Part III. — Internal Revenue Bulletin 1996-51

Medical Savings Accounts

Notice 96–53

The Health Insurance Portability and Accountability Act of 1996 added section 220 to the Internal Revenue Code to permit eligible individuals to establish medical savings accounts (MSAs) under a pilot project beginning on January 1, 1997. This notice provides certain basic information about MSAs. It does not attempt to summarize all of the specific rules that apply.

The notice is divided into seven parts. Part I of the notice explains what MSAs are and who can have them. Part II describes how MSAs can be established. Parts III and IV cover contributions to MSAs and distributions from MSAs. Part V deals with the statutory limit on the number of taxpayers who can use MSAs. Part VI relates to information reporting by MSA trustees and custodians, and Part VII addresses other matters relating to MSAs.

I. What Are MSAs and Who Can Have Them?

Q–1. What is an MSA? A–1. An MSA is a tax-exempt trust or custodial account established for the purpose of paying medical expenses in conjunction with a high-deductible health plan. A number of the rules that apply to MSA are similar to rules that apply to individual retirement arrangements (IRAs). For example, like an IRA, an MSA is established for the benefit of an individual, and is ‘‘portable’’. Thus, if the individual is an employee who later changes employers or leaves the work force, the MSA does not stay behind with the former employer, but stays with the individual. However, because MSAs differ from IRAs in some important respects, taxpayers cannot use an IRA as an MSA, and cannot combine an IRA and an MSA in a single account.

Q–2. Who is eligible to have an MSA?

A–2. Two types of individuals are eligible to establish an MSA:

(1) an employee (or spouse of an employee) of a ‘‘small employer’’ that maintains an individual or family ‘‘highdeductible health plan’’ covering that individual (employee or spouse); or

(2) a self-employed person (or the spouse of a self-employed person) main

taining an individual or family ‘‘highdeductible health plan’’ covering that individual (self-employed person or spouse). See A–6 and A–7 for additional limitations on who may establish MSAs.

Q–3. What is a ‘‘small employer’’ for MSA purposes?

A–3. An employer is a ‘‘small employer’’ for a calendar year if the employer employed an average of 50 or fewer employees on business days during either of the two preceding calendar years. Special rules apply to new employers, consolidated groups, and certain employers that have added employees. See Internal Revenue Code section 220(c)(4). Q–4. What is a ‘‘high-deductible health plan’’ that makes someone eligible for an MSA?

A–4. A ‘‘high-deductible health plan’’ is a health plan that: (1) has an annual deductible of at least $1,500, and not more than $2,250, for individual (selfonly) coverage; or (2) has an annual deductible of at least $3,000, and not more than $4,500, for family coverage (coverage of more than one individual). In addition, the annual out-of-pocket expenses under the plan cannot exceed $3,000 for individual coverage and $5,500 for family coverage. Out-ofpocket expenses include deductibles, copayments and other amounts the participant must pay for covered benefits, but do not include premiums.

Q–5. Can a health maintenance organization (HMO) offer a high-deductible health plan?

A–5. Yes. A high-deductible health plan may be offered by a variety of entities, including insurance companies and health maintenance organizations (HMOs).

Q–6. What kind of other health coverage makes an individual ineligible for an MSA?

A–6. Except as described in A–7, an individual is ineligible for an MSA if the individual is covered under a health plan (whether as an individual, spouse, or dependent) that is not a highdeductible health plan (including being covered as a beneficiary under Medicare) as well as under a high-deductible health plan.

Q–7. What other kinds of health coverage may an individual maintain without losing eligibility for an MSA?

A–7. An individual remains eligible for an MSA if, in addition to a high

deductible health plan, the individual has coverage (whether provided through insurance or otherwise) for accidents, disability, dental care, vision care, longterm care, insurance for a specified disease or illness, insurance that pays a fixed amount per day (or other period) of hospitalization; or insurance under which substantially all of the coverage provided relates to liabilities from workers’ compensation laws, torts, or ownership or use of property (such as automobile insurance).

Q–8. Are MSAs allowed under a cafeteria plan?

A–8. A high-deductible health plan (described in A–4) can be provided as part of a cafeteria plan. Such a highdeductible health plan can be used in conjunction with an MSA. However, the MSA must be established outside the cafeteria plan, because a cafeteria plan is not permitted to provide for contributions to an MSA. Outside of the cafeteria plan context, an employee will not be subject to taxation merely because the employee has a choice between employer contributions to an MSA and other employer-provided accident or health coverage.

II. How Can An MSA Be Established?

Q–9. How does an eligible individual establish an MSA?

A–9. Beginning January 1, 1997, any eligible individual (as described in A–2) can establish an MSA with a qualified MSA trustee or custodian, in much the same way that individuals establish IRAs with qualified IRA trustees or custodians. No permission or authorization from the Internal Revenue Service (IRS) is necessary to establish an MSA.

