IRS Releases Final Regulations Interpreting the Code Section 415 Limits on Benefits Under Tax-Qualified Retirement Plans

April 16, 2007

On April 5, the IRS issued final regulations under Section 415 of the Internal Revenue Code (“Code”). Section 415(c) of the Code generally limits the amount of annual contributions to a tax-qualified defined contribution plan on behalf of a participant to the lesser of 100% of compensation or $40,000 (adjusted for inflation; currently $45,000). Section 415(b) of the Code generally limits the annual benefit under a tax-qualified defined benefit plan to the lesser of $160,000 (adjusted for inflation; currently $180,000) or 100% of the participant’s high-3 year average compensation, subject to various adjustments based on when benefits commence (the limitation is lower for benefit commencement prior to age 62 and higher for benefit commencement after age 65) and the form of benefit payment.

The final regulations track closely the proposed regulations issued by the IRS in May 2005, with certain additions to reflect the changes made to Section 415 by the Pension Protection Act of 2006. The new final regulations incorporate statutory changes made since the prior version of the regulations was issued in 1981.

The most significant change made by the regulations is regarding the treatment of severance pay. As under the proposed regulations, the final regulations (along with concurrent changes to the Code Section 401(k) regulations) provide that terminated employees generally may not make 401(k) elective deferrals from compensation payable after termination of employment and that such payments do not qualify as “compensation” for purposes of the Code Section 415 limitations. The proposed regulations included two limited exceptions to this general rule for: (i) payments that, absent termination of employment, the employee would have earned as regular compensation for services performed during regular working hours or in a form of compensation such as overtime, a shift differential, commissions or bonuses, and (ii) payments for accrued bona fide sick, vacation or other leave that the employee could have used if he or she had remained employed. In each case, under the proposed regulations such amounts could qualify as “compensation” so long as they were paid no later than 2½ months following termination of employment. Under the final regulations, the timeframe for these exceptions has been expanded to the later of 2½ months following termination of employment or the end of the limitation year (which is the calendar year for most plans) that includes the date of termination. In addition, the final regulations provide that post-termination payments from a nonqualified deferred compensation plan may qualify as “compensation” if such payments are made within the timeframe described above and the payments would have been made at the same time if the employee had remained employed (e.g., deferred compensation distributions scheduled for a fixed date that falls within the permissible timeframe). The final regulations also provide that post-termination compensation paid to a permanently and totally disabled participant may qualify as “compensation,” provided certain conditions are satisfied.

As with the proposed regulations, under the final regulations elective deferrals generally may not be made from any other payments made after termination of employment, even if paid within the permissible timeframe. For example, deferrals may not be made from severance pay or payments from a nonqualified deferred compensation plan (except as described above). However, it appears that under the final regulations severance payments that are actually paid prior to termination of employment may be included as “compensation” under Section 415. Thus, employers that want to count severance as compensation under their tax-qualified plans generally will need to pay the severance in a lump sum no later than the last day of employment (which may not be practical if a binding release of claims is desired). Subject to this relatively narrow exception, the final regulations will require employers that have traditionally treated severance as eligible compensation under their tax-qualified retirement plans to end this practice.

The final regulations generally are effective for limitation years beginning on or after July 1, 2007 (which, for most plans, will be the 2008 calendar year). Most plans will need to be amended to reflect the final rules no later than the employer’s tax return due date (including extensions) for the year with respect to which the final regulations first become effective. This deadline generally will be September 15, 2009 for calendar year plans of calendar year taxpayers..  

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or

Stephen W. Fackler (650-849-5385, [email protected]),
David West (213-229-7654, [email protected]),
David I. Schiller (214-698-3205, [email protected]),
Michael J. Collins (202-887-3551, [email protected]),
Sean Feller (213-229-7579, [email protected]),
Amber Busuttil Mullen (213-229-7023, [email protected]),
Jennifer Patel (202-887-3564, [email protected]), 
Chad Mead (214-698-3134, [email protected]), 
Kimberly Woolley (415-393-8225, [email protected]), or
Jonathan Rosenblatt (650-849-5317, [email protected]).

© 2007 Gibson, Dunn & Crutcher LLP

The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.