Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

which an employer is required to maintain coverage and an employee is required to continue paying premiums. These changes are described below.

As a general matter, under FMLA, an employer has the obligation to offer coverage under any group health plan for the duration of FMLA leave, whether paid or unpaid, and under the same conditions as coverage would have been provided if the employee had been continuously working during the entire leave period. The employee has the right to keep this coverage by continuing to pay the premium. During the period of FMLA leave, the employer is required to continue payment of its share of the costs of group health insurance coverage, but may condition such continued payments on the employee paying his or her share of the costs under one of the methods set forth at 29 CFR 825.210. See also the notice requirements at 29 CFR 825.301(b)(1)(iv).

Furthermore, the employer must either allow the employee to revoke coverage while on unpaid FMLA leave, or continue coverage but allow the employee to discontinue his or her share of the premium payments while the employee is on unpaid leave. Although ordinarily health plan coverage would cease if an employee does not make his or her share of the premium payments, FMLA does not give the employee a right to require that the employer terminate coverage. The FMLA permits an employer to continue health plan coverage while the employee is on unpaid FMLA leave by paying both the employer’s and the employee’s share of group health plan contributions. In this event, the employer may recover the employee’s share of the contributions when the employee returns from leave or, if the employee fails to return from leave, the employer may recover the employee’s share of contributions and may also recover its own share as well under the circumstances set forth in 29 CFR 825.213(a). However, under the FMLA, an employee who chooses to discontinue premium payments may not be required to make contributions until the unpaid FMLA leave ends.

Upon return from leave, FMLA requires that the employee have the right to be reinstated under the same terms as if the employee had worked during the en

Section 42.—Low Income Housing Credit

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, page 434.

Section 125.—Cafeteria Plans

26 CFR 1.125–3: Effect of the Family and Medical Leave Act (FMLA) on the operation of cafeteria plans.

T.D. 8966

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Effect of the Family and Medical Leave Act on the Operation of Cafeteria Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to cafeteria plans that reflect changes made by the Family and Medical Leave Act of 1993 (Act). The final regulations provide the public with guidance needed to comply with the Act and affect employees who participate in cafeteria plans.

DATES: Effective Date : These regulations are effective October 17, 2001.

Applicability Date: These regulations are applicable for cafeteria plan years beginning on or after January 1, 2002.

FOR FURTHER INFORMATION CONTACT: Shoshanna Chaiton at (202) 6226080 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains additions to the Income Tax Regulations (26 CFR Part

1. under section 125 of the Internal Revenue Code of 1986 (Code). These additions conform the cafeteria plan regulations to the Family and Medical Leave Act of 1993 (FMLA), Public Law 103–3, 29 U.S.C. 2601 et seq. FMLA imposes certain requirements on employers regarding coverage, including family cover

age, under group health plans for employees taking FMLA leave and regarding the restoration of benefits to employees who return from FMLA leave. Proposed regulations, EE–20–95 (1996–1 C.B. 758), published in the Federal Register on December 21, 1995 (60 FR 66229), addressed a number of the principal questions that were raised about how these FMLA requirements affect the operation of cafeteria plans (including flexible spending arrangements) maintained under section 125. These final regulations are based on the 1995 proposed regulations, and include clarifications and other changes resulting from comments received on the proposed regulations.

Summary of Changes

A number of comments that were made in response to the 1995 proposed regulations relate to FMLA. The requirements pertaining to FMLA leave, including the employer’s obligation to maintain coverage under a group health plan during FMLA leave and to restore benefits upon return from FMLA leave, are established by FMLA, not the Code. The U.S. Department of Labor, in 29 CFR part 825, has published rules interpreting the requirements of FMLA, and the Department of Labor has jurisdiction relating to those rights or obligations. These final regulations do not interpret FMLA or the rules published by the Department of Labor. Rather, they provide guidance on the cafeteria plan rules that apply to an employee in circumstances to which FMLA and the Labor Regulations thereunder also apply. Accordingly, these final regulations include a number of changes intended to clarify which particular conditions must be satisfied to comply with FMLA and with the cafeteria plan rules.

The Department of the Treasury, including the Internal Revenue Service (IRS), discussed these final regulations with the Department of Labor to ensure that they do not conflict with, and are not inconsistent with, the provisions of FMLA or the Labor regulations thereunder, at 29 CFR Part 825. In response to those discussions and comments made by the public, these cafeteria plan regulations have been changed to clarify the circumstances under

November 5, 2001 422 2001–45 I.R.B.

tire leave period without any break in coverage. An employee who has revoked coverage or has failed to make required payments therefore has the right to be reinstated in the group health plan upon return from leave. If the employee does not elect to be reinstated in the group health plan upon return from FMLA leave, the employer may nevertheless require the employee to resume participation if the employer also requires employees who return from unpaid non-FMLA leave to resume participation upon return from leave. This reflects a change in position from the 1995 proposed regulations, which specifically prohibited an employer from requiring an employee whose coverage has terminated while on FMLA leave to reinstate coverage under a health FSA upon return from FMLA leave. Several commentators disagreed with this position, and suggested that the FMLA regulations do not require this rule. In response to these comments, the rule has been modified as described above.

One commentator questioned whether an employee on paid FMLA leave may change or revoke an election. Whether an employer is required to permit an employee on paid FMLA leave to revoke an election is governed by the FMLA and the Labor Regulations thereunder, rather than these regulations. As described above, the FMLA permits an employer to require that the employee continue coverage during an FMLA leave if the employer is continuing the employee’s pay during the FMLA leave and does not treat employees on paid FMLA leave differently from other employees on paid leave. If these two conditions are satisfied, as described in Q&A-4, an employer may require that an employee who goes on paid FMLA leave continue to pay premiums by the method normally used during any paid leave.

In response to comments, the rule in the 1995 regulations concerning the catch-up payment option was modified. Under the 1995 regulations, an employee who elected to use the catch-up payment option before going on FMLA leave was required to enter into an advance agreement with the employer specifying that the employee wanted to continue health coverage while on unpaid FMLA leave, that the employer would pay the premiums during the FMLA leave, and that the employee would repay these amounts

upon return. Commentators noted that this rule did not provide enough flexibility for employers attempting to recoup payments in situations where employees originally elected the pay-as-you-go method but then were not able to make those required payments. Accordingly, the rule under the final regulations eliminates the requirement that an employee who elects the catch-up payment option enter into an advance agreement with the employer. The new rule adds flexibility and permits continued coverage because, although employees may still use either the catch-up payment option or the aftertax pay-as-you-go method from the outset, now employers may continue coverage and, under the catch-up payment option, recoup any amounts paid on an employee’s behalf if the employee cannot make all the payments under the pay-asyou-go method.

The 1995 proposed regulations included a special proration rule for cases in which health coverage under a flexible spending arrangement (FSA) did not continue during an FMLA leave because the employee revoked coverage or failed to make required payments, and then the employee elects to resume the coverage when the leave ends during the same year. The proposed regulation permitted the employee’s coverage to be reduced after the employee resumes work if the employee did not have coverage during the FMLA leave. Based on information provided by the Department of Labor concerning FMLA, the final regulations require that, where an employee does not have coverage under the FSA during FMLA leave because the employee chooses to revoke coverage or does not pay required premiums for any reason during FMLA leave, the employer must provide the employee upon return from FMLA leave a choice between: (1) resuming coverage at the original level and making up the unpaid premium payments or (2) resuming coverage at a level that is reduced under the proration rule and resuming premium payments at the original level. Where the employee selects the prorated method and the plan has already made disbursements to the employee that exceed the premiums that will be paid for the year, the employer may not require the employee to pay any more than the remaining premiums due. If health FSA

coverage does continue during the leave (whether due to an FMLA coverage continuation election by the employee or because the employer’s plan requires health FSA coverage to be continued during a leave), there would of course be no proration.

Commentators requested clarification regarding whether employers are required to obtain elections from employees who are on FMLA leave when an open enrollment period occurs. In response to this comment, the final regulations clarify that employees on FMLA leave have the same rights during the leave period as employees participating in a cafeteria plan who are not on FMLA leave. Accordingly, employers are required to give employees on FMLA leave the right to enroll in a plan or change their election while they are on leave in the same manner as for active employees, rather than waiting for the employees on FMLA leave to return to work.

