that are attributable to losses incurred by old target on or before the acquisition date;

(D) D (which may be a negative number) equals old target’s undiscounted unpaid losses as of the close of the acquisition date, reduced by the cumulative amount of losses, loss adjustment expenses, and reinsurance premiums paid by new target through the end of the taxable year for losses incurred by old target on or before the acquisition date; and

(E) E equals the amount obtained by dividing the cumulative amount of reserve increases taken into account under this paragraph (d) in prior taxable years by A/B.

(iii) Increases in other reserves. The positive amount with respect to reserves other than discounted unpaid loss reserves is the net increase of those reserves due to changes in estimate, methodology, or other assumptions used to compute the reserves (including the adoption by new target of a methodology or assumptions different from those used by old target).

(4) Limitation on additional premium. The additional premium taken into account by new target under paragraph (d)(1) of this section is limited to the excess, if any, of—

(i) The fair market value of old target’s assets acquired by new target in the deemed asset sale (other than Class VI and Class VII assets); over

(ii) The AGUB allocated to those assets (including increases in AGUB allocated to those assets as the result of reserve increases by new target in prior taxable years).

(5) Treatment of additional premium under section 848. If a portion of the positive amounts described in paragraphs (d)(3)(ii) and (iii) of this section are attributable to an increase in reserves for specified insurance contracts (as defined in section 848(e)), new target takes an allocable portion of the additional premium in determining its specified policy acquisition expenses under section 848(c) for the taxable year of the reserve increase.

(6) Examples. The following examples illustrate this paragraph (d):

Example 1. (i) Facts. On January 1, 2006, P purchases all of the stock of T, a non-life insurance company, for $120 and makes a section 338 election for T. On the acquisition date, old T has total reserve liabilities under state law of $725, consisting of undiscounted unpaid losses of $625 and unearned premiums of $100. Old T’s tax reserves on the acquisition date are $580, which consist of discounted unpaid losses (as defined in section 846) of $500 and unearned premiums (as computed under section 832(b)(4)(B)) of $80. Old T has Class I through Class V assets with a fair market value of $800. Old T also has a Class VI asset with a fair market value of $75, consisting of the future profit stream of certain insurance contracts. During 2006, new T makes loss and loss adjustment expense payments of $200 with respect to the unpaid losses incurred by old T before the acquisition date. As of December 31, 2006, new T reports undiscounted unpaid losses of $475 attributable to losses incurred before the acquisition date. The related amount of discounted unpaid losses (as defined in section 846) for those losses is $390.

(ii) Computation and allocation of AGUB. Under §1.338-5 and paragraph (b)(1) of this section, as of the acquisition date, AGUB is $700, reflecting the sum of the amount paid for old T’s stock ($120) and the tax reserves assumed by new T in the transaction ($580). The fair market value of old T’s Class I through V assets is $800, whereas the AGUB available for such assets under §1.338-6 is $700. There is no AGUB available for old T’s Class VI assets, even though such assets have a fair market value of $75 on the acquisition date.

(iii) Adjustments for increases in reserves for unpaid losses. Under paragraph (d) of this section, new T must determine whether there are any amounts by which it increased its unpaid loss reserves that will be treated as an additional premium and an increase in AGUB. New T applies the formula of paragraph (d)(3) of this section, where A equals $500, B equals $625, C equals $475, D equals $425 ($625 - $200), and E equals $0. Under this formula, new T is treated as having increased its reserves for discounted unpaid losses attributable to losses incurred by old T by $40 ($500/$625 x ($475 -[$425+0]). The limitation under paragraph (d)(5) of this section based on the difference between the fair market value of old T’s Class I through Class V assets and the AGUB allocated to such assets is $100. Accordingly, new T includes an additional premium of $40 in gross income for 2006, and increases the AGUB allocated to old T’s Class I through Class V assets to reflect this additional premium.

Example 2. (i) Facts. Assume the same facts as in Example 1. Further assume that during 2007 new T deducts total loss and loss expense payments of $375 with respect to losses incurred by old T before the acquisition date. On December 31, 2007, new T reports undiscounted unpaid losses of $150 with respect to losses incurred before the acquisition date. The related amount of discounted unpaid losses (as defined in section 846) for those unpaid losses is $125.

(ii) Analysis. New T must determine whether any amounts by which it increased its unpaid losses during 2007 will be treated as an additional premium in paragraph (d)(3) of this section. New T applies the formula under paragraph (d)(3) of this section, where A equals $500, B equals $625, C equals $150, D equals $50 ($625 - $575), and E equals $50 ($40 divided by .8). In paragraph (d)(3) of this section, new T is treated as increasing its reserves for discounted unpaid losses by $40 during 2007 with respect to losses incurred by old T ($500/$625 x ($150 - [$50 + $50]). New T determines the limitation of paragraph (d)(5) of this section by comparing the $800 fair market value of the Class I through V assets on the acquisition date to the $740 AGUB allocated to such assets (which includes the $40 addition to AGUB included during 2006). Thus, new T recognizes $40 of additional premium as a result of the increase in reserves during 2007, and adjusts the AGUB allocable to the Class I through V assets acquired from old T to reflect such additional premium.

Example 3. (i) Facts. The facts are the same as Example 2, except that on January 1, 2008, new T reinsures the outstanding liability with respect to losses incurred by old T before the acquisition date through a portfolio reinsurance transaction with R, another non-life insurance company. R agrees to assume any remaining liability relating to losses incurred by old T before the acquisition date in exchange for a reinsurance premium of $200. Accordingly, as of December 31, 2008, new T reports no undiscounted unpaid losses with respect to losses incurred by old T before the acquisition date.

(ii) Analysis. New T must determine whether any amount by which it increased its unpaid loss reserves will be treated as an additional premium under paragraph (d) of this section. New T applies the formula of paragraph (d)(3) of this section, where A equals $500, B equals $625, C equals $0, and D equals -$150 ($625 - ($575 + $200), and E equals $100 ($80 divided by .8). Thus, new T is treated as having increased its discounted unpaid losses by $40 in 2008 with respect to losses incurred by old T before the acquisition date ($500/$625 x (0 - [-$150 + $100]). New T includes this positive amount in gross income, subject to the limitation of paragraph (d)(4) of this section. The limitation of paragraph (d)(4) of this section equals $20, which is computed by comparing the $800 fair market value of the Class I through V assets acquired from old T with the $780 AGUB allocated to such assets (which includes the $40 addition to AGUB in 2006 and the $40 addition to AGUB in 2007). Thus, New T includes $20 in additional premium, and increases the AGUB allocated to the Class I through V assets acquired from old T by $20. As a result of these adjustments, the limitation under paragraph (d)(4) of this section is reduced to zero.

(7) Effective/applicability date—(i) In general. This section applies to increases to reserves made by new target after a deemed asset sale occurring on or after April 10, 2006.

(ii) Application to pre-effective date increases to reserves. If either new target makes an election under §1.338(i)-1(c)(2) or old target makes an election under §1.338(i)-1(c)(3) to apply the rules of this section, in whole, to a qualified stock purchase occurring before April 10, 2006, then the rules contained in this section shall apply in whole to the qualified stock purchase.

(e) Effect of section 338 election on section 846(e) election—(1) In general. New target and old target are treated as the same corporation for purposes of an election by old target to use its historical loss payment pattern under section 846(e). See §1.338-1(b)(2)(vii). Therefore, if old target has a section 846(e) election in effect on the acquisition date, new target will continue to use the historical loss payment pattern of old target to discount unpaid losses incurred in accident years covered by the election, unless new target elects to revoke the section 846(e) election. In addition, new target may consider old target’s historical loss payment pattern when determining whether to make the section 846(e) election for a determination year that includes or is subsequent to the acquisition date.

(2) Revocation of existing section 846(e) election. New target may revoke old target’s section 846(e) election to use its historical loss payment pattern to discount unpaid losses. If new target elects to revoke old target’s section 846(e) election, new target will use the industry-wide patterns determined by the Secretary to discount unpaid losses incurred in accident years beginning on or after the acquisition date through the subsequent determination year. New target may revoke old target’s section 846(e) election by attaching a statement to new target’s original tax return for its first taxable year.

* * * * *

* * * * *

Par. 11. Section 1.381(c)(22)- 1(b)(7)(v) is amended by revising the last sentence of Example 3 to read as follows:

* * * * *

(b) * * *

(7) * * *

(v) * * *

Example 3. * * * In that case, in the taxable year of the indemnity reinsurance transaction, S takes into account as ordinary income the portion of the old T’s accounts ($1) that old T or S has not previously taken into account as income.

* * * * *

* * * * *

(d) Effect of section 338 election on section 846(e) election. For rules regarding qualified stock purchase occurring on or after April 10, 2006, see §§1.338-1(b)(2)(vii) and 1.338-11(e).

Par. 14. Section 1.846-4 is amended by revising the section heading and paragraph (b) to read as follows:

* * * * *

(b) Section 338 election. Section 1.846-2(d) applies to section 846(e) elections made with regard to a qualified stock purchase made on or after April 10, 2006.

Par. 15. For each entry in the “Section” column remove the phrase in the “Remove” column and add the phrase in the “Add” column in its place.

* * * * *

(b) * * *

Linda Stiff,
Deputy Commissioner for
Services and Enforcement.

Approved January 9, 2008.

Eric Solomon,
Assistant Secretary of the
Treasury (Tax Policy).

