Final Nondescrimination Regs for Qualified Plans

 [4830-01]

 ACTION: Final regulations.

 SUMMARY: This document contains final regulations relating to the scope and meaning of the term "compensation" for tax-qualified retirement plans under section 414(s) of the Internal Revenue Code of 1986. These regulations reflect changes made by the Tax Reform Act of 1986 and the Technical and Miscellaneous Revenue Act of 1988. These regulations provide guidance necessary to comply with the law and affect sponsors of, and participants in, tax-qualified retirement plans.

 EFFECTIVE DATE: These regulations are effective for plan years beginning on or after January 1, 1987, and are applied to those plan years except as set forth in section 1.414(s)-1(i).

 FOR FURTHER INFORMATION CONTACT: David Fuller at 202-377-9372 (not a toll-free number).

SUPPLEMENTARY INFORMATION: On May 14, 1990, the Internal Revenue Service published temporary regulations relating to the scope and meaning of the term "compensation" under sections 414(s) and 415(c)(3) of the Internal Revenue Code (Code) in the Federal Register (55 FR 19875). Those regulations provided guidance concerning the definition of compensation and conformed the regulations to section 1115 of the Tax Reform Act of 1986 and section 1011(j)(1) of the Technical and Miscellaneous Revenue Act of 1988. The text of those temporary regulations served as the comment document for a notice of proposed rulemaking also published in the Federal Register May 14, 1990 (55 FR 19945).

 Written comments were received from the public on the proposed regulations. In addition, on September 26, 27, and 28, 1990, a public hearing was held concerning the regulations. After consideration of all of the written comments received and the statements made at the public hearing, the proposed and temporary regulations are adopted as modified by this Treasury Decision.

BACKGROUND

 Section 414(s) and these regulations provide rules for defining compensation for purposes of applying any provision that specifically refers to section 414(s). For example, section 414(s) is explicitly referred to in many of the nondiscrimination provisions applicable to pension, profit-sharing, and stock bonus plans qualified under section 401(a). The amount of plan benefits or contributions, expressed as a percentage of compensation within the meaning of section 414(s), is generally one of the key factors in determining whether these nondiscrimination provisions are satisfied.

 The temporary regulations implemented the section 414(s) definition of compensation by providing design-based safe harbor definitions of compensation under section 415(c)(3) and a design- based safe harbor alternative definition under section 414(s). In addition, the temporary regulations generally provided that any other reasonable definition of compensation would satisfy section 414(s) if the definition did not by design favor highly compensated employees and satisfied a nondiscrimination requirement. Finally, the temporary regulations provided rules that permitted compensation to include elective salary reduction contributions specified in section 414(s)(2), section 457 deferred compensation, and section 414(h) employer pick-up amounts.

OVERVIEW OF DEVELOPMENT OF FINAL REGULATIONS

 The Department of the Treasury and the Internal Revenue Service have received a number of comments on the proposed and temporary regulations under section 414(s) and the regulations under the related Code sections with which the section 414(s) regulations were published (in particular, sections 401(a)(4), 401(l), and 410(b)). This Treasury Decision reflects consideration of all of the comments received. In general, the final regulations retain the approach taken in the temporary regulations. In response to comments, revisions have been made to increase the utility of the design-based safe harbors, to increase the flexibility of the rules permitting reasonable nondiscriminatory definitions, and to simplify and clarify certain aspects of the temporary regulations.

COMPENSATION SAFE HARBORS UNDER SECTION 415(c)(3) APPLICABLE FOR PURPOSES OF SECTION 414(s)

SECTION 1.415(c)(3) SAFE HARBOR DEFINITIONS.

 The temporary regulations under section 414(s) provided that definitions of compensation that satisfied section 415(c)(3) also would constitute safe harbor definitions of compensation for purposes of section 414(s). The temporary regulations also clarified the regulations under section 415(c)(3) as to what amounts were included in compensation. In addition, the temporary regulations added two new section 415(c)(3) safe harbors generally based on wages as defined for FICA tax purposes and on wages as defined for income tax withholding purposes.