These final regulations supplement the regulations that were issued at §1.125–4 (T.D. 8878, 2000–15 I.R.B. 857, issued in March of 2000 (65 FR 15548) and T.D. 8921, 2001–7 I.R.B. 532, issued in January of 2001 (66 FR 1837)) setting forth the conditions under which a cafeteria plan can permit an employee to make an election change during the year. Thus, as provided at §1.125–4(g), if an employee goes on an FMLA leave, section 125 allows a cafeteria plan to permit the employee to make an election change if the conditions in either these final regulations or the regulations at §1.125–4 are satisfied. Further, as described above, FMLA requires that an employee who goes on an FMLA leave have the same election rights under a group health plan as an employee who is not on FMLA leave. Thus, a cafeteria plan that is subject to FMLA must allow an employee who goes on an FMLA leave to be able to make the same election changes as an employee who is not on an FMLA leave.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C.

2001–45 I.R.B. 423 November 5, 2001

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Code, these regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Christine Keller, Division Counsel/Associate Chief Counsel (Office of Tax Exempt and Government Entities). However, other personnel from the IRS and Department of the Treasury participated in their development.

• ---

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.125–3 is added to read as follows:

§1.125–3 Effect of the Family and Medical Leave Act (FMLA) on the operation of cafeteria plans.

The following questions and answers provide guidance on the effect of the Family and Medical Leave Act (FMLA), 29 U.S.C. 2601 et. seq ., on the operation of cafeteria plans:

Q-1: May an employee revoke coverage or cease payment of his or her share of group health plan premiums when taking unpaid FMLA leave?

A-1: Yes. An employer must either allow an employee on unpaid FMLA leave to revoke coverage, or continue coverage but allow the employee to discontinue payment of his or her share of the premium for group health plan coverage (including a health flexible spending arrangement (FSA)) under a cafeteria plan for the period of the FMLA leave. See 29 CFR 825.209(e). FMLA does not require that an employer allow an employee to revoke coverage if the employer

pays the employee’s share of premiums. As discussed in Q&A-3, if the employer continues coverage during an FMLA leave, the employer may recover the employee’s share of the premiums when the employee returns to work. FMLA also provides the employee a right to be reinstated in the group health plan coverage (including a health FSA) provided under a cafeteria plan upon returning from FMLA leave if the employee’s group health plan coverage terminated while on FMLA leave (either by revocation or due to nonpayment of premiums). Such an employee is entitled, to the extent required under FMLA, to be reinstated on the same terms as prior to taking FMLA leave (including family or dependent coverage), subject to any changes in benefit levels that may have taken place during the period of FMLA leave as provided in 29 CFR 825.215(d)(1). See 29 CFR 825.209(e) and 825.215(d). In addition, such an employee has the right to revoke or change elections under §1.125–4 ( e.g., because of changes in status or cost or coverage changes as provided under §1.125–4) under the same terms and conditions as are available to employees participating in the cafeteria plan who are working and not on FMLA leave.

Q-2: Who is responsible for making premium payments under a cafeteria plan when an employee on FMLA leave continues group health plan coverage?

A-2: FMLA provides that an employee is entitled to continue group health plan coverage during FMLA leave whether or not that coverage is provided under a health FSA or other component of a cafeteria plan. See 29 CFR 825.209(b). FMLA permits an employer to require an employee who chooses to continue group health plan coverage while on FMLA leave to be responsible for the share of group health premiums that would be allocable to the employee if the employee were working, and, for this purpose, treats amounts paid pursuant to a pre-tax salary reduction agreement as amounts allocable to the employee. However, FMLA requires the employer to continue to contribute the share of the cost of the employee’s coverage that the employer was paying before the employee commenced FMLA leave. See 29 CFR 825.100(b) and 825.210(a).

Q-3: What payment options are required or permitted to be offered under a

cafeteria plan to an employee who continues group health plan coverage while on unpaid FMLA leave, and what is the tax treatment of these payments?

A-3: (a) In general. Subject to the limitations described in paragraph (b) of this Q&A-3, a cafeteria plan may offer one or more of the following payment options, or a combination of these options, to an employee who continues group health plan coverage (including a health FSA) while on unpaid FMLA leave; provided that the payment options for employees on FMLA leave are offered on terms at least as favorable as those offered to employees not on FMLA leave. These options are referred to in this section as prepay, pay-as-you-go, and catch-up. See also the FMLA notice requirements at 29 CFR 825.301(b)(1)(iv).

(1) Pre-pay . (i) Under the pre-pay option, a cafeteria plan may permit an employee to pay, prior to commencement of the FMLA leave period, the amounts due for the FMLA leave period. However, FMLA provides that the employer may not mandate that an employee pre-pay the amounts due for the leave period. See 29 CFR 825.210(c)(3) and (4).

(ii) Contributions under the pre-pay option may be made on a pre-tax salary reduction basis from any taxable compensation (including from unused sick days or vacation days). However, see Q&A-5 of this section regarding additional restrictions on pre-tax salary reduction contributions when an employee’s FMLA leave spans two cafeteria plan years.

(iii) Contributions under the pre-pay option may also be made on an after-tax basis.

(2) Pay-as-you-go . (i) Under the payas-you-go option, employees may pay their share of the premium payments on the same schedule as payments would have been made if the employee were not on leave or under any other payment schedule permitted by the Labor Regulations at 29 CFR 825.210(c) ( e.g., on the same schedule as payments are made under section 4980B (relating to coverage under the Consolidated Omnibus Budget Reconciliation Act (COBRA) 26 U.S.C. 4980B), under the employer’s existing rules for payment by employees on leave without pay, or under any other system voluntarily agreed to between the employer and the employee that is not incon

November 5, 2001 424 2001–45 I.R.B.

Example . (i) Employer Y allows employees to pay premiums for group health coverage during an FMLA leave on an after-tax basis while the employee is on unpaid FMLA leave. Under the terms of Y’s cafeteria plan, if an employee elects to continue health coverage during an unpaid FMLA leave and fails to pay one or more of the after-tax premium payments due for that coverage, the employee’s salary after the employee returns from FMLA leave is reduced to cover unpaid premiums ( i.e. the premiums that were to be paid by the employee on an after-tax basis during the FMLA leave, but were paid by the employer instead).

(ii) In this Example, Y’s cafeteria plan satisfies the conditions in this Q&A-3. Y’s cafeteria plan would also satisfy the conditions in this Q&A-3 if the plan provided for coverage to cease in the event the employee fails to make a premium payment when due during an unpaid FMLA leave.

Q-4: Do the special FMLA requirements concerning payment of premiums by an employee who continues group health plan coverage under a cafeteria plan apply if the employee is on paid FMLA leave?

A-4: No. The Labor Regulations provide that, if an employee’s FMLA leave is paid leave as described at 29 CFR 825.207 and the employer mandates that the employee continue group health plan coverage while on FMLA leave, the employee’s share of the premiums must be paid by the method normally used during any paid leave ( e.g ., by pre-tax salary reduction if the employee’s share of premiums were paid by pre-tax salary reduction before the FMLA leave began). See 29 CFR 825.210(b).

Q-5: What restrictions apply to contributions when an employee’s FMLA leave spans two cafeteria plan years?

A-5: (a) No amount will be included in an employee’s gross income due to participation in a cafeteria plan during FMLA leave, provided that the plan complies with other generally applicable cafeteria plan requirements. Among other requirements, a plan may not operate in a manner that enables employees on FMLA leave to defer compensation from one cafeteria plan year to a subsequent cafeteria plan year. See section 125(d)(2).

(b) The following example illustrates this Q&A-5:

Example. (i) Employee A elects group health coverage under a calendar year cafeteria plan maintained by Employer X. Employee A’s premium for health coverage is $100 per month throughout the 12-month period of coverage. Employee A takes FMLA leave for 12 weeks beginning on October 31 after making 10 months of premium payments totaling $1,000 (10 months x $ 100 = $1,000). Employee A elects to continue health coverage while on

sistent with this section or with 29 CFR 825.210(c)). (ii) Contributions under the pay-asyou-go option are generally made by the employee on an after-tax basis. However, contributions may be made on a pre-tax basis to the extent that the contributions are made from taxable compensation ( e.g ., from unused sick days or vacation days) that is due the employee during the leave period.

(iii) An employer is not required to continue the group health coverage of an employee who fails to make required premium payments while on FMLA leave, provided that the employer follows the notice procedures required under FMLA. See 29 CFR 825.212. However, if the employer chooses to continue the health coverage of an employee who fails to pay his or her share of the premium payments while on FMLA leave, FMLA permits the employer to recoup the premiums (to the extent of the employee’s share). See 29 CFR 825.212(b). Such recoupment may be made as set forth in paragraphs (a)(3)(i) and (ii) of this Q&A-3. See also Q&A-6 of this section regarding coverage under a health FSA when an employee fails to make the required premium payments while on FMLA leave.