Q–10. Who is a qualified MSA trustee or custodian?

A–10. Any insurance company or any bank (including a similar financial institution as defined in Internal Revenue Code section 408(n)) can be a MSA trustee or custodian. In addition, any other persons already approved by the IRS to be trustees or custodians of IRAs are automatically approved to be MSA trustees or custodians. Persons other than banks, insurance companies, or previously approved IRA trustees or custodians may request approval to be a trustee or custodian in accordance with the procedures set forth in Treasury Regulation § 1.408–2(e) (relating to IRA nonbank trustees). An eligible indi

vidual who is an employee may establish a MSA without any involvement of the employer.

Q–11. How does an individual or small employer sign up for or enroll in the MSA pilot project?

A–11. Neither individuals nor small employers ‘‘sign up for’’, ‘‘apply for’’, or otherwise ‘‘enroll in’’ the MSA pilot project. Rather, as described in A–9, eligible individuals or small employers can proceed to arrange for the establishment of MSAs with qualified trustees or custodians without awaiting permission or authorization from the IRS. (Sections V and VI, below, give further information on the limits Congress imposed on the number of taxpayers who can contribute to MSAs, and reporting by trustees and custodians.)

III. Contributions to MSAs.

Q–12. Who may contribute to an MSA?

A–12. In the case of an MSA established by an employee or by the spouse of an employee, the account holder (employee or spouse, respectively) may contribute to the MSA. Alternatively, the employee’s employer may contribute to the employee’s or spouse’s MSA. However, if an employer makes a contribution to an MSA for a given year, the account holder of that MSA may not contribute to any MSA for that year. (Additional restrictions apply if an employee’s spouse receives MSA contributions. See Internal Revenue Code section 220(b)(5)(B).)

In the case of an MSA established by a self-employed individual or spouse, the account holder (the self-employed individual or the spouse, respectively) may contribute to the MSA.

Q–13. How much may be contributed to an MSA?

A–13. The maximum annual amount permitted to be contributed to an MSA for a year is (1) for high-deductible individual coverage, 65 percent of the deductible; and (2) for high-deductible family coverage, 75 percent of the deductible. The same annual contribution limit applies whether the contributions are made by an employee, an employer, or a self-employed person. The annual contribution limit is the sum of the limits determined separately for each month, based on status, eligibility and health plan coverage as of the first day of the month. Although the annual limitation is calculated using monthly data, the contribution for the year can be

made in one or more payments, at the convenience of the individual or the employer, at any time within the deadline described in A–15.

For example, assume that an individual has self-only coverage under a high-deductible health plan with an annual deductible of $1,800. The annual contribution limit is 65 percent of $1,800 ($1,170), and the monthly contribution limit is $97.50 ($1,170/12). Assume further that the individual is an eligible individual for each of the first eight months of the year, but not thereafter. In that case, the contribution limit for the year is $780 (8 x $97.50).

Q–14. In what form may contributions be made to an MSA?

A–14. Contributions to an MSA must be made in cash. For example, contributions may not be made in the form of stock or other property.

Q–15. What is the tax treatment of an eligible individual’s MSA contributions?

A–15. Contributions by an eligible individual to an MSA (which are subject to the limits described in A–13) are deductible in computing adjusted gross income. Accordingly, the contributions are deductible whether or not the eligible individual itemizes deductions. The tax deduction for an employee or the employee’s spouse, however, cannot exceed the individual’s compensation attributable to the employer that sponsors the high-deductible plan covering the individual. For a self-employed individual, in addition to the contribution limits described in A–13, the tax deduction cannot exceed the individual’s earned income from the trade or business with respect to which the highdeductible plan is established. In addition, the statute denies a tax deduction to any individual who may be claimed as a dependent on another taxpayer’s return.

Q–16. What is the tax treatment of employer contributions to an eligible individual’s MSA?

A–16. Employer contributions to an eligible individual’s MSA (which are limited as described in A–13) are excludable from gross income, are not subject to withholding for income tax, and are not subject to other employment taxes (i.e., Social Security and Medicare taxes (FICA), federal unemployment tax (FUTA) or railroad retirement tax).

Q–17. What is the tax treatment of earnings on amounts in an MSA?

A–17. Earnings on amounts in an MSA are not taxable prior to distribu

tion from the MSA. See A–21 regarding the taxation of distributions.

Q–18. When is the deadline for an eligible individual to make contributions to an MSA for any particular year?

A–18. An eligible individual may make MSA contributions for a particular tax year no later than the time prescribed by law (without extensions) for filing the individual’s federal income tax return for that year. As in the case of IRAs, for calendar year taxpayers, generally the deadline for contributions to an MSA is April 15 following the year for which the contributions are made.