(a) * * * For example, sections 269 and 482 apply for any consolidated year. * * *

* * * * *

(g) Special rules for liquidations to which section 332 applies. Notwithstanding the general rule of section 381, if multiple members (distributee members) acquire assets of a corporation in a liquidation to which section 332 applies (regardless of whether any single member owns stock in the liquidating corporation meeting the requirements of section 1504(a)(2)), such members succeed to and take into account the items of the liquidating corporation (including items described in section 381(c), but excluding intercompany items under §1.1502-13) as provided in this paragraph (g) to the extent not otherwise prohibited by any applicable provision of law. This paragraph (g) does not apply to the intercompany items of the liquidating corporation. See §1.1502-13(j)(2)(ii).

(1) Income offset items and deferred income. Except as otherwise provided in this paragraph (g)(1), each distributee member succeeds to and takes into account the items of the liquidating corporation that could be used to offset the income of the group or any member (including deferred deductions, net operating loss carryovers, and capital loss carryovers) (income offset items) to the extent that such items would have been reflected in investment adjustments to the stock of the liquidating corporation owned by such distributee member under §1.1502-32(c) if, immediately prior to the liquidation, any stock of the liquidating corporation owned by nonmembers had been redeemed and then such items had been taken into account. However, each distributee member succeeds to the full amount of any deferred deduction or deferred income item attributable to the particular property or business operations distributed to such distributee in the liquidation to the extent that such item is not taken into account in the determination of the income or loss of the liquidating corporation with regard to the liquidation under chapter 1 of the Internal Revenue Code (Code). If the liquidating corporation is not a member of the group at the time of the liquidation, the rules of this paragraph (g)(1) are applied as if the liquidating corporation had been a member of the group.

(2) Accounting for deferred income items. Solely for the purpose of determining whether deferred income items of a liquidating corporation are taken into account under applicable principles of law as a result of a liquidation to which section 332 applies, the transfer of property to, and the assumption of liabilities by, a distributee member that does not own stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of §1.1502-34 immediately prior to the liquidation is not treated as part of a transaction to which section 381(a) applies. In addition, section 332(a) does not apply in determining the recognition or nonrecognition of any income realized by the distributee member under applicable principles of law on account of consideration received (or deemed received) on the assumption of the liquidating corporation’s obligation or liability attributable to any deferred income item.

(3) Credits and earnings and profits. Each distributee member succeeds to and takes into account a percentage of each credit of the liquidating corporation equal to the value of the stock of the liquidating corporation owned by such distributee at the time of the liquidation divided by the total value of all the stock of the liquidating corporation owned by members of the group at the time of the liquidation. Except to the extent that the distributee member’s earnings and profits already reflect the liquidating corporation’s earnings and profits, each distributee member succeeds to and takes into account under the principles of §1.1502-32(c) the earnings and profits, or deficit in earnings and profits, of the liquidating corporation (determined after taking into account the amount of earnings and profits properly applicable to distributions to non-member shareholders under §1.381(c)(2)-1(c)(2)). If the liquidating corporation is not a member of the group at the time of the liquidation, the rules of this paragraph (g)(3) are applied as if the liquidating corporation had been a member of the group.

(4) Other items. With regard to items to which neither paragraph (g)(1) nor (g)(3) of this section applies, a distributee member that, immediately prior to the liquidation, owns stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of §1.1502-34 succeeds to the items of the liquidating corporation in accordance with section 381 and other applicable principles. A distributee member that, immediately prior to the liquidation, does not own stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of §1.1502-34 succeeds to the items of the liquidating corporation to the extent that it would have succeeded to those items if it had purchased, in a taxable transaction, the assets or businesses of the liquidating corporation that it received in the liquidation and had assumed the liabilities that it assumed in the liquidation.

(5) Determination of the items of a liquidating subsidiary. For purposes of this section, the items of a liquidating subsidiary include the amount of any consolidated tax attribute attributable to the liquidating subsidiary that is determined pursuant to the principles of §1.1502-21(b)(2)(iv). In addition, if the liquidating subsidiary is a member of a separate return limitation year subgroup, the amount of a tax attribute that arose in a separate return limitation year that is attributable to that member shall also be determined pursuant to the principles of §1.1502-21(b)(2)(iv).

(6) Examples. The following examples illustrate the application of this paragraph (g):

Example 1. Liquidation-80 percent distributee. (i) Facts. X has only common stock outstanding. On January 1 of year 1, X acquired equipment with a 10-year recovery period and elected to depreciate the equipment using the straight-line method of depreciation. On January 1 of year 7, M1 and M2 own 80 percent and 20 percent, respectively, of X’s stock. X is a domestic corporation but is not a member of the group that includes M1 and M2. On that date, X distributes all of its assets to M1 and M2 in complete liquidation. The equipment is distributed to M1. Under section 334(b), M1’s basis in the equipment is the same as it would be in X’s hands. After computing its tax liability for the taxable year that includes the liquidation, X has net operating losses of $100, business credits of $40, and earnings and profits of $80.

(ii) Succession to items described in section 381(c). (A) Losses. Under paragraph (g)(1) of this section, each distributee member succeeds to X’s items that could be used to offset the income of the group or any member to the extent that such items would have been reflected in investment adjustments to the stock of X it owned under §1.1502-32(c) if, immediately prior to the liquidation, such items had been taken into account. Accordingly, M1 and M2 succeed to $80 and $20, respectively, of X’s net operating loss.

(B) Credits and earnings and profits. Under paragraph (g)(3) of this section, because, immediately prior to the liquidation, M1 and M2 hold 80 percent and 20 percent, respectively, of the value of the stock of X, M1 and M2 succeed to $32 and $8, respectively, of X’s $40 of business credits. In addition, because M1’s and M2’s earnings and profits do not reflect X’s earnings and profits, X’s earnings and profits are allocated to M1 and M2 under the principles of §1.1502-32(c). Therefore, M1 and M2 succeed to $64 and $16, respectively, of X’s earnings and profits.

(C) Depreciation of equipment’s basis. Under paragraph (g)(4) of this section, because M1 owns stock in X meeting the requirements of section 1504(a)(2) without regard to the application of §1.1502-34, M1 is required to continue to depreciate the equipment using the straight-line method of depreciation over the remaining recovery period of 4.5 years (assuming X used a half-year convention).

Example 2. Liquidation-no 80 percent distributee. (i) Facts. The facts are the same as in Example 1 except that M1 and M2 own 60 percent and 40 percent, respectively, of X’s stock. In addition, on January 1 of year 6, X entered into a long-term contract with Y, an unrelated party. The total contract price is $1000, and X estimates the total allocable contract costs to be $500. At the time of the liquidation, X had received $250 in progress payments under the contract and incurred costs of $125. X accounted for the contract under the percentage of completion method described in section 460(b). In the liquidation, M1 assumes X’s contract obligations and rights.

(ii) Succession to items described in section 381(c). (A) Losses. Under paragraph (g)(1) of this section, each distributee member succeeds to X’s items that could be used to offset the income of the group or any member to the extent that such items would have been reflected in investment adjustments to the stock of X it owned under §1.1502-32(c) if, immediately prior to the liquidation, such items had been taken into account. Accordingly, M1 and M2 succeed to $60 and $40, respectively, of X’s net operating loss.

(B) Credits and earnings and profits. Under paragraph (g)(3) of this section, because, immediately prior to the liquidation, M1 and M2 hold 60 percent and 40 percent, respectively, of the value of the stock of X, M1 and M2 succeed to $24 and $16, respectively, of X’s $40 of business credits. In addition, because M1’s and M2’s earnings and profits do not reflect X’s earnings and profits, X’s earnings and profits are allocated to M1 and M2 under the principles of §1.1502-32(c). Therefore, M1 and M2 succeed to $48 and $32, respectively, of X’s earnings and profits.

(C) Depreciation of equipment’s basis. Under section 334(a), M1’s basis in the equipment is its fair market value at the time of the distribution. Pursuant to section 168(i)(7), to the extent that M1’s basis in the equipment does not exceed X’s adjusted basis in the equipment at the time of the transfer, M1 is required to continue to depreciate the equipment using the straight-line method of depreciation over the remaining recovery period of 4.5 years (assuming X used a half-year convention). Any portion of M1’s basis in the equipment that exceeds X’s adjusted basis in the equipment at the time of the transfer is treated as being placed in service by M1 in the year of the transfer. Thus, M1 may choose any applicable depreciation method, recovery period, and convention under section 168 for such excess basis.

(D) Method of accounting for long-term contract. Under paragraph (g)(4) of this section, M1 does not succeed to X’s method of accounting for the contract. Rather, under §1.460-4(k)(2), M1 is treated as having entered into a new contract on the date of the liquidation. Under §1.460-4(k)(2)(iii), M1 must evaluate whether the new contract should be classified as a long-term contract within the meaning of §1.460-1(b) and account for the contract under a permissible method of accounting.

Example 3. Liquidation—deferred items. (i) Facts. X has only common stock outstanding, and M1 and M2 (who are members of the same group) own 80 percent and 20 percent, respectively, of X’s stock. X operates two divisions, each of which defers prepaid subscription income pursuant to an election under section 455. X distributes all of its assets in complete liquidation. M1 receives all of the assets of Division 1, including prepaid subscription income, and assumes X’s liability to furnish or deliver the newspaper, magazine, or other periodical to which the prepaid subscription income received by M1 relates. M2 receives all of the assets of Division 2, including prepaid subscription income, and assumes X’s liability to furnish or deliver the newspaper, magazine, or other periodical to which the prepaid subscription income received by M2 relates.