(3) Catch-up . (i) Under the catch-up option, the employer and the employee may agree in advance that the group coverage will continue during the period of unpaid FMLA leave, and that the employee will not pay premiums until the employee returns from the FMLA leave. Where an employee is electing to use the catch-up option, the employer and the employee must agree in advance of the coverage period that: the employee elects to continue health coverage while on unpaid FMLA leave; the employer assumes responsibility for advancing payment of the premiums on the employee’s behalf during the FMLA leave; and these advance amounts are to be paid by the employee when the employee returns from FMLA leave.

(ii) When an employee fails to make required premium payments while on FMLA leave, an employer is permitted to utilize the catch-up option to recoup the employee’s share of premium payments when the employee returns from FMLA leave. See, e.g ., 29 CFR 825.212(b). If the employer chooses to continue group

coverage under these circumstances, the prior agreement of the employee, as set forth in paragraph (a)(3)(i) of this Q&A3, is not required. (iii) Contributions under the catch-up option may be made on a pre-tax salary reduction basis from any available taxable compensation (including from unused sick days and vacation days) after the employee returns from FMLA leave. The cafeteria plan may provide for the catchup option to apply on a pre-tax salary reduction basis if premiums have not been paid on any other basis ( i.e ., have not been paid under the pre-pay or pay-asyou-go options or on a catch-up after-tax basis).

(iv) Contributions under the catch-up option may also be made on an after-tax basis.

(b) Exceptions . Whatever payment options are offered to employees on nonFMLA leave must be offered to employees on FMLA leave. In accordance with 29 CFR 825.210(c), cafeteria plans may offer one or more of the payment options described in paragraph (a) of this Q&A-3, with the following exceptions:

(1) FMLA does not permit the pre-pay option to be the sole option offered to employees on FMLA leave. However, the cafeteria plan may include pre-payment as an option for employees on FMLA leave, even if such option is not offered to employees on non-FMLA leave-without-pay.

(2) FMLA allows the catch-up option to be the sole option offered to employees on FMLA leave if and only if the catch-up option is the sole option offered to employees on non-FMLA leave-without-pay.

(3) If the pay-as-you-go option is offered to employees on non-FMLA leavewithout-pay, the option must also be offered to employees on FMLA leave. The employer may also offer employees on FMLA leave the pre-pay option and/or the catch-up option.

(c) Voluntary waiver of employee pay- ments . In addition to the foregoing payment options, an employer may voluntarily waive, on a nondiscriminatory basis, the requirement that employees who elect to continue group health coverage while on FMLA leave pay the amounts the employees would otherwise be required to pay for the leave period.

(d) Example . The following example illustrates this Q&A-3:

2001–45 I.R.B. 425 November 5, 2001

(3) The following examples illustrate the rules in this Q&A-6:

Example 1. (i) Employee B elects $1,200 worth of coverage under a calendar year health FSA provided under a cafeteria plan, with an annual premium of $1,200. Employee B is permitted to pay the $1,200 through pre-tax salary reduction amounts of $100 per month throughout the 12-month period of coverage. Employee B incurs no medical expenses prior to April 1. On April 1, B takes FMLA leave after making three months of contributions totaling $300 (3 months x $ 100 = $300). Employee B’s coverage ceases during the FMLA leave. Consequently, B makes no premium payments for the months of April, May, and June, and B is not entitled to submit claims or receive reimbursements for expenses incurred during this period. Employee B returns from FMLA leave and elects to be reinstated in the health FSA on July 1.

(ii) Employee B must be given a choice of resuming coverage at the level in effect before the FMLA leave ( i.e ., $1,200) and making up the unpaid premium payments ($300), or resuming health FSA coverage at a level that is reduced on a pro- rata basis for the period during the FMLA leave for which no premiums were paid ( i.e ., reduced for 3 months or 1/4 of the plan year) less prior reimbursements ( i.e ., $0) with premium payments due in the same monthly amount payable before the leave ( i.e ., $100 per month). Consequently, if B chooses to resume coverage at the level in effect before the FMLA leave, B’s coverage for the remainder of the plan year would equal $1,200 and B’s monthly premiums would be increased to $150 per month for the remainder of the plan year, to make up the $300 in premiums missed ($100 per month plus $50 per month ($300 divided by the remaining 6 months)). If B chooses prorated coverage, B’s coverage for the remainder of the plan year would equal $900, and B would resume making premium payments of $100 per month for the remainder of the plan year.

Example 2 . (i) Assume the same facts as Example 1 except that B incurred medical expenses totaling $200 in February and obtained reimbursement of these expenses.

(ii) The results are the same as in Example 1, except that if B chooses to resume coverage at the level in effect before the FMLA leave, B’s coverage for the remainder of the year would equal $1,000 ($1,200 reduced by $200) and the monthly payments for the remainder of the year would still equal $150. If instead B chooses prorated coverage, B’s coverage for the remainder of the plan year would equal $700 ($1,200 prorated for 3 months, and then reduced by $200) and the monthly payments for the remainder of the year would still equal $100.

Example 3. (i) Assume the same facts as Exam- ple 1 except that, prior to taking FMLA leave, B elects to continue health FSA coverage during the FMLA leave. The plan permits B (and B elects) to use the catch-up payment option described in Q&A3 of this section, and as further permitted under the plan, B chooses to repay the $300 in missed payments on a ratable basis over the remaining 6-month period of coverage ( i.e ., $50 per month).

(ii) Thus, B’s monthly premium payments for the remainder of the plan year will be $150 ($100 + $50).

FMLA leave and utilizes the pre-pay option by applying his or her unused sick days in order to make the required premium payments due while he or she is on FMLA leave.

(ii) Because A cannot defer compensation from one plan year to a subsequent plan year, A may prepay the premiums due in November and December ( i.e ., $100 per month) on a pre-tax basis, but A cannot pre-pay the premium payment due in January on a pre-tax basis. If A participates in the cafeteria plan in the subsequent plan year, A must either pre-pay for January on an after-tax basis or use another option ( e.g ., pay-as-you-go, catch-up, reduction in unused sick days, etc.) to make the premium payment due in January.

Q-6: Are there special rules concerning employees taking FMLA leave who participate in health FSAs offered under a cafeteria plan?

A-6: (a) In general . (1) A group health plan that is a flexible spending arrangement (FSA) offered under a cafeteria plan must conform to the generally applicable rules in this section concerning employees who take FMLA leave. Thus, to the extent required by FMLA (see 29 CFR 825.209(b)), an employer must – – (i) Permit an employee taking FMLA leave to continue coverage under a health FSA while on FMLA leave; and

(ii) If an employee is on unpaid FMLA leave, either – –

(A) Allow the employee to revoke coverage; or

(B) Continue coverage, but allow the employee to discontinue payment of his or her share of the premium for the health FSA under the cafeteria plan during the unpaid FMLA leave period.

(2) Under FMLA, the plan must permit the employee to be reinstated in health coverage upon return from FMLA leave on the same terms as if the employee had been working throughout the leave period, without a break in coverage. See 29 CFR 825.214(a) and 825.215(d)(1) and paragraph (b)(2) of this Q&A-6. In addition, under FMLA, a plan may require an employee to be reinstated in health coverage upon return from a period of unpaid FMLA leave, provided that employees who return from a period of unpaid leave not covered by the FMLA are also required to resume participation upon return from leave.

(b) Coverage . (1) Regardless of the payment option selected under Q&A-3 of this section, for so long as the employee continues health FSA coverage (or for so long as the employer continues the health FSA coverage of an employee who fails

to make the required contributions as described in Q&A-3(a)(2)(iii) of this section), the full amount of the elected health FSA coverage, less any prior reimbursements, must be available to the employee at all times, including the FMLA leave period.

(2) (i) If an employee’s coverage under the health FSA terminates while the employee is on FMLA leave, the employee is not entitled to receive reimbursements for claims incurred during the period when the coverage is terminated. If an employee subsequently elects or the employer requires the employee to be reinstated in the health FSA upon return from FMLA leave for the remainder of the plan year, the employee may not retroactively elect health FSA coverage for claims incurred during the period when the coverage was terminated. Upon reinstatement into a health FSA upon return from FMLA leave (either because the employee elects reinstatement or because the employer requires reinstatement), the employee has the right under FMLA: to resume coverage at the level in effect before the FMLA leave and make up the unpaid premium payments, or to resume coverage at a level that is reduced and resume premium payments at the level in effect before the FMLA leave. If an employee chooses to resume health FSA coverage at a level that is reduced, the coverage is prorated for the period during the FMLA leave for which no premiums were paid. In both cases, the coverage level is reduced by prior reimbursements.

(ii) FMLA requires that an employee on FMLA leave have the right to revoke or change elections (because of events described in §1.125–4) under the same terms and conditions that apply to employees participating in the cafeteria plan who are not on FMLA leave. Thus, for example, if a group health plan offers an annual open enrollment period to active employees, then, under FMLA, an employee on FMLA leave when the open enrollment is offered must be offered the right to make election changes on the same basis as other employees. Similarly, if a group health plan decides to offer a new benefit package option and allows active employees to elect the new option, then, under FMLA, an employee on FMLA leave must be allowed to elect the new option on the same basis as other employees.