Q–19. What happens when MSA contributions exceed the amount that may be deducted or excluded from gross income?

A–19. Contributions by individuals are not deductible to the extent that they exceed the limits in A–13 or A–15 or if they are made by an individual who is not an eligible individual. Contributions by employers are included in gross income to the extent that they exceed the limits in A–13 or if they are made on behalf of an individual who is not an eligible individual. In addition, under the statute an excise tax of six percent for each tax year is imposed on the account holder for these excess individual and employer contributions. If, however, the excess contributions for a tax year and the net income attributable to these excess contributions are paid to the account holder before the last day prescribed by law, including extensions, for filing the account holder’s tax return for the tax year, then (1) the excise tax does not apply; (2) the distribution of the excess contributions is not taxed; and (3) the net income attributable to the excess contributions is included in the account holder’s gross income for the tax year in which the distribution is made.

IV. Distributions From MSAs.

Q–20. When is an individual permitted to receive distributions from an MSA?

A–20. An individual is permitted to receive a distribution from an MSA at any time.

Q–21. How are distributions from an MSA taxed?

A–21. Distributions from an MSA are excludable from gross income if used for medical expenses of the MSA account holder and the account holder’s family, with certain exceptions, and are includible in gross income if used for

any other purpose. Under one such exception, in any year for which an MSA contribution is made, distributions from an MSA of that account holder to pay medical expenses are included in gross income if, for the month in which the expense was incurred, the individual for whom the expense was incurred was not covered under a high-deductible health plan or had coverage that makes a person ineligible for an MSA (see A–4 through A–7). If included in gross income, distributions generally are subject to an additional 15 percent tax. However, if distributions that are included in gross income are made after the account holder turns age 65, becomes disabled or dies, the additional 15 percent tax does not apply.

Q–22. What medical expenses are eligible for tax-free distributions?

A–22. Medical expenses are defined under section 213 of the Code, but do not include expenses for insurance other than long-term care insurance, premiums for ‘‘COBRA’’-type health care continuation coverage, or premiums for health care coverage while an individual receives unemployment compensation. Q–23. Must MSA trustees or custodians determine whether MSA distributions are used for medical expenses?

A–23. MSA trustees or custodians are not required to determine whether MSA distributions are used for medical expenses; individuals who have MSAs should make this determination.

V. Cap on Number of Taxpayers Using MSAs.

Q–24. Does the law limit the number of MSAs that can be established?

A–24. Yes. The statute authorizes MSAs as a ‘‘pilot project’’. Under the statute, the pilot project is scheduled to end in the year 2000; however, the ability to establish MSAs generally will end earlier if the number of taxpayers contributing (or receiving employer contributions) to an MSA exceeds certain statutory limits for 1997, 1998 or 1999. In general, in determining whether the limits are exceeded, certain previously uninsured individuals will not be counted.

Q–25. What happens after the pilot project ends?

A–25. After the pilot project ends, all eligible individuals (as described in A–2) who previously made or received MSA contributions (or who are employed by certain employers whose employees previously used MSAs) can

make or receive MSA contributions, if they remain eligible individuals. In addition, individuals can continue to receive distributions from MSAs as described in A–20 through A–22.

Q–26. Do any special deadlines apply if the ability to establish MSAs generally ends early?

A–26. If the statutory limits are reached and therefore the ability to establish MSAs ends early (as referred to in A–24), an eligible individual who is not covered by a high-deductible health plan by a ‘‘cut-off date’’ specified in the law will be unable to establish an MSA, unless the individual’s employer established a high-deductible health plan for its employees before that date and meets certain other requirements.

For employees of small employers, the law specifies two potential cut-off dates in 1997: September 1 and October

(For self-employed individuals, these dates are October 1, and November 1, 1997, respectively.) For each of 1998 and 1999, the potential cut-off date is October 1 of that year. If the employer’s health plan has a regularly scheduled enrollment period that occurs during the period between the potential cut-off date and the end of the relevant year, the potential cut-off date is deferred to December 31 of that year.

Q–27. How will a taxpayer know if the ability to establish MSA generally ends early?

A–27. If the statutory limits are reached and therefore the ability to establish MSAs generally ends early (as described in A–24), the IRS will make an announcement not later than October 1 of the relevant year stating the applicable cut-off date. The ability to establish MSAs will not be cut off before the announcement is made.

VI. Information Reporting by Trustees and Custodians.

Q–28. How will the number of MSAs be determined?

A–28. The statute requires MSA trustees and custodians to report by August 1 of each year (1997, 1998, and 1999) the number of MSAs established before July 1 of the year, and also to report by June 1, 1997, the number of MSAs established before May 1, 1997 (together with additional information). See Internal Revenue Code section 220(j). The IRS will release a form to be used in making these reports.

Q–29. What other information reporting is required?