(ii) Acceleration of deferred income items and succession to other deferred items. Under paragraph (g)(1) of this section, M1 succeeds to the full amount of the deferred prepaid subscription income of X attributable to Division 1. Under applicable law, X does not recognize the deferred prepaid subscription income attributable to Division 1 because X’s liability to furnish or deliver the newspaper, magazine, or other periodical ends as a result of a transaction to which section 381(a) applies. Under paragraph (g)(2) of this section, solely for purposes of determining whether the deferred income items of X attributable to Division 2 are taken into account as a result of the liquidation, the distribution of property to M2 is not treated as a transaction to which section 381(a) applies. Therefore, under applicable law, X’s deferred prepaid subscription income attributable to Division 2 is taken into account in the determination of X’s income or loss with regard to the liquidation. Further, under paragraph (g)(2) of this section, section 332(a) does not apply in determining the recognition or nonrecognition of any income that M2 realizes on account of consideration received (or deemed received) on its assumption of X’s liability to furnish or deliver the newspaper, magazine, or other periodical to which the prepaid subscription income relates.

(7) Effective/applicability date. This paragraph (g) applies to transactions occurring after April 14, 2008.

Linda E.Stiff,
Deputy Commissioner for
Services and Enforcement.

Approved January 8, 2008.

Eric Solomon,
Assistant Secretary of
the Treasury (Tax Policy).

(a) In general. This section sets forth certain rules that apply to statutory hybrid plans under section 411(a)(13). Paragraph (b) of this section describes special rules for certain statutory hybrid plans that determine benefits under a lump sum-based benefit formula. Paragraph (c) of this section describes the vesting requirement for statutory hybrid plans. Paragraphs (d) and (e) of this section contain definitions and effective/applicability dates, respectively.

(b) Calculation of benefit by reference to hypothetical account balance or accumulated percentage. Pursuant to section 411(a)(13)(A), a statutory hybrid plan that determines any portion of a participant’s benefits under a lump sum-based benefit formula is not treated as failing to meet the requirements of section 411(a)(2), or the requirements of section 411(c) or 417(e) with respect to the participant’s accrued benefit derived from employer contributions, solely because, with respect to benefits determined under that formula, the present value of those benefits is, under the terms of the plan, equal to the balance of the hypothetical account maintained for the participant or to the current value of the accumulated percentage of the participant’s final average compensation under that formula.

(c) Three-year vesting requirement—(1) In general. Pursuant to section 411(a)(13)(B), if any portion of the participant’s accrued benefit under a defined benefit plan is determined under a statutory hybrid benefit formula, the plan is not treated as meeting the requirements of section 411(a)(2) unless the plan provides that the participant has a nonforfeitable right to 100 percent of the participant’s accrued benefit if the participant has 3 or more years of service. Thus, this 3-year vesting requirement applies with respect to the entire accrued benefit of a participant under a defined benefit plan even if only a portion of the participant’s accrued benefit under the plan is determined under a statutory hybrid benefit formula. Similarly, if the participant’s accrued benefit under a defined benefit plan is, under the plan’s terms, the larger of two (or more) benefit amounts, where each amount is determined under a different benefit formula (including a benefit determined pursuant to an offset among formulas within the plan) and at least one of those formulas is a statutory hybrid benefit formula, the participant’s entire accrued benefit under the defined benefit plan is subject to the 3-year vesting rule of section 411(a)(13)(B) and this paragraph (c). The rule described in the preceding sentence applies even if the larger benefit is ultimately the benefit determined under a formula that is not a statutory hybrid benefit formula.

(2) Floor-offset arrangements involving a statutory hybrid plan. [Reserved]

(3) Examples. The provisions of this paragraph (c) are illustrated by the following examples:

Example 1. Employer M sponsors Plan X, pursuant to which each participant’s accrued benefit is equal to the sum of the benefit provided under two benefit formulas. The first benefit formula is a statutory hybrid benefit formula, and the second formula is not. Because a portion of each participant’s accrued benefit provided under Plan X is determined under a statutory hybrid benefit formula, the 3-year vesting requirement described in paragraph (c)(1) of this section applies to each participant’s entire accrued benefit provided under Plan X.

Example 2. The facts are the same as in Example 1, except that the benefit formulas described in Example 1 only apply to participants for service performed in Division A of Employer M and a different benefit formula applies to participants for service performed in Division B of Employer M. Pursuant to the terms of Plan X, the accrued benefit of a participant attributable to service performed in Division B is equal to the benefit provided by a benefit formula that is not a statutory hybrid benefit formula. Therefore, the 3-year vesting requirement described in paragraph (c)(1) of this section does not apply to a participant with an accrued benefit under Plan X if the participant’s benefit is solely attributable to service performed in Division B.

(d) Definitions—(1) In general. The definitions in this paragraph (d) apply for purposes of this section.

(2) Lump sum-based benefit formula. The term lump sum-based benefit formula means a lump sum-based benefit formula as defined in §1.411(b)(5)-1(e)(3).

(3) Statutory hybrid benefit formula—(i) In general. A statutory hybrid benefit formula means a benefit formula that is either a lump sum-based benefit formula or a formula that is not a lump sum-based benefit formula but that has an effect similar to a lump sum-based benefit formula.

(ii) Effect similar to a lump sum-based benefit formula. Except as provided in paragraph (d)(3)(iii) of this section, a benefit formula under a defined benefit plan that is not a lump sum-based benefit formula has an effect similar to a lump sum-based benefit formula if the formula provides that a participant’s accumulated benefit (within the meaning of §1.411(b)(5)-1(e)(2)) payable at normal retirement age (or benefit commencement, if later) is expressed as a benefit that includes the right to periodic adjustments (including a formula that provides for indexed benefits under §1.411(b)(5)-1(b)(2)) that are reasonably expected to result in a smaller annual benefit at normal retirement age (or benefit commencement, if later) for the participant than for a similarly situated, younger individual (within the meaning of §1.411(b)(5)-1(b)(5)) who is or could be a participant in the plan. A benefit formula that does not include periodic adjustments is treated as a formula with an effect similar to a lump sum-based benefit formula if the formula is otherwise described in the preceding sentence and the adjustments are provided pursuant to a pattern of repeated plan amendments. See §1.411(d)-4, A-1(c)(1).

(iii) Exceptions—(A) Post-retirement benefit adjustments. Post-annuity starting date adjustments of the amounts payable to a participant (such as cost-of-living increases) are disregarded in determining whether a benefit formula under a defined benefit plan has an effect similar to a lump sum-based benefit formula.

(B) Certain variable annuity benefit formulas. If the assumed interest rate used for purposes of the adjustment of amounts payable to a participant under a variable annuity benefit formula is at least 5 percent, then the adjustments under the variable annuity benefit formula are not treated as being reasonably expected to result in a smaller annual benefit at normal retirement age (or benefit commencement, if later) for the participant than for a similarly situated, younger individual (within the meaning of §1.411(b)(5)-1(b)(5)) who is or could be a participant in the plan, and thus such a variable annuity benefit formula does not have an effect similar to a lump sum-based benefit formula.

(C) Contributory plans. A benefit formula under a defined benefit plan that provides for a benefit equal to the benefit properly attributable to after-tax employee contributions does not have an effect similar to a lump sum-based benefit formula. See section 411(c)(2) for rules for determining benefits attributable to after-tax employee contributions.

(4) Variable annuity benefit formula. A variable annuity benefit formula means any benefit formula under a defined benefit plan which provides that the amount payable is periodically adjusted by reference to the difference between the rate of return of plan assets (or specified market indices) and a specified assumed interest rate.

(e) Effective/applicability date—(1) Statutory effective/applicability date—(i) In general. Except as provided in paragraphs (e)(1)(ii) and (e)(1)(iii) of this section, section 411(a)(13) applies for periods beginning on or after June 29, 2005.

(ii) Calculation of benefits. Section 411(a)(13)(A) applies to distributions made after August 17, 2006.

(iii) Vesting—(A) Plans in existence on June 29, 2005—(1) General rule. In the case of a plan that is in existence on June 29, 2005 (regardless of whether the plan is a statutory hybrid plan on that date), section 411(a)(13)(B) applies to plan years beginning on or after January 1, 2008.

(2) Hour of service required. [Reserved]

(3) Exception for plan sponsor election. See §1.411(b)(5)-1(f)(1)(iii)(A)(2) for a special election for early application of section 411(a)(13)(B).

(B) Plans not in existence on June 29, 2005—(1) In general. In the case of a plan not in existence on June 29, 2005, section 411(a)(13)(B) applies for periods beginning on or after June 29, 2005.

(2) Hour of service required. [Reserved]

(C) Collectively bargained plans. Notwithstanding paragraphs (e)(1)(iii)(A) and (B) of this section, in the case of a collectively bargained 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, the requirements of section 411(a)(13)(B) do not apply for plan years beginning before the earlier of—

(1) The later of—

(i) The date on which the last of those collective bargaining agreements terminates (determined without regard to any extension thereof on or after August 17, 2006), or

(ii) January 1, 2008; or

(2) January 1, 2010.

(D) Treatment of plans with both collectively bargained and non-collectively bargained employees. In the case of a plan where a collective bargaining agreement applies to some, but not all, of the plan participants, the plan is considered a collectively bargained plan for purposes of paragraph (e)(1)(iii)(C) of this section if at least 25 percent of the participants in the plan are members of collective bargaining units for which the benefit levels under the plan are specified under a collective bargaining agreement.

(2) Effective/applicability date of regulations. This section applies for plan years beginning on or after January 1, 2009 (or, if later, the date applicable under paragraph (e)(1)(iii)(C) of this section). For the periods after the statutory effective date set forth in paragraph (e)(1) of this section and before the regulatory effective date set forth in the preceding sentence, a plan must comply with section 411(a)(13). During these periods, a plan is permitted to rely on the provisions of this section for purposes of satisfying the requirements of section 411(a)(13).