November 5, 2001 426 2001–45 I.R.B.

Q-7: Are employees entitled to nonhealth benefits while taking FMLA leave?

A-7: FMLA does not require an employer to maintain an employee’s nonhealth benefits ( e.g ., life insurance) during FMLA leave. An employee’s entitlement to benefits other than group health benefits under a cafeteria plan during a period of FMLA leave is to be determined by the employer’s established policy for providing such benefits when the employee is on nonFMLA leave (paid or unpaid). See 29 CFR 825.209(h). Therefore, an employee who takes FMLA leave is entitled to revoke an election of non-health benefits under a cafeteria plan to the same extent as employees taking non-FMLA leave are permitted to revoke elections of non-health benefits under a cafeteria plan. For example, election changes are permitted due to changes of status or upon enrollment for a new plan year. See § 1.125–4. However, FMLA provides that, in certain cases, an employer may continue an employee’s non-health benefits under the employer’s cafeteria plan while the employee is on FMLA leave in order to ensure that the employer can meet its responsibility to provide equivalent benefits to the employee upon return from unpaid FMLA. If the employer continues an employee’s non-health benefits during FMLA leave, the employer is entitled to recoup the costs incurred for paying the employee’s share of the premiums during the FMLA leave period. See 29 CFR 825.213(b). Such recoupment may be on a pre-tax basis. A cafeteria plan must, as required by FMLA, permit an employee whose coverage terminated while on FMLAleave (either by revocation or nonpayment of premiums) to be reinstated in the cafeteria plan on return from FMLA leave. See 29 CFR 825.214(a) and 825.215(d).

Q-8: What is the applicability date of the regulations in this section?

A-8: This section is applicable for cafeteria plan years beginning on or after January 1, 2002.

Par. 3. Section 1.125-4 is amended by adding a sentence at the end of paragraph (g) to read as follows:

David A. Mader, Acting Deputy Commissioner

of Internal Revenue.

of 2001 (EGTRRA), Pub. L. 107–16. Specifically, this revenue ruling provides questions and answers on:

• Benefit increases that may be provided as a result of the increased § 415 limitations under EGTRRA;

• Plan amendments that may be adopted to take into account the increased § 415 limitations under EGTRRA;

• The effect of the increased § 415 limitations under EGTRRA on other qualification requirements; and

• How the “sunset” provision of EGTRRA is taken into account for purposes of §§ 412 and 404.

II. Background

Rules in Effect Prior to EGTRRA

Section 415 of the Code imposes limitations on contributions and benefits under qualified plans. The benefits that may be provided to a participant under a defined benefit plan must not exceed the limitations of § 415(b). Section 415(b) provides that benefits provided to a participant under a defined benefit plan must not exceed the lesser of the defined benefit dollar limitation of § 415(b)(1)(A) and the defined benefit compensation limitation of § 415(b)(1)(B), both adjusted as required under § 415(b). The defined benefit dollar limitation prior to the effective date of the EGTRRA amendment is $90,000, adjusted annually for cost-ofliving increases under § 415(d), with the adjusted limit effective January 1 of the following calendar year. The defined benefit dollar limitation in effect for a calendar year ( e.g ., $140,000, effective January 1, 2001) applies to all limitation years that end with or within the calendar year. Prior to the effective date of the EGTRRA amendment, the defined benefit dollar limitation is adjusted under § 415(b)(2) for commencement of benefits before or after a participant’s social security retirement age. Under § 415(b)(5), the defined benefit dollar limitation is adjusted for less than 10 years of participation. The defined benefit compensation limitation is equal to a participant’s high 3-year average compensation, adjusted, if applicable, under § 415(b)(5) for less than 10 years of service. The limitations of § 415 as in effect immediately prior to the effective date for a plan of changes enacted under

§ 1.125–4 Permitted election changes.

• ---

(g) Special requirements relating to the Family and Medical Leave Act. - * * See § 1.125–3 for additional rules.

Approved October 9, 2001.

Mark Weinberger, Assistant Secretary of the

Treasury (Tax Policy).

(Filed by the Office of the Federal Register on October 16, 2001, 8:45 a.m., and published in the issue of the Federal Register for October 17, 2001, 66 F.R. 52676)

Section 280G.—Golden Parachute Payments

Federal short-term, mid-term, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, page 434.

Section 382.—Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change

The adjusted applicable federal long-term rate is set forth for the month of November 2001. See Rev. Rul. 2001–52, page 434.

Section 412.—Minimum Funding Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, page 434.

Section 415.—Limitations on Benefits and Contributions Under Qualified Plans

Limitations on benefits and contri- butions. This ruling provides guidance on the limitations under section 415 of the Code, as amended by the Economic Growth and Tax Relief Reconciliation Act of 2001.

Rev. Rul. 2001–51

I. Purpose

This revenue ruling provides guidance relating to the increases in the limitations of § 415 of the Internal Revenue Code (Code) enacted as part of the Economic Growth and Tax Relief Reconciliation Act

• ---

2001–45 I.R.B. 427 November 5, 2001

EGTRRA are referred to in this revenue ruling as the “pre-EGTRRA § 415 limitations.”

Annual additions credited to a participant’s account under a defined contribution plan must not exceed the limitations of § 415(c). Section 415(c) provides that annual additions credited on behalf of a participant under a defined contribution plan must not exceed the lesser of the defined contribution dollar limitation of § 415(c)(1)(A), or the defined contribution compensation limitation of § 415(c)(1)(B). Prior to the effective date of the EGTRRA amendment, the defined contribution dollar limitation is $30,000, adjusted annually under § 415(d) for costof-living increases, with the adjusted limit effective January 1 of the following calendar year. The defined contribution dollar limitation in effect for a calendar year ( e.g., $35,000, effective January 1, 2001) applies to all limitation years that end with or within the calendar year. Prior to the effective date of the EGTRRA amendment, the defined contribution compensation limitation is 25 percent of a participant’s compensation.

Section 411(a) prescribes rules as to when an employee’s right to his or her normal retirement benefit must become nonforfeitable under a qualified plan. Section 411(d)(6) generally prohibits a plan amendment, except for an amendment described in § 412(c)(8), that has the effect of decreasing a participant’s accrued benefits under the plan.

Section 1106(h) of the Taxpayer Reform Act of 1986, Pub. L. 99–514, provides that notwithstanding any other provision of law, except as provided in regulations prescribed by the Secretary of the Treasury, a plan may incorporate by reference the limitations under § 415 of the Code. In Notice 87–21 (1987–1 C.B. 458) Q&A–11, the Service provided guidance for plans to incorporate by reference the limitations of § 415, for limitation years beginning on or after January 1, 1987.

Section 401(a)(4) prescribes nondiscrimination rules for qualified plans. Section 1.401(a)(4)–2 of the Income Tax Regulations imposes requirements relating to nondiscrimination in amount of employer contributions under a defined contribution plan. For this purpose, § 1.401(a)(4)–2(b) provides two safe harbor tests, and § 1.401(a)(4)–2(c) provides

a general test. In order to satisfy either of the safe harbors, a plan must provide for either a uniform allocation formula or a uniform points allocation formula as described in the regulation.

Section 1.401(a)(4)–3 imposes requirements relating to nondiscrimination in amount of benefits under a defined benefit plan. For this purpose, § 1.401(a) (4)–3(b) provides several safe harbor tests, and § 1.401(a)(4)–3(c) provides a general test. In order to satisfy any of the safe harbors, a plan must provide for a uniform normal retirement benefit, uniform post-normal retirement benefit, and uniform subsidies. Plans that satisfy the general test may do so by testing benefits with or without the application of the § 415 limitations.

Changes Under EGTRRA

Section 611(a)(1) of EGTRRA increased the defined benefit dollar limitation of § 415(b) of the Code to $160,000, effective for limitation years ending after December 31, 2001. Under section 611(a)(2) of EGTRRA, effective for limitation years ending after December 31, 2001, the § 415(b) dollar limitation is reduced for commencement of benefits prior to age 62, rather than for commencement of benefits prior to a participant’s social security retirement age, and no adjustment to the dollar limitation is required where a participant’s benefit commences after age 62 and not later than age 65. Under section 611(a)(3) of EGTRRA, effective for limitation years ending after December 31, 2001, the § 415(b) dollar limitation is increased when benefits commence after age 65, rather than for benefits that commence after a participant’s social security retirement age.