A–29. Information reporting required for MSAs is similar to information reporting for IRAs. The IRS will release forms and instructions to report MSA contributions, distributions and deductions. For further information, contact the Information Reporting Call Site on (304) 263–8700 (not a toll-free number).

VII. Other Matters.

MSAs are subject to a variety of other statutory rules and provisions, many of which are not addressed in this notice. No inference should be drawn regarding issues not expressly addressed in this notice that may be suggested by a particular question or answer, or by the inclusion or exclusion of certain questions.

Among the statutory provisions not addressed in this notice are:

The requirement that employers make comparable MSA contributions for all comparable participating employees.
The investment restrictions on MSAs.
The rollover rules for MSAs.
The special rules that apply upon divorce or death of the account holder.
The rules for allocating the deduction for MSA contributions between married people.
The Congressionally mandated study as to the effects of MSAs in the small group market on selection (including adverse selection), health costs (including the impact on premiums of individuals with comprehensive coverage), use of preventive care, consumer choice, the scope of coverage of highdeductible plans purchased in conjunction with such accounts, and other issues. The statutory provisions governing MSAs, including new section 220 of the Internal Code are contained in section 301 of the Health Insurance Portability and Accountability Act of 1996, P. L. No. 104–191, 110 Stat. 1936.

VIII. Comments Invited.

Comments are invited on new section 220 of the Internal Revenue Code. Written comments are requested by March 16, 1997. Send submissions to: CC:DOM:CORP:R (Notice 96–53), Room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (Notice 96–53), Courier’s Desk, Internal Revenue Service, 1111 Constitution Av

enue, NW, Washington, DC. Alternatively, taxpayers may submit comments electronically via the internet by submitting comments directly to the IRS internet site at htpi//www.irs.ustreas.gov/ prod/tax_regs/comments.html.

The principal author of this notice is Felix Zech of the Office of Associate Chief Counsel (Employee Benefits and Exempt Organizations). For further information regarding this notice, call (202) 622–4606 (not a toll-free call).

Request for Comments on the Desirability of Guidance Relating to Section 457 Nonqualified Deferred Compensation Plans of State and Local Government and Tax-Exempt Employers

Notice 96–63

This notice invites public comment on possible changes to procedures relating to requests for private letter rulings under § 457 of the Code. These changes may include (1) the publication of model amendments for existing § 457 plans in lieu of the issuance of rulings on individual plan amendments reflecting changes applicable to plans that meet the requirements of § 457(b) under the Small Business Job Protection Act of 1996, P.L. 104–188 (‘‘SBJPA’’), and (2) the creation of a Master and Prototype plan program for plans that meet the requirements of § 457(b).

BACKGROUND

Section 457 plans are nonqualified, deferred compensation plans established by state and local government and taxexempt employers. These employers may establish either eligible plans that meet the requirements of § 457(b) or ineligible § 457(f) plans. The plans are subject to the specific requirements and deferral limitations of § 457 of the Code. Under § 457(a), compensation deferred pursuant to eligible plans that meet the requirements of § 457(b) and the income attributable to such deferred compensation is not taxable until the taxable year in which the deferred amounts are actually paid or made available to the plan participant or other beneficiary. In contrast, compensation deferred under a plan described in § 457(f) is included in the participant’s or beneficiary’s gross income for the first taxable year in which there is no substantial risk of forfeiture of the rights to the compensation. In addition, prior to the enactment of the SBJPA,

§ 457(b)(6) mandated that eligible plans under § 457(b) be unfunded and that plan assets not be set aside for the exclusive benefit of participants.

The SBJPA changed certain requirements for plans under § 457(b). Section 457(g), added by § 1448 of the SBJPA, now mandates that all assets and income of eligible state and local government plans (but not eligible plans of taxexempt entities) must be held in trust for the exclusive benefit of participants and their beneficiaries. The trust requirement applies immediately to eligible plans established after August 20, 1996. For government plans already in existence on that date, the effective date of the § 457(g) requirement is January 1, 1999. However, a trust may be added to existing government plans at any time.

In addition, all plans that meet the requirements of § 457(b) may implement changes to § 457(e) made by § 1447 of the SBJPA. Section 457(e)(9) provides that certain benefits will not be treated as made available by reason of certain elections with regard to distributions from eligible § 457(b) plans. Also, § 457(e)(15) provides a cost-of-living adjustment for the maximum deferral amount under § § 457(b)(2) and (c)(1) of the Code. These amendments made by § 1447 of the SBJPA apply to taxable years beginning after December 31, 1996. The Service is considering issuing model language that will provide plan sponsors of eligible plans that meet the requirements of § 457(b) with a streamlined method for amending their plans to comply with the new requirements of § 457. This model language can be adopted by existing eligible plans in lieu of receiving a new ruling under § 457(b). This approach will provide time and cost savings to employers who have previously received favorable ruling letters with respect to their § 457(b) plans.