Par. 3. Section 1.411(b)(5)-1 is added to read as follows:

(a) In general. This section sets forth certain rules related to reduction in the rate of benefit accrual under a defined benefit plan. Paragraph (b) of this section describes certain plan design-based safe harbors (including statutory hybrid plans) that are deemed to satisfy the age discrimination rules under section 411(b)(1)(H). Paragraph (c) of this section describes rules relating to statutory hybrid plan conversion amendments. Paragraph (d) of this section describes rules restricting interest credits (or equivalent amounts) under a statutory hybrid plan to a market rate of return. Paragraphs (e) and (f) of this section contain definitions and effective/applicability dates, respectively.

(b) Safe harbors for certain plan designs—(1) Accumulated benefit testing—(i) In general. Pursuant to section 411(b)(5)(A), and subject to paragraph (b)(1)(ii) of this section, a plan is not treated as failing to meet the requirements of section 411(b)(1)(H)(i) if, as of any date, the accumulated benefit of a participant would not be less than the accumulated benefit of any similarly situated, younger participant. This test requires a comparison of the accumulated benefit of each individual who is or could be a participant in the plan with the accumulated benefit of each other similarly situated, younger individual who is or could be a participant in the plan. See paragraph (b)(5) of this section for rules regarding whether each younger individual who is or could be a participant is similarly situated to a participant. The comparison described in this paragraph (b)(1)(i) is based on—

(A) The annuity payable at normal retirement age (or current age, if later) if the accumulated benefit of the participant under the terms of the plan is expressed as an annuity payable at normal retirement age (or current age, if later);

(B) The balance of a hypothetical account if the accumulated benefit of the participant under the terms of the plan is expressed as a hypothetical account balance; or

(C) The current value of an accumulated percentage of the participant’s final average compensation if the accumulated benefit of the participant under the terms of the plan is expressed as an accumulated percentage of final average compensation.

(ii) Benefit formulas for comparison—(A) In general. The safe harbor provided by section 411(b)(5)(A) and paragraph (b)(1)(i) of this section does not apply to a plan if the accumulated benefit of a participant under the plan is not described in paragraph (b)(1)(i)(A), (B) or (C) of this section. In addition, except as provided in paragraph (b)(1)(ii)(B) of this section, that safe harbor also does not apply to a plan if the comparison required under paragraph (b)(1)(i) of this section involves comparing accumulated benefits that are described in different subparagraphs of paragraph (b)(1)(i) of this section. Thus, for example, if a plan provides an accumulated benefit that is expressed under the terms of the plan as an annuity payable at normal retirement age as described in paragraph (b)(1)(i)(A) of this section for participants who are age 55 or over, and the plan provides an accumulated benefit that is expressed as the balance of a hypothetical account as described in paragraph (b)(1)(i)(B) of this section for participants who are younger than age 55, the safe harbor described in section 411(b)(5)(A) and paragraph (b)(1)(i) of this section does not apply to the plan.

(B) Greater-of and sum-of benefit formulas. If a plan provides that a participant’s accumulated benefit is equal to the sum of accumulated benefits that are described in different subparagraphs of paragraph (b)(1)(i) of this section, then the plan is deemed to satisfy paragraph (b)(1)(i) of this section if the plan satisfies the comparison described in paragraph (b)(1)(i) of this section separately for each of the different accumulated benefits. Similarly, if a plan provides that a participant’s accumulated benefit is equal to the greater of accumulated benefits that are described in different subparagraphs of paragraph (b)(1)(i) of this section, then the plan is deemed to satisfy paragraph (b)(1)(i) of this section if the plan satisfies the comparison described in paragraph (b)(1)(i) of this section separately for each of the different accumulated benefits. For purposes of this paragraph (b)(1)(ii)(B), a similarly situated, younger participant is treated as having an accumulated benefit of zero under a benefit formula if the benefit formula does not apply to the participant.

(iii) Disregard of certain subsidized benefits. For purposes of paragraph (b)(1)(i) of this section, any subsidized portion of any early retirement benefit that is included in a participant’s accumulated benefit is disregarded. For this purpose, the subsidized portion of an early retirement benefit is the retirement-type subsidy within the meaning of §1.411(d)-3(g)(6) that is contingent on a participant’s severance from employment and commencement of benefits before normal retirement age.

(2) Indexed benefits—(i) In general. Except as provided in paragraph (b)(2)(iv) of this section, pursuant to section 411(b)(5)(E) and this paragraph (b)(2)(i), a defined benefit plan is not treated as failing to meet the requirements of section 411(b)(1)(H) solely because a benefit formula under the plan (other than a lump sum-based benefit formula) provides for the periodic adjustment of accrued benefits under the plan, but only if the adjustment is by means of the application of a recognized investment index or methodology described in paragraph (b)(2)(ii) of this section and the plan satisfies paragraph (b)(2)(iii) of this section. A statutory hybrid plan that is not treated as failing to satisfy section 411(b)(1)(H) pursuant to the preceding sentence must nevertheless satisfy the qualification requirements otherwise applicable to statutory hybrid plans, including the requirements of §1.411(a)(13)-1(c) (relating to minimum vesting standards), paragraph (c) of this section (relating to plan conversion amendments), and paragraph (d) of this section (relating to market rates of return).

(ii) Recognized investment index or methodology. An adjustment is made pursuant to a recognized investment index or methodology if it is made pursuant to—

(A) An eligible cost-of-living index as described in §1.401(a)(9)-6, A-14(b);

(B) The rate of return on the aggregate assets of the plan; or

(C) The rate of return on the annuity contract for the employee issued by an insurance company licensed under the laws of a State.

(iii) Similarly situated participant test. A plan satisfies this paragraph (b)(2)(iii) if the aggregate periodic adjustments of each participant’s accrued benefit under the plan (determined as a percentage of the unadjusted accrued benefit) would not be less than the aggregate periodic adjustments of any similarly situated, younger participant. This test requires a comparison of the aggregate periodic adjustments of each individual who is or could be a participant in the plan for any specified period with the aggregate periodic adjustments of each other similarly situated, younger individual who is or could be a participant in the plan for the same period. See paragraph (b)(5) of this section for rules regarding whether each younger individual who is or could be a participant is similarly situated to a participant.

(iv) Protection against loss—(A) In general. Paragraph (b)(2)(i) of this section does not apply unless the plan satisfies section 411(b)(5)(E)(ii) and paragraph (d)(2)(ii) of this section (relating to preservation of capital).

(B) Exception for variable annuity benefit formulas. The requirement to satisfy section 411(b)(5)(E)(ii) and paragraph (d)(2)(ii) of this section does not apply in the case of a benefit provided under a variable annuity benefit formula, but only if the adjustments under the variable annuity benefit formula are based on the rate of return on the aggregate assets of the plan or the rate of return on the annuity contract for the employee issued by an insurance company licensed under the laws of a State.

(3) Certain offsets permitted. A plan is not treated as failing to meet the requirements of section 411(b)(1)(H) solely because the plan provides offsets against benefits under the plan to the extent the offsets are allowable in applying the requirements of section 401(a) and the applicable requirements of the Employee Retirement Income Security Act of 1974, Public Law 93-406 (88 Stat. 829), and the Age Discrimination in Employment Act of 1967, Public Law 90-202 (81 Stat. 602).

(4) Permitted disparities in plan contributions or benefits. A plan is not treated as failing to meet the requirements of section 411(b)(1)(H) solely because the plan provides a disparity in contributions or benefits with respect to which the requirements of section 401(l) are met.

(5) Definition of similarly situated. For purposes of paragraphs (b)(1) and (b)(2) of this section, an individual is similarly situated to another individual if the individual is identical to that other individual in every respect that is relevant in determining a participant’s benefit under the plan (including period of service, compensation, position, date of hire, work history, and any other respect) except for age. In determining whether an individual is similarly situated to another individual, any characteristic that is relevant for determining benefits under the plan and that is based directly or indirectly on age is disregarded. For example, if a particular benefit formula applies to a participant on account of the participant’s age, an individual to whom the benefit formula does not apply and who is identical to the participant in all other respects is similarly situated to the participant. By contrast, an individual is not similarly situated to a participant if a different benefit formula applies to the individual and the application of the different formula is not based directly or indirectly on age.

(c) Special rules for plan conversion amendments—(1) In general. Pursuant to section 411(b)(5)(B)(ii), (iii), and (iv), if there is a conversion amendment within the meaning of paragraph (c)(4) of this section with respect to a defined benefit plan, then the plan is treated as failing to meet the requirements of section 411(b)(1)(H) unless the plan, after the amendment, satisfies the requirements of paragraph (c)(2) of this section.

(2) Separate calculation of post-conversion benefit—(i) In general. A statutory hybrid plan satisfies the requirements of this paragraph (c)(2) if the plan provides that, in the case of an individual who was a participant in the plan immediately before the date of adoption of the conversion amendment, the participant’s benefit at any subsequent annuity starting date is not less than the sum of:

(A) The participant’s section 411(d)(6) protected benefit (as defined in §1.411(d)-3(g)(14)) with respect to service before the effective date of the conversion amendment, determined under the terms of the plan as in effect immediately before the effective date of the amendment; and

(B) The participant’s section 411(d)(6) protected benefit with respect to service on and after the effective date of the conversion amendment, determined under the terms of the plan as in effect after the effective date of the amendment.

(ii) Rules of application. For purposes of this paragraph (c)(2), except as provided in paragraph (c)(3) of this section, the benefits under paragraph (c)(2)(i)(A) and (B) of this section must each be determined in the same manner as if they were provided under separate plans that are independent of each other (for example, without any benefit offsets), and, except to the extent permitted under §1.411(d)-3 or §1.411(d)-4 (or other applicable law), each optional form of payment provided under the terms of the plan with respect to a participant’s section 411(d)(6) protected benefit as in effect before the amendment must be available thereafter to the extent of the plan’s benefits for service prior to the effective date of the amendment.