Specific amendments affecting multiemployer plans (as defined in § 414(f)) were made to §§ 415(b)(11) and 415(f) of the Code, respectively, by sections 654(a) and (b) of EGTRRA to provide, respectively, that: (1) the defined benefit compensation limit of § 415(b)(1)(B) does not apply to a multiemployer plan, effective for limitation years beginning after December 31, 2001; and (2) multiemployer plans are not combined or aggregated (a) with any other plan which is not a multiemployer plan for purposes of applying § 415(b)(1)(B) to such other plan, or (b)

with any other multiemployer plan for purposes of applying the limitations of § 415, effective for limitation years beginning after December 31, 2001.

Section 611(b) of EGTRRA increased the defined contribution dollar limitation of § 415(c)(1)(A) of the Code to $40,000, effective for limitation years beginning after December 31, 2001. Section 632(a) of EGTRRA increased the “25 percent” in the defined contribution compensation limitation of § 415(c)(1)(B) of the Code to “100 percent,” effective for years beginning after December 31, 2001.

Section 611 of EGTRRA also made changes to the methodology for determining cost-of-living increases under § 415(d) of the Code.

Section 901(a) of EGTRRA provides a “sunset” provision under which all provisions of, and amendments made by, EGTRRA shall not apply to taxable, plan, or limitation years beginning after December 31, 2010.

The Conference Report (H.R.Conf. Rep. No. 84, 107th Cong., 1st Sess. 212, 214 (2001)) that accompanies EGTRRA provides that in adopting rules regarding the application of the increases in the defined benefit plan limits, it is intended that the Secretary will apply rules similar to those adopted in Notice 99-44 (1999–2 C.B. 326) regarding benefit increases due to the repeal of the combined plan limit under former § 415(e).

III. Questions and Answers on § 415 Changes Under EGTRRA

Q-1: What is the effective date of the increase in the dollar limitation for defined benefit plans under section 611(a) of EGTRRA?

A-1: In accordance with section 611(i)(2) of EGTRRA, the increase in the dollar limitation for defined benefit plans under section 611(a) of EGTRRA is effective for the first limitation year ending after December 31, 2001. Thus, the defined benefit dollar limitation applicable to any limitation year ending in 2002 is $160,000.

With respect to limitation years ending after December 31, 2001, a defined benefit plan will not fail to satisfy § 415 solely because the plan provides that the benefit of any participant exceeds the pre-EGTRRA § 415(b) limitations. Accordingly, the pre

November 5, 2001 428 2001–45 I.R.B.

EGTRRA § 415 limitations will not limit the benefit of a participant in a defined benefit plan whose benefit has not commenced as of the first day of the first limitation year ending after December 31, 2001. For rules regarding the application of the pre-EGTRRA § 415(b) limitations to a participant in a defined benefit plan whose benefit has commenced as of that date, see Q&A-5.

Example 1

Plan A is a defined benefit plan with a calendar year limitation year. When will the dollar limit applicable to the benefits of participants under Plan A be increased to $160,000 under EGTRRA?

For participants of Plan A, the increase in the dollar limitation to $160,000 is effective for the limitation year beginning January 1, 2002 (and ending December 31, 2002).

Example 2

Plan B is a defined benefit plan with a limitation year that begins February 1. When will the dollar limit applicable to the benefits of participants under Plan B increase to $160,000 under EGTRRA?

For participants of Plan B, the increase in the dollar limitation to $160,000 is effective for the limitation year beginning February 1, 2001 (and ending January 31, 2002).

Q-2: If a defined benefit plan is not amended to take into account the increased § 415 limitations under EGTRRA, how may the benefits of plan participants be affected?

A-2: If a defined benefit plan is not amended to take into account the increased § 415 limitations under EGTRRA, the effect on the benefits of plan participants will depend on the plan’s existing provisions for applying the limitations of § 415 and any other relevant plan provisions. In some circumstances, a plan’s existing provisions could result in automatic benefit increases for participants as of the effective date of the increased § 415 limitations for the plan. For example, the increased § 415 limitations under EGTRRA could result in automatic benefit increases for participants in

defined benefit plans that incorporate by reference the limitations of § 415.

Example

Participant B, a participant in a defined benefit plan (Plan R) with a limitation year beginning March 1, 2001, and ending February 28, 2002, retires on April 1, 2001, at age 65 (Participant B’s social security retirement age) and receives a single-sum distribution of his benefit on May 1, 2001. On retirement, Participant B’s annual benefit in the form of an annuity under the plan formula was $170,000, but Participant B’s accrued benefit under the plan was limited to $140,000 to satisfy § 415. Participant B received the single-sum equivalent of an annual benefit of $140,000. The terms of Plan R incorporate the limitations of § 415 of the Code by reference. What effect does the increase in the defined benefit dollar limitation under EGTRRA have on Participant B’s benefit?

The defined benefit dollar limitation in effect for 2001 ($140,000) was used in the calculation of the single sum distributed on May 1, 2001. The increase in the defined benefit dollar limitation to $160,000 under EGTRRA is effective for Plan R for the limitation year beginning March 1, 2001, and ending February 28, 2002. Therefore, the $160,000 dollar limitation applies to Participant B’s benefit, and Participant B’s benefit must increase. Participant B must receive an additional lump sum amount to reflect the higher dollar limitation applicable to Participant B’s benefit. The additional lump sum benefit is calculated as the actuarial equivalent of the excess of (1) Participant B’s accrued benefit in the form of a straight life annuity when the dollar limitation applicable at Participant B’s retirement age under EGTRRA is taken into account, over (2) Participant B’s accrued benefit in the form of a straight life annuity when the pre-EGTRRA dollar limitation applicable at Participant B’s retirement age is taken into account.

Q-3: How do the increased § 415(b) limitations under EGTRRA affect the methodology used to apply the § 415(b) limitations to a benefit under a defined

benefit plan that is not payable in the form of an annual straight life annuity within the meaning of § 415(b)(2)(A)?

A-3: The determination as to whether such a benefit satisfies the 415(b) limitations generally follows the same steps and procedures as those used in Q&A-7 and Q&A-8, as applicable, of Rev. Rul. 98–1 (1998–1 C.B. 249), with the following modifications. As in Rev. Rul. 98–1, to satisfy the limitations of § 415(b), a participant’s benefit must not exceed the lesser of the § 415(b) dollar limitation applicable to the participant and the § 415(b) compensation limitation applicable to the participant. See Rev. Rul. 98–1 for a more detailed description of the methodology used in the steps below.

Step 1 , the determination of the annual benefit in the form of a straight life annuity commencing at the same age that is actuarially equivalent to the plan benefit, is unchanged from Q&A-7 and Q&A-8, as applicable, of Rev. Rul. 98–1.

Step 2 , the determination of the § 415(b) dollar limitation that applies at the age the benefit is payable under Q&A-7 and Q&A-9, as applicable, of Rev. Rul. 98–1, is modified to reflect the increase of the defined benefit dollar limitation to $160,000, and the amendment of § 415(b)(2)(C) and § 415(b)(2)(D), as described in the following two paragraphs.

Effective for limitation years ending after December 31, 2001, § 415(b)(2)(C) as amended by EGTRRA provides that the § 415(b) dollar limitation is reduced when a participant’s benefit commences prior to age 62, rather than for a benefit that commences prior to a participant’s social security retirement age, and there are no age adjustments to the dollar limitation where a participant’s benefit commences after age 62 and no later than age 65. Where a participant’s benefit commences prior to age 62, the § 415(b) dollar limitation applicable to the participant at the earlier age is the annual benefit payable in the form of a straight life annuity commencing at the earlier age that is actuarially equivalent to the § 415(b) dollar limitation applicable to the participant at age 62, calculated using assumptions that satisfy § 415(b)(2)(E).

2001–45 I.R.B. 429 November 5, 2001

Effective for limitation years ending after December 31, 2001, § 415(b)(2)(D) as amended by EGTRRA provides that the § 415(b) dollar limitation is increased when a participant’s benefit commences after age 65, rather than for a benefit that commences after a participant’s social security retirement age. Where a participant’s benefit commences after age 65, the § 415(b) dollar limitation applicable to the participant at the later age is the annual benefit payable in the form of a straight life annuity commencing at the later age that is actuarially equivalent to the § 415(b) dollar limitation applicable to the participant at age 65, calculated using assumptions that satisfy § 415(b) (2)(E).

Step 3, the determination of the § 415(b) compensation limitation applicable to the participant, is unchanged. However, see Q&A-8 of this revenue ruling for new rules relating to multiemployer plans.

Q-4: What special considerations for a defined benefit plan that has a normal retirement age less than 65 must be taken into account once the amendments to § 415 under EGTRRA are effective for the plan?