 Commentators generally favored the addition of a safe harbor definition based on wages for purposes of income tax withholding. This safe harbor definition is retained without modification in the final regulations.

 In contrast, many commentators found the new safe harbor definition based on FICA wages to be of limited utility from an administrative point of view. In addition, comments indicated that the use of FICA wages as an alternative compensation definition under section 415(c)(3) was being misinterpreted and misapplied. Moreover, commentators pointed out that often the data was not readily accessible because many employers do not keep a separate accounting of FICA wages after an employee's wages exceed the taxable wage base limitation.

 A number of commentators requested a safe harbor definition based on wages reported in Box 10 on Form W-2, Wage and Tax Statement (Box 10 Compensation), indicating that it would be a useful safe harbor definition of compensation. Box 10 Compensation does not precisely match either FICA wages or wages for income tax withholding purposes since it includes items that are not wages" under either definition. However, the commentators noted that for many employers this is the most accessible individual employee compensation amount retained in their data bases.

 In response to these comments and to further administrability, the final regulations eliminate the section 415(c)(3) safe harbor definition of compensation based on FICA wages and replace it with a new safe harbor definition for compensation required to be reported under sections 6041 and 6051. This safe harbor definition is intended to be a safe harbor for Box 10 Compensation. Employers may assume that, as long as the instructions to the Form W-2 concerning the amount to report in Box 10 remain the same as they are for the 1990 or 1991 Form W-2, the amount reported in Box 10 for any employee satisfies this safe harbor. In addition, the final regulations permit employers to adjust the Box 10 compensation amount by excluding moving expense reimbursements if it is reasonable to believe that a corresponding deduction is allowable under section 217.

2. RESIDENTS OF CERTAIN U.S. POSSESSIONS.

 Sections 931 and 933 provide that the gross income of residents of American Samoa, Guam, the Northern Mariana Islands, or Puerto Rico does not include income derived from sources within these specified possessions or Puerto Rico, respectively. The temporary regulations under section 415(c)(3) provided that an item or amount is only compensation to the extent that it is includible in gross income. The final regulations clarify that the exclusions from gross income under sections 931 and 933 are disregarded for purposes of determining whether income from any of the specified possessions or Puerto Rico is compensation under section 415(c)(3). The final regulations also provide that similar principles are to be applied in determining compensation of self-employed individuals who are residents of specified possessions or Puerto Rico.

COMPENSATION UNDER SECTION 414(s)

1. DEFINITIONS OF COMPENSATION THAT SATISFY SECTION 414(s).

 Under section 414(s)(3), the Secretary is granted authority to prescribe alternative definitions of compensation by regulation. Section 1.414(s)-1(c)(3) of the temporary regulations exercised that authority by prescribing a safe harbor alternative definition of compensation that automatically satisfies section 414(s). Under the safe harbor alternative definition, an employer may generally define compensation as including regular or base salary or wages, plus commissions, tips, overtime and other premium pay, and bonuses, and excluding all of the items specified in the regulation for this purpose (even if includible in gross income). These specified exclusions are reimbursements or other expense allowances, fringe benefits (whether cash or noncash), moving expenses, deferred compensation, and welfare benefits.

 This safe harbor definition is retained in the final regulations. The final regulations also retain the rule permitting an employer to elect to modify a section 415(c)(3) definition or the safe harbor alternative definition to include the amount of certain elective contributions, section 457 deferred compensation, and section 414(h) employer pickup amounts, provided that all these amounts are included.

 Commentators asked that the safe harbor alternative definition be expanded to allow additional items to be excluded from the compensation of highly compensated employees. The final regulations amplify the temporary regulations by permitting an employer to modify any of the safe harbor definitions to permit additional items or amounts of compensation to be excluded on a uniform and consistent basis from the compensation of highly compensated employees, but not from the compensation of any nonhighly compensated employees. This modification is permitted to be made after the inclusion of elective contributions and deferred compensation. Thus, for example, a definition of compensation under section 415(c)(3) could be first modified to include all elective contributions, section 457 deferred compensation, and employer pick-up amounts, but then be further modified to exclude section 457 deferred compensation on a uniform consistent basis from the compensation of highly compensated employees.