(3) Establishment of opening hypothetical account balance—(i) In general. Provided that the requirements of paragraph (c)(3)(ii) of this section are satisfied, a statutory hybrid plan under which an opening hypothetical account balance or opening accumulated percentage of the participant’s final average compensation is established as of the effective date of the conversion amendment does not fail to satisfy the requirements of paragraph (c)(2) of this section merely because benefits attributable to that opening hypothetical account balance or opening accumulated percentage (that is, benefits that are not described in paragraph (c)(2)(i)(B) of this section) are substituted for benefits described in paragraph (c)(2)(i)(A) of this section.

(ii) Comparison of benefits—(A) Testing requirement. For any optional form of benefit payable at an annuity starting date where there was an optional form of benefit within the same generalized optional form of benefits (within the meaning 1.411(d)-3(g)(8)) that would have been available to the participant at that annuity starting date under the terms of the plan as in effect immediately before the effective date of the conversion amendment, the requirements of this paragraph (c)(3)(ii) are satisfied only if the plan provides that the amount of the benefit under that optional form of benefit available to the participant under the lump sum-based benefit formula that is attributable to the opening hypothetical account balance or opening accumulated percentage as described in paragraph (c)(3)(i) of this section, determined under the terms of the plan as of the annuity starting date (including actuarial conversion factors), is not less than the benefit under that optional form of benefit described in paragraph (c)(2)(i)(A) of this section. To satisfy this requirement, if the benefit under an optional form attributable to the opening hypothetical account balance or opening accumulated percentage is less than the benefit described in paragraph (c)(2)(i)(A) of this section, then the benefit attributable to the opening hypothetical account balance or opening accumulated percentage must be increased to the extent necessary to provide the minimum benefit described in this paragraph (c)(3)(ii)(A). Thus, if a plan is using the option under this paragraph (c)(3) to satisfy paragraph (c)(2) of this section with respect to a participant, the participant must receive a benefit equal to not less than the sum of:

(1) The greater of the benefit attributable to the opening hypothetical account balance as described in this paragraph (c)(3)(ii) and the benefit described in paragraph (c)(2)(i)(A) of this section, and

(2) The benefit described in paragraph (c)(2)(i)(B) of this section.

(B) Special rule for post-conversion optional forms of benefit. If an optional form of benefit is available on the annuity starting date with respect to the benefit attributable to the opening hypothetical account balance or opening accumulated percentage, but no optional form within the same generalized optional form of benefit (within the meaning of §1.411(d)-3(g)(8)) was available at that annuity starting date under the terms of a plan as in effect immediately prior to the effective date of the conversion amendment, then, for purposes of this paragraph (c)(3)(ii), the plan is treated as if such an optional form of benefit were available immediately prior to the effective date of the conversion amendment. In that event, paragraph (c)(3)(ii)(A) of this section must be applied by taking into account the optional form of benefit that is treated as if it were available on the annuity starting date under the terms of the plan as in effect immediately prior to the effective date of the conversion amendment. Thus, for example, if a single sum optional form of payment is not available under the plan terms applicable to the accrued benefit described in paragraph (c)(2)(i)(A) of this section, but a single sum form of payment is available with respect to the benefit attributable to the opening hypothetical account balance or opening accumulated percentage as of the annuity starting date, then, for purposes of paragraph (c)(3)(ii)(A) of this section, the plan is treated as if a single sum (to which section 417(e)(3) applies) were available under the terms of the plan as in effect immediately prior to the effective date of the conversion amendment.

(4) Conversion amendment—(i) In general. An amendment is a conversion amendment that is subject to the requirements of this paragraph (c) with respect to a participant if—

(A) The amendment reduces or eliminates the benefits that, but for the amendment, the participant would have accrued after the effective date of the amendment under a benefit formula that is not a statutory hybrid benefit formula (and under which the participant was accruing benefits prior to the amendment); and

(B) After the effective date of the amendment, all or a portion of the participant’s benefit accruals under the plan are determined under a statutory hybrid benefit formula.

(ii) Rules of application—(A) In general. Paragraphs (c)(4)(iii), (iv), and (v) of this section describe special rules that treat certain arrangements as conversion amendments. The rules described in those paragraphs apply both separately and in combination. Thus, for example, in an acquisition described in §1.410(b)-2(f), if the buyer adopts an amendment under which a participant’s benefits under the seller’s plan that is not a statutory hybrid plan are coordinated with a separate plan of the buyer that is a statutory hybrid plan, such as through an offset of the participant’s benefit under the buyer’s plan by the participant’s benefit under the seller’s plan, the seller and buyer are treated as a single employer under paragraph (c)(4)(iv) of this section and they are treated as having adopted a conversion amendment under paragraph (c)(4)(iii) of this section. However, pursuant to paragraph (c)(4)(iii) of this section, if there is no coordination between the two plans, there is no conversion amendment.

(B) Covered amendments. Only amendments that eliminate or reduce accrued benefits described in section 411(a)(7), or a retirement-type subsidy described in section 411(d)(6)(B)(i), that would otherwise accrue as a result of future service are treated as amendments described in paragraph (c)(4)(i)(A) of this section.

(C) Operation of plan terms treated as covered amendment. If, under the terms of a plan, a change in the conditions of a participant’s employment results in a reduction of the participant’s benefits that would have accrued in the future under a benefit formula that is not a statutory hybrid benefit formula, the plan is treated for purposes of this paragraph (c)(4) as if such plan terms constitute an amendment that reduces the participant’s benefits that would have accrued after the effective date of the change under a benefit formula that is not a statutory hybrid benefit formula. Thus, for example, if a participant transfers from an operating division that is covered by a non-statutory hybrid benefit formula to an operating division that is covered by a statutory hybrid benefit formula, there has been a conversion amendment as of the date of the transfer.

(iii) Multiple plans. An employer is treated as having adopted a conversion amendment if the employer adopts an amendment under which a participant’s benefits under a plan that is not a statutory hybrid plan are coordinated with a separate plan that is a statutory hybrid plan, such as through a reduction (offset) of the benefit under the plan that is not a statutory hybrid plan.

(iv) Multiple employers. If the employer of an employee changes as a result of a transaction described in §1.410(b)-2(f), then the two employers are treated as a single employer for purposes of this paragraph (c)(4).

(v) Multiple amendments—(A) In general—(1) General rule. For purposes of this paragraph (c)(4), a conversion amendment includes multiple amendments that result in a conversion amendment even if the amendments are not conversion amendments individually. For example, an employer is treated as having adopted a conversion amendment if the employer first adopts an amendment described in paragraph (c)(4)(i)(A) of this section and, at a later date, adopts an amendment that adds a benefit under a statutory hybrid benefit formula as described in paragraph (c)(4)(i)(B) of this section, if they are consolidated under paragraph (c)(4)(v)(A)(2) of this section.

(2) Delay between plan amendments. In the case of an amendment to provide a benefit under a statutory hybrid benefit formula that is adopted within three years after adoption of an amendment to reduce non-statutory hybrid benefit formula benefits, those amendments are consolidated in determining whether a conversion amendment has been adopted. Thus, the later adoption of the statutory hybrid benefit formula will cause the earlier amendment to be treated as a conversion amendment. In the case of an amendment to provide a benefit under a statutory hybrid benefit formula that is adopted more than three years after adoption of an amendment to reduce benefits under a non-statutory hybrid benefit formula, there is a presumption that the amendments are not consolidated unless the facts and circumstances indicate that adoption of the amendment to provide a benefit under a statutory hybrid benefit formula was intended at the time of reduction in the non-statutory hybrid benefit formula.

(B) Multiple conversion amendments. If an employer adopts multiple amendments reducing benefits described in paragraph (c)(4)(i)(A) of this section, each amendment is treated as a separate conversion amendment, provided that paragraph (c)(4)(i)(B) of this section is applicable at the time of the amendment (taking into account the rules of this paragraph (c)(4)).

(vi) Effective date of a conversion amendment. The effective date of a conversion amendment is, with respect to a participant, the date as of which the reduction of the participant’s benefits described in paragraph (c)(4)(i)(A) of this section occurs. In accordance with section 411(d)(6), the date of a reduction of those benefits cannot be earlier than the date of adoption of the conversion amendment.

(5) Examples. The following examples illustrate the application of paragraph (c) of this section:

Example 1. (i) Facts where plan does not establish opening hypothetical account balance for participants and participant elects life annuity at normal retirement age. Employer N sponsors Plan E, a defined benefit plan that provides an accumulated benefit, payable as a straight life annuity commencing at age 65 (which is Plan E’s normal retirement age), based on a percentage of highest average compensation times the participant’s years of service. Plan E permits any participant who has had a severance from employment to elect payment in the following optional forms of benefit (with spousal consent if applicable), with any payment not made in a straight life annuity converted to an equivalent form based on reasonable actuarial assumptions: a straight life annuity; and a 50 percent, 75 percent, or 100 percent joint and survivor annuity. The payment of benefits may commence at any time after attainment of age 55, with an actuarial reduction if the commencement is before normal retirement age. In addition, the plan offers a single sum payment after attainment of age 55 equal to the present value of the normal retirement benefit using the applicable interest rate and mortality table under section 417(e)(3) in effect under the terms of the plan on the annuity starting date.