A-4: In the case of a defined benefit plan with a normal retirement age less than 65, the requirements for nonforfeitability of benefits and actuarial increase for delayed retirement of § 411 of the Code must be coordinated with the requirements of § 415. Under § 411, if benefits are not paid to a participant after the participant attains the plan’s normal retirement age, and the plan’s terms do not provide for the “suspension” of the participant’s benefits in accordance with § 411(a)(3)(B) of the Code and 29 C.F.R. § 2530.203–3, then the participant’s benefit must be actuarially increased for late retirement to avoid any forfeiture of the participant’s benefit. However, under § 415 as amended by EGTRRA, the dollar limitation applicable to a participant does not increase between ages 62 and 65. If a participant continues to work past a plan’s normal retirement age that is less than 65, and the participant’s benefit equals the § 415 dollar limitation at an age between 62 and 65, any actuarial increase to the participant’s benefit after that age and prior to age 65 would violate § 415. In such a case, in

order to satisfy §§ 415 and 411, the terms of the plan must either provide for the inservice payment of the participant’s benefit (where the participant has attained normal retirement age and has a benefit that cannot be actuarially increased without violating § 415), or provide for the suspension of benefits in accordance with § 411(a)(3)(B) of the Code and 29 C.F.R. § 2530.203–3.

Q-5: May a defined benefit plan provide for benefit increases to reflect the increased § 415 limitations under EGTRRA for a current or former employee who has commenced benefits under the plan prior to the effective date of such increases?

A-5: A defined benefit plan may provide for benefit increases to reflect the increased § 415 limitations under EGTRRA for a current or former employee who has commenced benefits under the plan prior to the effective date of the § 415 increases under EGTRRA, but only if the employee or former employee is a participant in the plan on or after that effective date. For this purpose, an employee or former employee is a participant in the plan on a date if the employee or former employee has an accrued benefit (other than an accrued benefit resulting from a benefit increase that arises solely as a result of the increases in the § 415 limitations under EGTRRA) on that date. Thus, benefit increases to reflect the increases in the § 415 limitations under EGTRRA cannot be provided to current or former employees who do not have accrued benefits under the plan on or after the effective date of the § 415 increases under EGTRRA for the plan. However, if a current or former employee accrues additional benefits under the plan that could have been accrued without regard to the increased § 415 limitations under EGTRRA (including benefits that accrue as a result of a plan amendment) on or after the effective date of the increased § 415 limitations under EGTRRA for the plan, then the current or former employee may receive a benefit arising from the increased § 415 limitations under EGTRRA.

Q-6: How is the maximum permissible benefit increase calculated for a current or former employee who has commenced benefits under a defined benefit plan in a

form not subject to § 417(e)(3) prior to the effective date of the increased § 415 limitations under EGTRRA?

A-6: For any limitation year beginning on or after the effective date for the plan of the increased § 415 limitations under EGTRRA, the benefit payable to any current or former employee who has commenced benefits under the plan prior to such effective date in a form not subject to § 417(e)(3) may be increased to a benefit that is no greater than the benefit that could have been provided had the provisions of EGTRRA been in effect at the time of the commencement of benefit. Thus, the annual benefit for limitation years beginning on or after the effective date for the plan of the increased § 415 limitations under EGTRRA is limited to the § 415(b) limitation for the employee (increased for cost-of-living adjustments, if the plan provides for such adjustments) based on the employee’s age at the time of commencement. Benefits attributable to limitation years beginning before the effective date for the plan of the increased § 415 limitations under EGTRRA cannot reflect benefit increases that could not be paid for those years because of § 415(b). In addition, any plan amendment to provide an increase as a result of the increased § 415 limitations under EGTRRA can be effective no earlier than the effective date of the increased § 415 limitations under EGTRRA for the plan.

Example

Plan A has a calendar year limitation year, and provides that retiree benefits limited by § 415 are increased as COLA adjustments are made under § 415(d). Participant S, a participant of Plan A, retired in 2000 at age 60 with 20 years of participation. Participant S’s social security retirement age is 66. Participant S’s annual benefit under the plan formula before limitation for § 415 was $180,000, and this benefit was limited by the defined benefit dollar limit to $85,252 (the applicable mortality table and 6 percent are used under the plan for early retirement purposes). The defined benefit compensation limitation applicable to Participant S was $200,000 and, thus, did not limit Participant S’s benefit. How will Participant S’s benefit be affected by

November 5, 2001 430 2001–45 I.R.B.

the changes made to § 415 under section 611 of EGTRRA?

Following the increase in the § 415(b) dollar limit on January 1, 2001, to $140,000, Participant S’s benefit was increased to $88,409 [$85,252 x ($140,000/$135,000)]. After the § 415(b) increase in the dollar limit under EGTRRA is applicable to Plan A for the limitation year beginning January 1, 2002, Participant S’s annual benefit may be increased to an amount equal to the annual benefit commencing at age 60 that is actuarially equivalent (calculated using actuarial assumptions that satisfy § 415(b)(2)(E)) to an annual benefit of $160,000 payable at age 62. In other words, Participant S’s benefit may be increased to an amount equal to the benefit that a 60 year old could receive if the defined benefit dollar limit is $160,000 (with no reduction in the dollar limit for benefits that commence before age 65 and on or after age 62, but reduced actuarially for benefits that commence before age 62). Participant S’s annual benefit may be increased to $134,720. However, Participant S may not receive this increased benefit until January 1, 2002.

Q-7: How is the maximum permissible benefit increase calculated for a current or former employee under a defined benefit plan whose benefit is payable in a form subject to § 417(e)(3) prior to the effective date of the increased § 415 limitations under EGTRRA?

A-7: In the case of a form of benefit that is subject to § 417(e)(3), the benefit payable for any limitation year beginning on or after the effective date for the plan of the increased § 415 limitations under EGTRRA may be increased by an amount that is actuarially equivalent to the amount of increase that could have been provided had the benefit been paid in the form of a straight life annuity. Benefits attributable to limitation years beginning before the effective date for the plan of the increased § 415 limitations under EGTRRA cannot reflect benefit increases that could not be paid for those years because of § 415(b). In addition, any plan amendment to provide an increase as a result of the increased § 415 limitations under EGTRRA can be effective no ear

lier than the effective date of the increased § 415 limitations under EGTRRA for the plan.

Example

Participant D, a participant in a defined benefit plan (Plan T) with a calendar year limitation year and plan year, retires on January 1, 2001, D’s 64th birthday, with 25 years of service and participation. Participant D’s social security retirement age is 65. The terms of Plan T provide for increases in retiree benefits (that are limited by § 415(b)) as the § 415 limits are increased for COLAs under § 415(d). On retirement, D’s annual benefit in the form of an annuity under the plan formula, before limitation for § 415, is $200,000. Participant D’s accrued benefit under the plan in the form of an annuity is limited to $130,667

[(140,000) x (1–(5/9)(12)(.01)] to satisfy § 415(b). Participant D’s benefit is payable in the form of 10 equal annual installments commencing January 1, 2001. For purposes of actuarial equivalence for early commencement and optional forms, the plan provides for the use of the applicable mortality table and the applicable interest rate (assumed to be 6 percent for purposes of this example). What is the maximum benefit increase that D can receive under Plan T as a result of the increased § 415 limitations under EGTRRA?

When D’s benefits began, the benefit was calculated as a straight life annuity of $130,667 per year, adjusted for payment as 10 annual payments. The annuity benefit of $130,667 was multiplied by an age 64 annuity factor (calculated using the applicable mortality table and the applicable interest rate), and the resulting amount was spread over 10 years, using the applicable interest rate. Participant D has an accrued benefit under Plan T when EGTRRA becomes effective for Plan T on January 1, 2002. If Plan T is amended to provide for such increases to retired participants, then D’s benefit, if payable in the form of a straight life annuity, could be increased to a straight life annuity of $160,000 in the limitation year beginning January 1, 2002.

As of January 1, 2002, D has nine remaining installment payments. The remaining nine installment payments could be increased by the actuarial equivalent (spread over a period of nine years) of the value of the increase in the straight life annuity that would have been payable beginning January 1, 2002, if D had elected a straight life annuity on retirement rather than the installment payment option. That is, the maximum increase that D is permitted to receive in 2002 as a result of the § 415(b) increase under EGTRRA is the amount equal to the product of $29,333 ($160,000 – $130,667) times an age 65 annuity factor (derived using the applicable mortality table and the applicable interest rate), spread over 9 years at an assumed interest rate equal to the applicable interest rate.

Q-8: In addition to the changes enacted to § 415 under section 611 of EGTRRA, how did the § 415(b) limitation specifically applicable to multiemployer defined benefit plans change under EGTRRA?