In addition, the Service is considering the establishment of a ruling program for master and prototype § 457(b) plans that will consider the statutory changes to § 457 under the SBJPA. The Service believes that this type of program is particularly well suited to ruling requests under § 457(b). For example, under such a program, if a state creates a plan, it can then be adopted by the political subdivisions, agencies and instrumentalities of that state, without the need for individual rulings for each state employer that adopts the same plan. In addition, the prototype plan program

could be used by banks, insurance companies and mutual fund companies, who may be interested in receiving advance rulings for plans that meet the requirements of § 457(b).

REQUEST FOR PUBLIC COMMENT

The Service is now evaluating possible changes to the advance letter ruling program for eligible § 457 plans. Accordingly, the Service requests comments concerning the usefulness of the model language and master and prototype plan approaches, and welcomes comments on any other useful approaches the Service might consider. Comments can be addressed to CC:DOM:CORP:R (Notice 96–63), room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Alternatively, taxpayers may transmit comments electronically via the IRS Internet site at http:// www.irs.ustreas.gov/prod/tax_regs/ comments.html. In the alternative, comments may be hand delivered between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (Notice 96–63), Courier’s Desk, Internal Revenue Building, 1111 Constitution Avenue NW., Washington, DC.

DRAFTING INFORMATION

The principal author of this revenue procedure is Cheryl Press of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations). For further information regarding this notice, contact Cheryl Press at (202) 622–6030 (not a toll-free number).

Nondiscrimination Rules for Plans Maintained by Governments and Tax-Exempt Organizations

Notice 96–64

I. PURPOSE

This notice addresses certain issues relating to the nondiscrimination rules that apply to qualified plans maintained by governments and by organizations exempt from taxation under § 501(a) of the Internal Revenue Code (‘‘tax-exempt organizations’’).

For governmental plans, this notice—

Extends the date for applying the regulations under § 401(k) and (m) until the first plan year beginning on or after October 1, 1997 (or, if later, 90 days after the opening of the first legislative session beginning on or after October 1,

1997, of the governing body with authority to amend the plan, if that body does not meet continuously);

Clarifies that deemed satisfaction of the § 401(a)(4) and § 410(b) nondiscrimination and minimum coverage rules also applies for purposes of the references to those sections under § 401(k) and (m);
Provides a special option for applying the § 401(k) and (m) nondiscrimination tests for years before 1999; and
Allows governments until the 2001 plan year to apply, for nondiscrimination purposes, a reasonable, good faith interpretation of existing law in determining which entities must be aggregated, with any further guidance applying prospectively for plan years beginning in or after 2001.

For plans maintained by tax-exempt organizations, this notice—

Extends the date for applying the regulations under §§ 401(a)(4), 401(a)(5), 401(l), 410(b), 414(r), and 414(s) until the first plan year beginning on or after October 1, 1997;
Extends the remedial amendment period and other administrative relief until the last day of the first plan year beginning on or after October 1, 1997;
Extends through the 1997 plan year the relief under existing regulations permitting employees of certain taxexempt entities to be disregarded in applying § 410(b) to a § 401(k) plan maintained by a taxable entity; and
Allows tax-exempt organizations until the 2001 plan year to apply, for nondiscrimination purposes, a reasonable, good faith interpretation of existing law in determining which entities must be aggregated, with any further guidance applying prospectively for plan years beginning in or after 2001.

II. BACKGROUND

A. Governmental Plans

Announcement 95–48, 1995–23 I.R.B. 13, provides that, in the case of governmental plans described in § 414(d), the regulations under § 401(k) and (m) apply to plan years beginning on or after the later of January 1, 1997, or 90 days after the opening of the first legislative session beginning on or after January 1, 1997, of the governing body with authority to amend the plan, if that body does not meet continuously. The regulations under §§ 401(a)(4), 401(a)(26), 410(b), and 414(s) apply to plan years beginning on or after the later of Janu

Announcement 95–48 provides that, in the case of plans maintained by tax-exempt organizations, other than church plans described in § 410(c)(1)(B) (‘‘nonelecting church plans’’), the regulations under §§ 401(a)(4), 401(a)(5), 401(l), 410(b), 414(r), and 414(s) apply to plan years beginning on or after January 1, 1997. For plan years beginning before that effective date, a plan maintained by a tax-exempt organization must be operated in accordance with a reasonable, good faith interpretation of §§ 401(a)(4), 401(a)(5), 401(l), 410(b), 414(r), and 414(s). The remedial amendment period for plans maintained by tax-exempt organizations was ex

ary 1, 1999, or 90 days after the opening of the first legislative session beginning on or after January 1, 1999, of the governing body with authority to amend the plan, if that body does not meet continuously (‘‘1999 legislative date’’). For plan years beginning before the applicable effective date, governmental plans are deemed to satisfy §§ 401(a)(4), 401(a)(26), 401(k), 401(m), 410(b), and 414(s).