(ii) Facts relating to the conversion amendment. On January 1, 2010, Plan E is amended to eliminate future accruals under the highest average compensation benefit formula and to base future benefit accruals on a hypothetical account balance. For service on or after January 1, 2010, each participant’s hypothetical account balance is credited monthly with a pay credit equal to a specified percentage of the participant’s compensation during the month and also with interest based on the third segment rate described in section 430(h)(2)(C)(iii). With respect to benefits under the hypothetical account balance attributable to service on and after January 1, 2010, a participant is permitted to elect (with spousal consent if applicable) payment in the same generalized optional forms of benefit (even though different actuarial factors apply) as under the terms of the plan in effect before January 1, 2010, and also as a single sum distribution. The plan provides for the benefits attributable to service before January 1, 2010, to be determined under the terms of the plan as in effect immediately before the effective date of the amendment, and the benefits attributable to service on and after January 1, 2010 to be determined separately, under the terms of the plan as in effect after the effective date of the amendment, with neither benefit offsetting the other in any manner. Thus, each participant’s benefits are equal to the sum of the benefits attributable to service before January 1, 2010 (to be determined under the terms of the plan as in effect immediately before the effective date of the amendment), plus the benefits attributable to the participant’s hypothetical account balance.

(iii) Facts relating to an affected participant. Participant A is age 62 on January 1, 2010 and, on December 31, 2009, A’s benefit for years of service before January 1, 2010, payable as a straight life annuity commencing at A’s normal retirement age (age 65) which is January 1, 2013, is $1,000 per month. Participant A has a severance from employment on January 1, 2013, and, on January 1, 2013, the hypothetical account balance, with pay credits and interest from January 1, 2010, to January 1, 2013, has become $11,000. Using the conversion factors under the plan as amended on January 1, 2013, that balance is equivalent to a straight life annuity of $100 per month commencing on January 1, 2013. This benefit is in addition to the benefit attributable to service before January 1, 2010. Participant A elects (with spousal consent) a straight life annuity of $1,100 per month commencing January 1, 2013.

(iv) Conclusion. Participant A’s benefit satisfies the requirements of paragraph (c)(3)(ii)(A) of this section because Participant A’s benefit is not less than the sum of Participant A’s section 411(d)(6) protected benefit (as defined in §1.411(d)-3(g)(14)) with respect to service before the effective date of the conversion amendment, determined under the terms of the plan as in effect immediately before the effective date of the amendment, and Participant A’s section 411(d)(6) protected benefit with respect to service on and after the effective date of the conversion amendment, determined under the terms of the plan as in effect after the effective date of the amendment.

Example 2. (i) Facts involving plan’s establishment of opening hypothetical account balance and payment of pre-conversion accumulated benefit in life annuity at normal retirement age. The facts in this Example 2 are the same as the facts under paragraph (i) of Example 1.

(ii) Facts relating to the conversion amendment. On January 1, 2010, Plan E is amended to eliminate future accruals under the highest average compensation benefit formula and to base future benefit accruals on a hypothetical account balance. An opening hypothetical account balance is established for each participant, and, under the plan’s terms, that balance is equal to the present value of the participant’s accumulated benefit on December 31, 2009 (payable as a straight life annuity at normal retirement age or immediately, if later), using the applicable interest rate and applicable mortality table under section 417(e)(3) on January 1, 2010. Under Plan E, the account based on this opening hypothetical account balance is maintained as a separate account from the account for accruals on or after January 1, 2010. The hypothetical account balance maintained for each participant for accruals on or after January 1, 2010, is credited monthly with a pay credit equal to a specified percentage of the participant’s compensation during the month. A participant’s hypothetical account balance (including both of the separate accounts) is credited monthly with interest based on the third segment rate described in section 430(h)(2)(C)(iii).

(iii) Facts relating to optional forms of benefit. Following severance from employment and attainment of age 55, a participant is permitted to elect (with spousal consent if applicable) payment in the same generalized optional forms of benefit as under the plan in effect prior to January 1, 2010, with the amount payable calculated based on the hypothetical account balance on the annuity starting date and the applicable interest rate and applicable mortality table on the annuity starting date. The single sum distribution is equal to the hypothetical account balance.

(iv) Facts relating to conversion protection. The plan provides that, as of a participant’s annuity starting date, the plan will determine whether the benefit attributable to the opening hypothetical account payable in the particular optional form of benefit selected is greater than or equal to the benefit accrued under the plan through the date of conversion and payable in the same generalized optional form of benefit with the same annuity starting date. If the benefit attributable to the opening hypothetical account balance is greater, the plan provides that such benefit is paid in lieu of the pre-conversion benefit, together with the benefit attributable to post-conversion contribution credits. If the benefit attributable to the opening hypothetical account balance is less, the plan provides that such benefit is increased sufficiently to provide the pre-conversion benefit, together with the benefit attributable to post-conversion contribution credits.

(v) Facts relating to an affected participant. On January 1, 2010, the opening hypothetical account balance established for Participant A is $80,000, which is the present value of Participant A’s straight life annuity of $1,000 per month commencing at January 1, 2013, using the applicable interest rate and applicable mortality table under section 417(e)(3) in effect on January 1, 2010. On January 1, 2010, the applicable interest rate for Participant A is equivalent to a level rate of 5.5 percent. Thereafter, Participant A’s hypothetical account balance for subsequent accruals is credited monthly with a pay credit equal to a specified percentage of the participant’s compensation during the month. In addition, Participant A’s hypothetical account balance (including both of the separate accounts) is credited monthly with interest based on the third segment rate described in section 430(h)(2)(C)(iii).

(vi) Facts relating to calculation of the participant’s benefit. Participant A has a severance from employment on January 1, 2013 at age 65, and elects (with spousal consent) a straight life annuity commencing January 1, 2013. On January 1, 2013, the opening hypothetical account balance, with interest credits from January 1, 2010, to January 1, 2013, has become $95,000, which, using the conversion factors under the plan on January 1, 2013, is equivalent to a straight life annuity of $1,005 per month commencing on January 1, 2013 (which is greater than the $1,000 a month payable at age 65 under the terms of the plan in effect before January 1, 2010). This benefit is in addition to the benefit determined using the hypothetical account balance for service after January 1, 2010.

(vii) Conclusion. The benefit satisfies the requirements of paragraph (c)(3)(ii)(A) of this section with respect to Participant A because A’s benefit is not less than the sum of (A) the greater of Participant A’s benefits attributable to the opening hypothetical account balance and A’s section 411(d)(6) protected benefit (as defined in §1.411(d)-3(g)(14)) with respect to service before the effective date of the conversion amendment, determined under the terms of the plan as in effect immediately before the effective date of the amendment, and (B) Participant A’s section 411(d)(6) protected benefit with respect to service on and after the effective date of the conversion amendment, determined under the terms of the plan as in effect after the effective date of the amendment.

Example 3. (i) Facts involving a subsequent decrease in interest rates. The facts are the same as in Example 2, except that, because of a decrease in bond rates after January 1, 2010, and before January 1, 2013, the rate of interest credited in that period averages less than 5.5 percent, and, on January 1, 2013, the effective applicable interest rate under section 417(e)(3) under the plan’s terms is 4.7 percent. As a result, Participant A’s opening hypothetical account balance plus attributable interest credits has increased to only $87,000 on January 1, 2013, and, using the conversion factors under the plan on January 1, 2013, is equivalent to a straight life annuity commencing on January 1, 2013, of $775 per month. Under the terms of Plan E, the benefit attributable to A’s opening account balance is increased so that A’s straight life annuity commencing on January 1, 2013, is $1,000 per month. This benefit is in addition to the benefit attributable to the hypothetical account balance for service after January 1, 2010.

(ii) Conclusion. The benefit satisfies the requirements of paragraph (c)(3)(ii)(A) of this section with respect to Participant A because A’s benefit is not less than the sum of (A) the greater of A’s benefits attributable to the opening hypothetical account balance and A’s section 411(d)(6) protected benefit (as defined in §1.411(d)-3(g)(14)) with respect to service before the effective date of the conversion amendment, determined under the terms of the plan as in effect immediately before the effective date of the amendment, and (B) A’s section 411(d)(6) protected benefit with respect to service on and after the effective date of the conversion amendment, determined under the terms of the plan as in effect after the effective date of the amendment.

Example 4. (i) Facts involving payment of a subsidized early retirement benefit. The facts are the same as in Example 2, except that under the terms of Plan E on December 31, 2009, a participant who retires before age 65 and after age 55 with 30 years of service has only a 3 percent per year actuarial reduction. Participant A has a severance from employment on January 1, 2011, when A is age 63 and has 30 years of service. On January 1, 2011, A’s opening hypothetical account balance, with interest from January 1, 2010, to January 1, 2011, has become $86,000, which, using the conversion factors under the plan (as amended) on January 1, 2011, is equivalent to a straight life annuity commencing on January 1, 2011, of $850 per month.

(ii) Facts relating to calculation of the participant’s benefit. Under the terms of Plan E on December 31, 2009, Participant A is entitled to a straight life annuity commencing on January 1, 2011, equal to at least $940 per month ($1,000 reduced by 3 percent for each of the 2 years that A’s benefits commence before normal retirement age). Under the terms of Plan E, the benefit attributable to A’s opening account balance is increased so that A is entitled to a straight life annuity of $940 per month commencing on January 1, 2013. This benefit is in addition to the benefit determined using the hypothetical account balance for service after January 1, 2010.

(iii) Conclusion. The benefit satisfies the requirements of paragraph (c)(3)(ii)(A) of this section with respect to Participant A because A’s benefit is not less than the sum of (A) the greater of Participant A’s benefits attributable to the opening hypothetical account balance (increased by attributable interest credits) and A’s section 411(d)(6) protected benefit (as defined in §1.411(d)-3(g)(14)) with respect to service before the effective date of the conversion amendment, determined under the terms of the plan as in effect immediately before the effective date of the amendment, and (B) Participant A’s section 411(d)(6) protected benefit with respect to service on and after the effective date of the conversion amendment, determined under the terms of the plan as in effect after the effective date of the amendment.