A-8: As provided in section 654 of EGTRRA, the compensation limitation of § 415(b)(1)(B) of the Code does not apply to multiemployer defined benefit plans for limitation years beginning after December 31, 2001. Additionally, the § 415 aggregation rules affecting multiemployer plans were changed to provide that, for limitation years beginning after December 31, 2001, a multiemployer plan is not combined or aggregated (1) with a nonmultiemployer plan for purposes of applying the § 415(b)(1)(B) compensation limit to the non-multiemployer plan, or (2) with any other multiemployer plan for purposes of applying the § 415 limitations.

Q-9: What is the effective date of the increase in the § 415(c)(1)(A) dollar limitation for defined contribution plans?

A-9: As provided in section 611(b) of EGTRRA, the increase in the § 415(c)(1)(A) dollar limitation for defined contribution plans under EGTRRA is effective for the first limitation year beginning after December 31, 2001.

Example

Plan C is a defined contribution plan with a limitation year that begins February 1. What is the § 415(c)(1)(A)

2001–45 I.R.B. 431 November 5, 2001

limitation applicable to Plan C for the limitation years beginning February 1, 2001, and February 1, 2002?

Reg. § 1.415–6 (Limitation for defined contribution plans) provides that the dollar limitation of § 415(c)(1)(A) is adjusted for cost-of-living increases under § 415(d), and the COLA-adjusted dollar limitation is effective as of January 1 of each calendar year and applies to limitation years that end during that calendar year. The limitation year beginning February 1, 2001, ends in the calendar year 2002 (on January 31, 2002), so the defined contribution dollar limitation that applies to the limitation year is the defined contribution dollar limit in effect January 1, 2002, without regard to EGTRRA ($35,000, increased if applicable, to reflect increases in the cost-of-living, announced by the Service). The defined contribution dollar limit effective January 1, 2002, has not yet been announced. The increase in the defined contribution dollar limitation to $40,000 under EGTRRA (adjusted under § 415(d), if applicable) is first effective for Plan C for the limitation year beginning February 1, 2002, and ending January 31, 2003.

Q-10: What is the effective date for the increase in the compensation limitation for defined contribution plans under § 415(c)(1)(B)?

A-10: As provided in section 632(a) of EGTRRA, the 25 percent compensation limitation in § 415(c)(1)(B) of the Code is increased to 100 percent, effective for the first limitation year beginning after December 31, 2001.

Q-11: How will a defined contribution or defined benefit plan that takes into account the increased § 415 limitations under EGTRRA as of the first day of the first limitation year for which the increases are effective for the plan, satisfy the nondiscrimination in amount of benefits requirement?

A-11: A defined contribution or defined benefit plan that uses a safe harbor and takes into account the increased § 415 limitations under EGTRRA as of the first day of the first limitation year for which the increases are effective for the plan,

will not fail to satisfy the uniformity requirements of §§ 1.401(a)(4)–2(b) or 1.401(a)(4)–3(b)(2) merely because the increased § 415 limitations under EGTRRA are taken into account under the plan.

For purposes of the general test for nondiscrimination in amount of contributions, increased contributions allocated under the terms of a defined contribution plan due to the increased § 415 limitations under EGTRRA must be taken into account in accordance with the rules of § 1.401(a)(4)–2(c)(2)(ii) for the plan year for which the increased allocations are made. For purposes of the general test for nondiscrimination in amount of benefits, increased benefits provided to an employee under the terms of a defined benefit plan due to the increased § 415 limitations under EGTRRA must be included as increases in the employee’s accrued benefit (within the meaning of § 411(a) (7)(A)(i)) and the employee’s most valuable optional form of payment of the accrued benefit (within the meaning of § 1.401(a)(4)–3(d)(1)(ii)) in accordance with the rules of § 1.401(a)(4)–3(d), and must be included in the computation of both the normal and most valuable accrual rates for any measurement period that includes the plan year for which the increase occurs. If the limitations of § 415 are taken into account in testing the plan for limitation years for which the increased § 415 limitations under EGTRRA are effective for the plan, those limitations must reflect the increased § 415 limitations under EGTRRA.

Q-12: If benefit increases are provided to employees and former employees under a plan as a result of the increased § 415 limitations under EGTRRA, how are the requirements of §§ 1.401(a)(4)–5 and 1.401(a)(4)–10 satisfied?

A-12: If benefit increases resulting from the increased § 415 limitations under EGTRRA are provided as of the effective date of the increased § 415 limitations under EGTRRA for the plan to either (1) all current and former employees who have an accrued benefit under the plan immediately before the effective date of the increased § 415 limitations under EGTRRA, or (2) all employees participating in the plan that have one hour of ser

vice after the effective date of the increased § 415 limitations under EGTRRA for the plan, through the adoption of a plan amendment, then the timing of such an amendment satisfies the requirements of § 1.401(a)(4)–5, and the requirements of § 1.401(a)(4)–10(b) are satisfied. If, as of the effective date of the increased § 415 limitations under EGTRRA for the plan, benefit increases are provided to either of the two groups described in the preceding sentence through the operation of the plan’s existing provisions, then the requirements of §§ 1.401(a)(4)–5 and 1.401(a)(4)–10(b) are satisfied. If benefit increases due to the increased § 415 limitations under EGTRRA are provided only to a certain group of current or former employees not described in the preceding paragraph through the adoption of a plan amendment, or if a plan amendment to reflect the increased § 415 limitations under EGTRRA is effective as of a later date than the effective date of the increased § 415 limitations under EGTRRA for the plan, then the timing of such an amendment (considered in conjunction with the effect of the increased § 415 limitations under EGTRRA) must satisfy a facts-andcircumstances determination under § 1.401(a)(4)–5(a)(2), and the requirements of § 1.401(a)(4)–10 must be applied.

Q-13: May a plan be amended to limit the extent to which a participant’s benefit would otherwise automatically increase under the terms of the plan as a result of the increased § 415 limitations under EGTRRA?

A-13: A plan may be amended to limit the extent to which a participant’s benefit would otherwise automatically increase under the terms of the plan as a result of the increased § 415 limitations under EGTRRA, if the amendment is adopted before the effective date of the increased § 415 limitations for the plan. However, see Q&A-14 for certain qualification requirements that may be affected by such an amendment. A plan sponsor may wish to make a plan amendment to preclude a benefit increase that would otherwise occur as a result of the increased § 415 limitations under EGTRRA in order to provide time for the plan sponsor to consider the extent to which a benefit increase relating to the increased § 415 limitations under EGTRRA should or

November 5, 2001 432 2001–45 I.R.B.

should not be provided at some later date consistent with all relevant qualification requirements. A plan amendment to limit the extent to which such a benefit increase would otherwise occur that is not both adopted prior to, and effective as of, the first day of the first limitation year for which the increased § 415 limitations under EGTRRA are effective for the plan may fail to satisfy § 411(d)(6). Therefore, a plan amendment that is intended to limit such a benefit increase should be both adopted prior to, and effective as of, the first day of the first limitation year for which the increased § 415 limitations under EGTRRA are effective for the plan. The following is an example of language that could be used by a plan sponsor, on an interim or permanent basis, in amending a defined benefit plan that would otherwise provide for a benefit increase due to the increased § 415 limitations under EGTRRA, to retain the effect of the preEGTRRA § 415 limitations in determining a participant’s accrued benefit under the plan (without failing to satisfy § 411(d)(6)):

Effective as of the first day of the first limitation year for which the increased § 415 limitations under EGTRRA are effective for the plan (the “Effective Date”), and notwith- standing any other provision of the Plan, the accrued benefit for any par- ticipant shall be determined by applying the terms of the Plan imple- menting the limitations of § 415 as if the limitations of § 415 continued to include the limitations of § 415 as in effect on the day immediately prior to the Effective Date.

Q-14: Are there qualification requirements that may not be satisfied if a plan continues to limit benefits after the first day of the first limitation year for which the increased § 415 limitations under EGTRRA are effective for the plan using the pre-EGTRRA § 415 limitations?

A-14: There are some qualification requirements that may not be satisfied if a plan continues to limit benefits using the pre-EGTRRA § 415 limitations after the first day of the first limitation year for which the increased § 415 limitations under EGTRRA are effective for the plan. Any exception from the otherwise applic

able qualification rules that is permitted solely in order to satisfy the maximum limitations on contributions or benefits under § 415 with respect to a participant does not apply if the participant’s contributions or benefits are below the limitations of § 415. Thus, such an exception is not permitted where a plan limits benefits in a manner that is more restrictive than required under § 415. For example, at any time on or after the first day of the first limitation year beginning on or after January 1, 2002, a qualified defined contribution plan could not provide that the provisions of § 1.415–6(b)(6) would be applied to place an amount that does not exceed the limitations under § 415, but that does exceed the pre-EGTRRA § 415 limitations, in an unallocated suspense account as an excess annual addition. Similarly, a qualified cash or deferred arrangement could not provide that the provisions of § 1.415–6(b)(6)(iv) would be applied to permit the distribution of elective deferrals that do not exceed the limitations under § 415, but that exceed the preEGTRRA § 415 limitations. The qualification issues described in this Q&A-14 may arise whenever a lower limitation is applied under a plan in lieu of a statutory § 415 limitation that applies for the limitation year.