Announcement 95–48 also provides that the remedial amendment period under § 401(b) for governmental plans extends to the last day of the first plan year beginning on or after the later of January 1, 1999, or the 1999 legislative date. During the remedial amendment period, additional administrative relief provided under Notice 92–36, 1992–2 C.B. 364, continues to be available.

Announcement 95–48 solicited comments on the application of the nondiscrimination requirements to governmental plans. Comments included discussion of state law restrictions on modifying benefits for current employees and noted that it may be difficult to identify the appropriate governmental entity to be treated as the employer for purposes of nondiscrimination testing. For example, in the case of a state-wide plan covering members of a particular occupation (such as public school teachers), questions have been raised whether the employers for testing purposes would be the special districts (such as the school districts), the local governments, or other governmental entities. Comments also raised the issue of whether deemed satisfaction of § 401(a)(4) and § 410(b) by a governmental plan applies for purposes of certain requirements under § 401(k) and (m).

B. Plans Maintained by Tax-

Exempt Organizations

tended in Announcement 95–48 to the last day of the first plan year beginning on or after January 1, 1997. During the remedial amendment period, additional administrative relief provided under Notice 92–36 continues to be available. (See section V of Notice 92–36, and section IV of Rev. Proc. 94–13, 1994–1 C.B. 566, for the definition of ‘‘plan maintained by a tax-exempt organization.’’)

Announcement 95–48 solicited comments on the issue of which entities must be aggregated under § 414(b) and (c) (relating to the definition of employer) and on any other related nondiscrimination issues affecting tax-exempt organizations. No comments were submitted on behalf of tax-exempt organizations in response to Announcement 95–48, and the Treasury and the Service have not identified any other unique characteristics of tax-exempt organizations that require special rules for applying §§ 401(a)(4), 401(a)(5), 401(l), 410(b), 414(r), or 414(s) to plans maintained by tax-exempt organizations (other than nonelecting church plans).

C. Nonelecting Church Plans

Under Announcement 95–48, in the case of nonelecting church plans, the regulations under §§ 401(a)(4), 401(a)(5), 401(l), and 414(s) apply to plan years beginning on or after January 1, 1999. For plan years beginning before that effective date, a nonelecting church plan must be operated in accordance with a reasonable, good faith interpretation of §§ 401(a)(4), 401(a)(5), 401(l), and 414(s). The remedial amendment period for nonelecting church plans was extended in Announcement 95–48 to the last day of the first plan year beginning on or after January 1, 1999. During the remedial amendment period, additional administrative relief provided under Notice 92–36 continues to be available.

III. EXTENSION OF EFFECTIVE DATES

A. Governmental Plans

Under the extension provided by this notice, in the case of governmental plans, the regulations under § 401(k) and (m) apply only to plan years beginning on or after the later of October 1, 1997, or 90 days after the opening of the first legislative session beginning on or after October 1, 1997, of the governing body with authority to amend the plan, if that body does not meet continuously. For plan years beginning before

this extended effective date, governmental plans are deemed to satisfy § 401(k) and (m). The special rule in § 1.402(a)– 1(d)(3)(v) of the Income Tax Regulations (providing an income tax deferral for certain elective contributions) is extended for the same period. The Treasury and the Service do not anticipate issuing any further guidance on the application of the regulations under § 401(k) and (m) to governmental plans prior to the effective date.

B. Plans Maintained by Tax-

Exempt Organizations

Under the extension provided by this notice, in the case of plans maintained by tax-exempt organizations (other than nonelecting church plans), the regulations under §§ 401(a)(4), 401(a)(5), 401(l), 410(b), 414(r), and 414(s) apply only to plan years beginning on or after October 1, 1997. For plan years beginning before this extended effective date, such plans must be operated in accordance with a reasonable, good faith interpretation of these sections. The Treasury and the Service do not anticipate issuing any further guidance on the application of the regulations under these sections to plans maintained by tax-exempt organizations prior to the effective date.

C. Nonelecting Church Plans

As noted above, under Announcement 95–48, in the case of nonelecting church plans, the regulations under §§ 401(a)(4), 401(a)(5), 401(l), and 414(s) do not apply until the 1999 plan year.