Example 5. (i) Facts involving addition of a single sum payment option. The facts are the same as in Example 2, except that, before January 1, 2010, Plan E did not offer payment in a single sum distribution for amounts in excess of $5,000. Plan E, as amended on January 1, 2010, offers payment in any of the available annuity distribution forms commencing at any time following severance from employment as were provided under Plan E before January 1, 2010. In addition, Plan E, as amended on January 1, 2010, offers payment in the form of a single sum attributable to service before January 1, 2010, which is the greater of the opening hypothetical account balance (increased by attributable interest credits) or a single sum distribution of the straight life annuity payable at age 65 using the same actuarial factors as are used for mandatory cashouts for amounts equal to $5,000 or less under the terms of the plan on December 31, 2009. Participant B is age 40 on January 1, 2010, and B’s opening hypothetical account balance (increased by attributable interest credits) is $33,000 (which is the present value, using the conversion factors under the plan (as amended) on January 1, 2010, of Participant B’s straight life annuity of $1,000 per month commencing at January 1, 2035, which is when B will be age 65). Participant B has a severance from employment on January 1, 2013, and elects (with spousal consent) an immediate single sum distribution. Participant B’s opening hypothetical account balance (increased by attributable interest) on January 1, 2013, is $45,000. The present value, on January 1, 2013, of Participant B’s benefit of $1,000 per month, commencing immediately using the actuarial factors for mandatory cashouts under the terms of the plan on December 31, 2009, would result in a single sum payment of $44,750. Participant B is paid a single sum distribution equal to the sum of $45,000 plus an amount equal to B’s January 1, 2013, hypothetical account balance for benefit accruals for service after January 1, 2010.

(ii) Conclusion. Because, under Plan E, Participant B is entitled to the sum of (A) The greater of the $45,000 opening hypothetical account balance (increased by attributable interest credits) and $44,750 (present value of the benefit with respect to service prior to January 1, 2010, using the actuarial factors for mandatory cashout distributions under the terms of the plan on December 31, 2009), plus (B) An amount equal to B’s hypothetical account balance for benefit accruals for service after January 1, 2010, the benefit satisfies the requirements of paragraph (c)(3)(ii)(A) of this section with respect to Participant B. If Participant B’s hypothetical account balance under Plan E was instead less than $44,750 on January 1, 2013, Participant B would be entitled to a single sum payment equal to the sum of $44,750 and an amount equal to B’s hypothetical account balance for benefit accruals for service after January 1, 2010.

Example 6. (i) Facts involving addition of new annuity optional form of benefit. The facts are the same as in Example 2, except that, after December 31, 2009, and before January 1, 2013, Plan E is amended to offer payment in a 5-, 10-, or 15-year term certain and life annuity, using the same actuarial assumptions that apply for other optional forms of distribution. When Participant A has a severance from employment on January 1, 2013, A elects (with spousal consent) a 5-year term certain and life annuity commencing immediately equal to $935 per month. Application of the same actuarial assumptions to Participant A’s benefit of $1,000 per month (under Plan E as in effect on December 31, 2009), commencing immediately on January 1, 2013, would result in a 5-year term certain and life annuity commencing immediately equal to $955 per month. Under the terms of Plan E, the benefit attributable to A’s opening account balance is increased so that, using the conversion factors under the plan (as amended) on January 1, 2013, A’s opening hypothetical account balance (increased by attributable interest credits) produces a 5-year term certain and life annuity commencing immediately equal to $955 per month commencing on January 1, 2013. This benefit is in addition to the benefit determined using the January 1, 2013, hypothetical account balance for service after January 1, 2010.

(ii) Conclusion. This benefit satisfies the requirements of paragraph (c)(3)(ii)(A) of this section with respect to Participant A.

Example 7. (i) Facts involving addition of distribution option before age 55. The facts are the same as in Example 5, except that Participant B (age 43) elects (with spousal consent) a straight life annuity. Under Plan E, the straight life annuity attributable to Participant B’s opening hypothetical account balance at age 43 is $221 per month. Application of the same actuarial assumptions to Participant B’s benefit of $1,000 per month (under Plan E as in effect on December 31, 2009), commencing immediately on January 1, 2013, would result in a straight life annuity at age 43 equal to $219 per month.

(ii) Conclusion. Because, under its terms, Plan E provides that Participant B is entitled to an amount not less than the present value (using the same actuarial assumptions as apply on January 1, 2013, in converting the $45,000 hypothetical account balance attributable to the opening hypothetical account balance to the $221 straight life annuity) of Participant B’s straight life annuity of $1,000 per month commencing at January 1, 2035, and the $221 straight life annuity is in addition to the benefit accruals for service after January 1, 2010, payment of the $221 monthly annuity would satisfy the requirements of paragraph (c)(3)(ii)(A) of this section with respect to Participant B.

(d) Market rate of return—(1) In general—(i) Basic test. Subject to paragraph (d)(3) of this section, a statutory hybrid plan satisfies the requirements of section 411(b)(1)(H) and this paragraph (d) only if, for any plan year, the interest crediting rate under the terms of the plan is no greater than a market rate of return.

(ii) Definition of interest crediting rate and interest credit. For purposes of this paragraph (d), a plan’s interest crediting rate means the rate by which a participant’s benefit is increased under the ongoing terms of the plan to the extent the amount of the increase is not conditioned on current service, regardless of how the amount of that increase is calculated. The amount of such an increase is an interest credit. Thus, whether the amount is an interest credit for this purpose is determined without regard to whether the amount is calculated by reference to a rate of interest, a rate of return, an index, or otherwise.

(iii) Single rates. Except as is otherwise provided in this paragraph (d)(1), an interest crediting rate is not in excess of a market rate of return only if the plan provides an interest credit for the year at a rate that is equal to one of the following rates that is specified in the terms of the plan:

(A) The interest rate on long-term investment grade corporate bonds (as described in paragraph (d)(4) of this section);

(B) An interest rate that is deemed to be not in excess of a market rate of return under paragraph (d)(5) of this section; or

(C) An interest rate that is described in paragraph (d)(6) of this section.

(iv) Timing rules—(A) In general. A plan must specify the timing for determining the plan’s interest crediting rate that will apply for each plan year (or portion of a plan year) using either of the methods described in paragraph (d)(1)(iv)(B) of this section and must specify the frequency of interest crediting under the plan pursuant to paragraph (d)(1)(iv)(C) of this section.

(B) Methods to determine interest crediting rate. A plan is permitted to provide daily interest credits using a daily interest crediting rate based on the permitted rates specified in paragraph (d)(1)(iii) of this section. Alternatively, a plan is permitted to provide an interest credit for a stability period that is based on the interest crediting rate for a specified lookback month with respect to that stability period. The stability period and lookback month must satisfy the rules for selecting the stability period and lookback month under §1.417(e)-1(d)(4). (However, the interest rates can be any of the rates in paragraph (d)(1)(iii) of this section and the stability period and lookback month need not be the same as those used under the plan for purposes of section 417(e)(3).)

(C) Frequency of interest crediting. Interest credits under a plan must be made on an annual or more frequent periodic basis. If a plan provides for the crediting of interest more frequently than annually (for example, monthly or quarterly), then the interest credit for that period must be a pro rata portion of the annual interest credit. Thus, for example, if a plan’s terms provide for interest to be credited monthly and for the interest crediting rate to be equal to the interest rate on long-term investment grade corporate bonds (as described in paragraph (d)(4) of this section), and that interest rate for a plan year is 6 percent, the accumulated benefits at the beginning of each month would be increased by 0.5 percent per month during the plan year. Interest credits under the terms of a plan are not treated as creating an effective rate of return that is in excess of a market rate of return merely because an otherwise permissible interest crediting rate is compounded more frequently than annually.

(v) Lesser rates. An interest crediting rate is not in excess of a market rate of return if the plan provides an interest crediting rate that, under all circumstances, is always less than one of the rates described in paragraph (d)(1)(iii) of this section.

(vi) Greater-of rates. If a statutory hybrid plan provides for an interest credit that is equal to the interest credits determined under the greater of 2 or more different interest crediting rates, the effective interest crediting rate is not in excess of a market rate of return only if each of the different rates satisfies the requirements of paragraph (d)(1)(ii) of this section and the additional requirements of paragraph (d)(7) of this section are satisfied.

(2) Preservation of capital requirement—(i) In general. A statutory hybrid plan is treated as failing to meet the requirements of section 411(b)(1)(H) if the requirements of paragraph (d)(2)(ii) of this section are not satisfied.

(ii) Preservation of capital defined—(A) In general. The requirements of this paragraph (d)(2)(ii) are satisfied if the plan provides that, as of the participant’s annuity starting date, the participant’s benefit under the plan is no less than the benefit determined as of that date based on the sum of the hypothetical contributions credited under the plan (or the accumulated percentage of the participant’s final average compensation, or the participant’s accrued benefits determined without regard to any indexing under section 411(b)(5)(E), as applicable).

(B) Hypothetical contributions defined. For purposes of this paragraph (d)(2)(ii), a hypothetical contribution is any amount credited under a statutory hybrid plan other than an interest credit (as defined in paragraph (d)(1)(ii) of this section). Thus, if an opening hypothetical account balance or opening accumulated percentage of the participant’s final average compensation is established pursuant to paragraph (c)(3) of this section, that opening hypothetical account balance or opening accumulated percentage as of the date established is treated as a hypothetical contribution and, thus, is taken into account for purposes of the preservation of capital requirement of this paragraph (d)(2)(ii).