Q-15: How may a plan that continues to limit benefits after the first day of the first limitation year for which the increased § 415 limitations under EGTRRA are effective for the plan, using the preEGTRRA § 415 limitations, satisfy the nondiscrimination in amount of benefits requirement?

A-15: Section 1.401(a)(4)–2(b)(4)(iv) provides that the use of safe harbors by defined contribution plans, for nondiscrimination in amount of contributions purposes, is not precluded by plan provisions (which must apply uniformly to all employees) that (1) limit allocations otherwise provided under the allocation formula to a maximum dollar amount or a maximum percentage of plan year compensation, (2) limit the dollar amount of plan year compensation taken into account in determining the amount of allocations, or (3) apply the restrictions of § 409(n) or the limits of § 415. Section 1.401(a)(4)–3(b)(6)(v) provides that the use of safe harbors by defined benefit

plans, for nondiscrimination in amount of benefits purposes, is not precluded by plan provisions (which must apply uniformly to all employees) that (1) limit benefits otherwise provided under the benefit formula or accrual method to a maximum dollar amount or to a maximum percentage of average annual compensation or in accordance with § 401(a)(5)(D), (2) apply the limits of § 415, or (3) limit the dollar amount of compensation taken into account in determining benefits. Because the preEGTRRA § 415 limitations uniformly limit allocations or benefits to a maximum dollar amount or percentage of compensation, a plan that continues to apply the pre-EGTRRA § 415 limitations does not fail to satisfy a safe harbor solely because it continues to apply such limitations.

If a plan continues to limit benefits using the pre-EGTRRA § 415 limitations, on or after the first day of the first limitation year for which the increased § 415 limitations under EGTRRA are effective for the plan, the annual additions or accrued benefits that are taken into account in performing the general tests for nondiscrimination in amount of contributions or benefits must reflect the plan provisions that limit benefits in this manner.

Q-16: How are the increased § 415 limitations under EGTRRA treated under the plan for purposes of § 412?

A-16: For purposes of § 412, any increase in the liabilities of a plan as a result of the increased § 415 limitations under EGTRRA must be treated as occurring pursuant to a plan amendment effective no earlier than the first day of the first limitation year for which the increased § 415 limitations under EGTRRA are effective for the plan (whether the increase in liabilities under the terms of the plan arises pursuant to a plan amendment, or pursuant to existing plan provisions, i.e ., where benefits automatically increase as of the date the increased § 415 limitations under EGTRRA are effective for the plan). Accordingly, any amortization base that is established under § 412 for an increase in liabilities under a plan resulting from the increased § 415 limitations under EGTRRA must have an amortization period of 30 years. A plan amend

2001–45 I.R.B. 433 November 5, 2001

ment that makes the increased § 415 limitations under EGTRRA effective for a plan cannot be taken into account for purposes of § 412 prior to the effective date of the increased § 415 limitations under EGTRRA for the plan.

Q-17: How is the sunset provision of section 901 of EGTRRA taken into account for purposes of §§ 412 and 404 of the Code, and with respect to the calculation of benefit payments that must not exceed the limitations of § 415?

A-17: The “sunset” provision of section 901 of EGTRRA is not taken into account for purposes of § 412 of the Code for years beginning on or before December 31, 2010. Thus, for example, projected benefits under a defined benefit plan are computed assuming that the increase in the dollar limitation to $160,000, as adjusted under § 415(d), remains in effect for limitation years beginning after December 31, 2010. Section 404(j) provides that benefits or contributions in excess of the limitations of § 415 are not taken into account in computing the amount of any deduction allowable under paragraphs (1), (2), (3), (4), (7), or (9) of § 404(a). For years beginning on or before December 31, 2010, the determination that contributions do not exceed the limitation of § 404(j) is made without regard to the sunset provision of section 901 of EGTRRA. Until further guidance is provided, a participant’s benefit will be tested for satisfaction of the § 415 limitations using the limitations currently in effect and applicable to the participant.

IV. Effect on Other Documents

Rev. Rul. 98–1 is modified.

DRAFTING INFORMATION

The principal author of this revenue ruling is Ann Trichilo of Employee Plans. For further information regarding this revenue ruling, please contact the Employee Plans’ taxpayer assistance telephone service at 1-877-829-5500, between the hours of 8:00 a.m. and 9:30 p.m. Eastern time, Monday through Fri

day (a toll-free number). Ms. Trichilo may be reached at (202) 283-9695 (not a toll-free number).

Section 467.—Certain Payments for the Use of Property or Services

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, on this page.

Section 468.—Special Rules for Mining and Solid Waste Reclamation and Closing Costs

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, on this page.

Section 482.—Allocation of Income and Deductions Among Taxpayers

Federal short-term, mid-term, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, on this page.

Section 483.—Interest on Certain Deferred Payments

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, on this page.

Section 642.—Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, on this page.

Section 807.—Rules for Certain Reserves

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, on this page.

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, on this page.

Section 1274.—Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property

(Also sections 42, 280G, 382, 412, 467, 468, 482, 483, 642, 807, 846, 1288, 7520, 7872.)

Federal Rates; adjusted federal rates; adjusted federal long-term rate and the long-term exempt rate. For purposes of sections 382, 1274, 1288, and other sections of the Code, tables set forth the rates for October 2001.

Rev. Rul. 2001–52

This revenue ruling provides various prescribed rates for federal income tax purposes for November 2001 (the current month). Table 1 contains the short-term, mid-term, and long-term applicable federal rates (AFR) for the current month for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes of section 1288(b). Table 3 sets forth the adjusted federal long-term rate and the long-term tax-exempt rate described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income housing credit described in section 42(b)(2) for buildings placed in service during the current month. Finally, Table 5 contains the federal rate for determining the present value of an annuity, an interest for life or for a term of years, or a remainder or a reversionary interest for purposes of section 7520.

November 5, 2001 434 2001–45 I.R.B.

REV. RUL. 2001–52 TABLE 1

Applicable Federal Rates (AFR) for November 2001

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-Term

AFR 2.73% 2.71% 2.70% 2.69% 110% AFR 3.00% 2.98% 2.97% 2.96% 120% AFR 3.28% 3.25% 3.24% 3.23% 130% AFR 3.55% 3.52% 3.50% 3.49%

Mid-Term

AFR 4.13% 4.09% 4.07% 4.06% 110% AFR 4.55% 4.50% 4.47% 4.46% 120% AFR 4.97% 4.91% 4.88% 4.86% 130% AFR 5.39% 5.32% 5.29% 5.26% 150% AFR 6.23% 6.14% 6.09% 6.06% 175% AFR 7.29% 7.16% 7.10% 7.06%

Long-Term

AFR 5.31% 5.24% 5.21% 5.18% 110% AFR 5.84% 5.76% 5.72% 5.69% 120% AFR 6.39% 6.29% 6.24% 6.21% 130% AFR 6.93% 6.81% 6.75% 6.72%

Mid-Term

Long-Term

REV. RUL. 2001–52 TABLE 2

Adjusted AFR for November 2001

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term adjusted AFR 2.39% 2.38% 2.37% 2.37%

Mid-term adjusted AFR 3.41% 3.38% 3.37% 3.36%

Long-term adjusted AFR 4.74% 4.69% 4.66% 4.64%

REV. RUL. 2001–52 TABLE 3

Rates Under Section 382 for November 2001

Adjusted federal long-term rate for the current month 4.74%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted federal long-term rates for the current month and the prior two months.) 4.85%

REV. RUL. 2001–52 TABLE 4

Appropriate Percentages Under Section 42(b)(2) for November 2001

Appropriate percentage for the 70% present value low-income housing credit 8.10%

Appropriate percentage for the 30% present value low-income housing credit 3.47%

2001–45 I.R.B. 435 November 5, 2001

REV. RUL. 2001–52 TABLE 5

Rate Under Section 7520 for November 2001

Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest 5.0%

Section 1288.—Treatment of Original Issue Discount on Tax- Exempt Obligations

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, page 434.

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of November 2001. See Rev. Rul. 2001–52, page 434.

Section 7872.—Treatment of Loans With Below-Market Interest Rates

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of November 2001. See Rev. Rul. 2001–52, page 434.

November 5, 2001 436 2001–45 I.R.B.