IV. EXTENSION OF REMEDIAL AMENDMENT PERIOD AND ADMINISTRATIVE RELIEF

A. Remedial Amendment Period

Notice 92–36 and Announcement 95–48 set forth the remedial amendment period described in § 401(b) applicable to governmental plans and plans maintained by tax-exempt organizations. The remedial amendment period is the period during which a plan may be amended retroactively to comply with certain plan qualification requirements. Notice 92–36 makes additional administrative relief available during the remedial amendment period. For example, the transition relief under Alternative II D of Notice 88–131, 1988–2 C.B. 546, applies. This permits, during the remedial amendment period, the continued accrual of certain benefits under a plan that would otherwise fail to comply with

§ 401(a)(4) until the plan is amended to comply with that section. In addition, for purposes of testing benefits, rights and features for the first plan year in which the regulations under § 401(a)(4) are effective, Notice 92–36 provides that any amendment made during the plan year regarding eligibility for a benefit, right or feature may be treated as if it had been in effect for the entire plan year.

B. Governmental Plans and

Nonelecting Church Plans

As noted above, under Announcement 95–48, administrative relief under Notice 92–36, including the remedial amendment period, extends to the last day of the first plan year beginning on or after the later of January 1, 1999, or the 1999 legislative date in the case of governmental plans, and to the last day of the first plan year beginning on or after January 1, 1999, in the case of nonelecting church plans.

C. Plans Maintained by Tax-

Exempt Organizations

Under this notice, the remedial amendment period for plans maintained by tax-exempt organizations (other than nonelecting church plans) is extended to the last day of the first plan year beginning on or after October 1, 1997. The additional administrative relief provided under Notice 92–36 also applies through this extended remedial amendment period. Thus, in the case of a plan with a plan year of October 1 through September 30, any amendments required to comply with the regulations under §§ 401(a)(4), 401(a)(5), 401(l), 410(b), 414(r), and 414(s) for the plan year beginning October 1, 1997, must be made by September 30, 1998. In the case of a plan using a calendar plan year, these regulations are first effective for the 1998 plan year, and any amendments required to comply with these regulations for that year must be made by December 31, 1998.

V. SPECIAL RULES FOR § 401(k) AND (m) PLANS

A. Governmental Plans

1. Application of §§ 401(a)(4) and 410(b) As noted above, for governmental plans, the regulations under §§ 401(a)(4), 401(a)(26), 410(b), and 414(s) apply to plan years beginning on or after the later of January 1, 1999, or the 1999 legislative date. For plan years begin

ning before the applicable effective date, governmental plans are deemed to satisfy these provisions. Certain provisions of § 401(k) and (m) and the regulations thereunder separately require that a plan, or certain aspects of a plan, satisfy § 401(a)(4) or 410(b). For example, § 401(k)(3)(A)(i) requires that the employees eligible to benefit under a cash or deferred arrangement satisfy § 410(b)(1). This notice clarifies that, for plan years beginning before the later of January 1, 1999, or the 1999 legislative date, a governmental plan is deemed to satisfy § 401(a)(4) and § 410(b) for all purposes, including for purposes of § 401(k) and (m). Thus, for example, a governmental plan that is subject to § 401(k) is deemed to satisfy § 401(k)(3)(A)(i) without regard to whether the group of eligible employees satisfies § 410(b)(1), and a governmental plan that is subject to § 401(m) is deemed to satisfy § 401(a)(4) and § 410(b) for purposes of § 1.401(m)–1(a)(2) and (e)(4).

2. Special Testing Rule

Under §§ 1.410(b)–7(c)(4)(ii)(C), 1.401(k)–1(g)(11), and 1.401(m)–1(f)(14), in the case of a plan that covers employees of more than one employer, the tests under § 401(k)(3) and § 401(m)(2) must be applied on an employer-by-employer basis. As discussed above, comments have noted that it may be difficult to identify the appropriate employer for purposes of testing a plan that covers employees of different governmental entities. Under this notice, for plan years beginning before the later of January 1, 1999, or the 1999 legislative date, in applying the tests under § 401(k)(3) and § 401(m)(2) to a governmental plan the employees covered by the plan may be treated as employed by a single governmental employer. Thus, the tests under § 401(k)(3) and § 401(m)(2) may be applied to a governmental plan on a plan-wide basis, notwithstanding the fact that the plan may cover employees of more than one governmental employer.

B. Plans Maintained by Controlled

Groups Consisting of Tax- Exempt and Taxable Entities

Some employers consist of taxexempt entities and taxable entities that must be aggregated under § 414(b) or (c) in determining whether a plan is qualified. Under § 401(k)(4)(B), prior to its amendment by § 1426 of the Small Business Job Protection Act of 1996

(‘‘SBJPA’’), tax-exempt organizations were precluded from establishing plans that included qualified cash or deferred arrangements under § 401(k). Thus, an employer that included both taxable and tax-exempt entities was only permitted to maintain a plan that included a qualified cash or deferred arrangement under § 401(k) for the taxable entities. However, the SBJPA amended § 401(k)(4)(B) to repeal this prohibition and permit tax-exempt entities to establish such plans for plan years beginning after 1996. Special rules are provided in §§ 1.401(a)(26)–1(b)(4) and 1.410(b)– 6(g) for a qualified cash or deferred arrangement under § 401(k) for the employees of a taxable entity that must be aggregated with a tax-exempt entity. Under these special rules, if certain requirements are met, the employees of the tax-exempt entity that are precluded from being covered in the qualified cash or deferred arrangement may be disregarded when determining whether the arrangement maintained by the taxable entity satisfies § 401(a)(26) or § 410(b). The special rules apply only to employees whose employer is precluded under § 401(k)(4)(B) from maintaining a qualified cash or deferred arrangement.