(3) Plan termination—(i) In general. Except as provided in paragraph (d)(3)(ii) of this section, a statutory hybrid plan is treated as meeting the requirements of paragraph (d)(1) of this section only if the terms of the plan provide that, upon termination of the plan, a participant’s benefit as of the termination is determined using the interest rate and mortality table otherwise applicable for determining that benefit under the plan (without regard to termination of the plan).

(ii) Variable interest rates. A statutory hybrid plan is treated as meeting the requirements of paragraph (d)(1) of this section only if the terms of the plan provide that, upon termination of the plan, any interest rate used to determine a participant’s benefits under the plan (including any interest crediting rate and any interest rate used to determine annuity benefits) that is a variable rate is determined as the average of the rates of interest used under the plan for that purpose during the 5-year period ending on the termination date.

(4) Long-term investment grade corporate bonds. For purposes of this paragraph (d), the rate of interest on long-term investment grade corporate bonds means the third segment rate described in section 430(h)(2)(C)(iii) (determined with or without regard to the transition rules of section 430(h)(2)(G)), provided that such rate floats on a periodic basis not less frequently than annually. However, for plan years beginning prior to January 1, 2008, the rate of interest on long-term investment grade corporate bonds means the rate described in section 412(b)(5)(B)(ii)(II) prior to amendment by the Pension Protection Act of 2006, Public Law 109-280 (120 Stat. 780) (PPA ’06).

(5) Safe harbor rates of interest—(i) Rates based on Treasury bonds with margins. An interest crediting rate is deemed to be not in excess of a market rate of return if the rate is adjusted at least annually and is equal to the sum of any of the following rates of interest for Treasury bonds and the associated margin for that interest rate:

(ii) Eligible cost-of-living indices. An interest crediting rate is deemed to be not in excess of a market rate of return if the rate is adjusted no less frequently than annually and is equal to the rate of increase with respect to an eligible cost-of-living index described in §1.401(a)(9)-6, A-14(b), except that for purposes of this paragraph (d)(5)(ii), the eligible cost-of-living index described in §1.401(a)(9)-6, A-14(b)(2), is increased by 300 basis points.

(iii) Additional safe harbors. The Commissioner may, in guidance of general applicability, specify additional interest crediting rates that are deemed to be not in excess of a market rate of return. See §601.601(d)(2)(ii)(b) of this chapter.

(6) Other interest rates—(i) Reasonable minimum guaranteed rate of return. [Reserved]

(ii) Equity-based rates. [Reserved]

(7) Combinations of rates of return—(i) In general. If a plan provides an interest crediting rate that is equal to the interest credits determined under the greater of 2 or more different interest crediting rates where each of the different rates satisfies the requirements of paragraph (d)(1)(iii) of this section, then the interest credits provided by the plan satisfy this paragraph (d)(7) only if one or more of the different interest crediting rates under the plan are adjusted as provided in paragraphs (d)(7)(iii) or (d)(7)(iv) of this section in order to provide that the effective interest crediting rate resulting from the use of the greater of 2 or more rates does not exceed a market rate of return. This paragraph (d)(7) provides the exclusive rules that may be used for this purpose and, therefore, a plan does not satisfy the requirements of this paragraph (d) if the plan provides for interest credits determined using the greater of 2 or more interest crediting rates and that combination of interest crediting rates is not specifically permitted by this paragraph (d)(7).

(ii) Coordination with preservation of capital rule. No adjustment under this paragraph (d)(7) is required merely because the plan satisfies the requirements of paragraph (d)(2) of this section.

(iii) Combination of fixed and variable interest rates. [Reserved]

(iv) Other combinations. [Reserved]

(8) Section 411(d)(6)—(i) General rule. Except as provided in this paragraph (d)(8), to the extent that benefits have accrued under the terms of a statutory hybrid plan that entitle the participant to future interest credits, an amendment to the plan to change the interest crediting rate for such interest credits violates section 411(d)(6) if the revised rate under any circumstances could result in a lower interest crediting rate as of any date after the applicable amendment date of the amendment (within the meaning of §1.411(d)-3(g)(4)) changing the interest crediting rate. For additional rules, see §1.411(d)-3(a)(1).

(ii) Adoption of long-term investment grade corporate bond rate or safe harbor rate. An amendment to a statutory hybrid plan to change the interest crediting rate for future periods from an interest crediting rate described in paragraph (d)(5) of this section to the interest crediting rate described in paragraph (d)(4) of this section does not constitute a decrease of an accrued benefit and, therefore, does not violate section 411(d)(6). However, an amendment described in this paragraph (d)(8)(ii) cannot be effective less than 30 days after adoption and, on the effective date of the amendment, the new interest crediting rate cannot be less than the interest crediting rate that would have applied in the absence of the amendment.

(iii) Other changes not treated as prohibited reduction of accrued benefit. [Reserved]

(e) Definitions—(1) In general. The definitions in this paragraph (e) apply for purposes of this section.

(2) Accumulated benefit. A participant’s accumulated benefit at any date means the participant’s benefit, as expressed under the terms of the plan, accrued to that date. For this purpose, the accumulated benefit of a participant may be expressed under the terms of the plan as either the balance of a hypothetical account or the current value of an accumulated percentage of the participant’s final average compensation, even if the plan defines the participant’s accrued benefit as an annuity beginning at normal retirement age that is actuarially equivalent to that balance or value.

(3) Lump sum-based benefit formula—(i) In general. A lump sum-based benefit formula means a benefit formula used to determine all or any part of a participant’s accumulated benefit under a defined benefit plan under which the benefit provided under the formula is expressed as the balance of a hypothetical account maintained for the participant or as the current value of the accumulated percentage of the participant’s final average compensation. Whether a benefit formula is a lump sum-based benefit formula is determined based on how the accumulated benefit of a participant is expressed under the terms of the plan, and does not depend on whether the plan provides an optional form of benefit in the form of a single sum payment.

(ii) Exception for contributory plans. A participant is not treated as having a lump sum-based benefit formula merely because the participant is entitled to a benefit under a defined benefit plan that is equal to the greater of the otherwise applicable benefit formula and the benefit properly attributable to after-tax employee contributions.

(4) Statutory hybrid benefit formula. A statutory hybrid benefit formula means a statutory hybrid benefit formula as defined in §1.411(a)(13)-1(d)(3).

(5) Statutory hybrid plan. A statutory hybrid plan means a defined benefit plan that contains a statutory hybrid benefit formula.

(6) Variable annuity benefit formula. A variable annuity benefit formula means a variable annuity benefit formula as defined in §1.411(a)(13)-1(d)(4).

(f) Effective/applicability date—(1) Statutory effective/applicability dates—(i) In general. Except as provided in paragraph (f)(1)(iii) of this section, section 411(b)(5) applies for periods beginning on or after June 29, 2005.

(ii) Conversion amendments. The requirements of section 411(b)(5)(B)(ii), (iii), and (iv) apply to a conversion amendment (as defined in paragraph (c)(4) of this section) that is adopted after, and takes effect after, June 29, 2005.

(iii) Market rate of return—(A) Plans in existence on June 29, 2005—(1) In general. In the case of a plan that is in existence on June 29, 2005 (regardless of whether the plan is a statutory hybrid plan on that date), section 411(b)(5)(B)(i) only applies to plan years beginning on or after January 1, 2008.

(2) Exception for plan sponsor election. Notwithstanding paragraph (f)(1)(iii)(A)(1) of this section, a plan sponsor of a plan that is in existence on June 29, 2005 (regardless of whether the plan is a statutory hybrid plan on that date) may elect to have the requirements of section 411(a)(13)(B) and section 411(b)(5)(B)(i) apply for any period after June 29, 2005, and before the first plan year beginning after December 31, 2007. In accordance with section 1107 of the PPA ’06, an employer is permitted to adopt an amendment to make this election as late as the last day of the first plan year that begins on or after January 1, 2009 (January 1, 2011, in the case of a governmental plan as defined in section 414(d)) if the plan operates in accordance with the election.

(B) Plans not in existence on June 29, 2005. In the case of a plan not in existence on June 29, 2005, section 411(b)(5)(B)(i) applies to the plan on and after the later of June 29, 2005, and the date the plan becomes a statutory hybrid plan.

(2) Effective/applicability date of regulations. This section applies for plan years beginning on or after January 1, 2009 (or, if later, the date applicable under paragraph (f)(3) of this section). For the periods after the statutory effective date set forth in paragraph (f)(1) or (f)(3) of this section and before the regulatory effective date set forth in the preceding sentence, a plan must comply with section 411(b)(5). During these periods, a plan is permitted to rely on the provisions of this section for purposes of satisfying the requirements of section 411(b)(5).

(3) Collectively bargained plans—(i) In general. Notwithstanding paragraph (f)(1)(iii) of this section, in the case of a collectively bargained 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, the requirements of section 411(b)(5)(B)(i) do not apply to plan years beginning before the earlier of—

(A) The later of—

(1) The date on which the last of those collective bargaining agreements terminates (determined without regard to any extension thereof on or after August 17, 2006), or

(2) January 1, 2008; or

(B) January 1, 2010.

(ii) Treatment of plans with both collectively bargained and non-collectively bargained employees. In the case of a plan where a collective bargaining agreement applies to some, but not all, of the plan participants, the plan is considered a collectively bargained plan for purposes of paragraph (f)(3)(i) of this section if at least 25 percent of the participants in the plan are members of collective bargaining units for which the benefit levels under the plan are specified under the collective bargaining agreement.

Linda E. Stiff,
Deputy Commissioner for
Services and Enforcement.

(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 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 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—

(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.