Beginning in 1997, these special rules would no longer apply because employees of a tax-exempt entity are permitted to be covered by a qualified cash or deferred arrangement. The Treasury and the Service recognize that this change presents practical issues for employers consisting of both tax-exempt and taxable entities as they consider possible redesign of their retirement programs in light of § 1426 of the SBJPA. Consequently, this notice extends the relief provided under § 1.410(b)–6(g) for these employers through the 1997 plan year. Through the 1997 plan year only, these employers may continue to disregard employees of tax-exempt entities when testing a qualified cash or deferred arrangement maintained by a taxable entity in accordance with § 1.410(b)– 6(g). Section 1432 of the SBJPA provides that, beginning in the 1997 plan year, § 401(a)(26) applies only to defined benefit plans. Accordingly, it is not necessary to extend the relief provided by § 1.401(a)(26)–1(b)(4) with respect to § 401(a)(26).

VI. 403(b) PLANS

Notice 89–23, 1989–1 C.B. 654, discusses the nondiscrimination requirements under § 403(b)(12)(A) for annuity contracts, custodial accounts, or retirement income accounts purchased under plans eligible for favorable tax treatment under § 403(b) (‘‘403(b) plans’’). Section 403(b)(12)(A)(i) provides that, with respect to nonelective contributions, a 403(b) plan must meet the requirements of §§ 401(a)(4), (5), (17) and (26), 401(m), and 410(b). Notice 89–23 provides that § 403(b)(12) is satisfied if an employer operates its 403(b) plan in accordance with a reasonable, good faith interpretation of § 403(b)(12). As provided in Announcement 95–48, until further guidance is issued, employers maintaining 403(b) plans may continue to rely on Notice 89–23. However, employers maintaining 403(b) plans may not continue to rely on a reasonable, good faith interpretation of § 401(a)(17), but must comply with the regulations under § 401(a)(17) as of the applicable effective dates set forth in § 1.401(a)(17)–1(d). Of course, for the period for which a qualified plan is deemed to satisfy any particular statutory nondiscrimination requirement, the nonelective contributions under a governmental 403(b) plan also are deemed to satisfy that requirement.

VII. APPLICATION OF § 414(b) AND (c)

Until further guidance is issued, governments and tax-exempt organizations (including churches) may apply a reasonable, good faith interpretation of existing law in determining which entities must be aggregated under § 414(b) and (c). Any further guidance will be applied on a prospective basis only and will not be effective before plan years beginning in 2001.

The Treasury and the Service invite specific suggestions for an aggregation standard or standards appropriate for tax-exempt organizations under § 414(b), (c) and (o). In particular, comments are requested on the appropriateness of the standard described in Section V.B.2.a of Notice 89–23, under which two entities are in the same controlled group if at least 80% of the directors, trustees or other individual members of one entity’s governing body are either representatives of or directly or indirectly control, or are controlled by, the other entity. However, because questions have arisen as to whether this

standard would be appropriate and sufficient in all circumstances, the Treasury and the Service intend to consider alternative and additional standards as well.

VIII. COMMENTS

Comments or suggestions in response to this notice should be submitted by April 30, 1997, and should be addressed to: CC:DOM:CORP:T:R (Notice 96–64), Room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, D.C. 20044. Alternatively, taxpayers may hand-deliver comments between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (Notice 96–64), Courier’s desk, Internal Revenue Service, 1111 Constitution Ave., NW, Washington, DC, or may submit comments electronically via the IRS internet site at http://www.irs.ustreas.gov/prod/tax_regs/ comments.html.

IX. EFFECT ON OTHER DOCUMENTS

Notice 89–23 and Notice 92–36 are modified.

DRAFTING INFORMATION

The principal author of this notice is Diane S. Bloom of the Employee Plans Division. For further information regarding this notice, please contact the Employee Plans Division’s taxpayer assistance telephone service at (202) 622– 6074 or (202) 622–6075, between the hours of 1:30 p.m. and 4 p.m. Eastern Time, Monday through Thursday, or Ms. Bloom at (202) 622–6214. Alternatively, please contact Patricia McDermott of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations) at (202) 622–6030. (These telephone numbers are not toll-free.)

26 CFR 601.201: Rulings and determinations letters.

Rev. Proc. 96–56