2. REASONABLE DEFINITION OF COMPENSATION.

 In addition to the safe harbor alternative definition, the temporary regulations provided that any other alternative definition of compensation would satisfy section 414(s) if the definition was reasonable, did not by design favor highly compensated employees, and satisfied a nondiscrimination requirement. This flexible approach was intended to accommodate employers' legitimate business needs while retaining the basic statutory requirement that the compensation definition must be nondiscriminatory. Comments on this approach were generally favorable, and, therefore, the final regulations retain this general rule. Commentators also asked for clarification on certain aspects of the rule. Thus, final regulations provide further guidance on circumstances under which a definition is not reasonable. For example, under the final regulations, a definition of compensation is not reasonable if the definition includes an item or amount not includible under a safe harbor definition (e.g., business expenses substantiated to the payor under an accountable plan). In addition, a definition is not reasonable if it provides that each employee's compensation is a specified portion of the employee's total compensation (such as 90 percent) measured for the otherwise applicable determination period.

3. USE OF RATE-OF-PAY DEFINITION FOR PURPOSES OF SECTION 414(s).

 Commentators indicated that many plans use a rate-of-pay definition of compensation under the plan benefit formula and requested that the regulations permit use of a rate-of-pay definition as an alternative definition under section 414(s). Often an employer uses rate of pay in the benefit formula because it reduces data collection, is predictable, and is easily administered. The proposed regulations under section 401(a)(4) and the temporary regulations under section 414(s) did not preclude employers from retaining a rate-of-pay definition of compensation for purposes of applying the plan formula. However, a plan using a rate-of-pay benefit formula would have been required to use a different definition of compensation in testing for compliance with the nondiscrimination rules and could not have satisfied the nondiscrimination rules on a safe harbor basis.

 Rate of pay as an alternative section 414(s) definition of compensation was not included in the temporary regulations because rate of pay is a projected figure, rather than a reflection of actual compensation. Thus, it appeared to be inconsistent with the underlying purpose of the definition of compensation under section 414(s). Nevertheless, the Treasury and the Service recognize that use of a rate-of-pay formula by a plan facilitates plan administration and may, in fact, be reasonable and nondiscriminatory under specified conditions. Consequently, the final regulations permit rate of pay (referred to as rate of compensation in the regulations) as an alternative definition under section 414(s). However, to limit possible distortions, if rate-of-pay compensation is used for purposes of section 414(s), amounts based on the employee's rate of pay can only be credited under the formula for 30 days after an employee terminates employment (or is otherwise absent without pay). Of course, as with any section 414(s) definition of compensation other than one included in a safe harbor, the definition must be nondiscriminatory. By permitting rate of pay as an alternative section 414(s) definition of compensation, plans using a rate-of-pay benefit formula may be able to satisfy section 401(a)(4) on a safe harbor basis.

4. CREDITING COMPENSATION DURING LEAVES OF ABSENCE.

 Commentators suggested that the permissible definitions of compensation under section 414(s) should allow crediting of compensation while an employee is on leave of absence in order to permit continued accruals under the plan. During the interim between the temporary regulations and the final regulations, attention was focused on this issue as a result of the Persian Gulf conflict. Specifically, employers asked whether compensation credited to reservists under employee benefit plans while on leave of absence due to active military duty would satisfy section 414(s) as a reasonable definition of compensation.

 In response to these comments, the final regulations provide that compensation credited for benefit accrual purposes during an unpaid absence from service for a reason other than termination from employment can satisfy section 414(s). Under the final regulations, compensation may be credited indefinitely for absence from service due to military duty or jury duty. In addition to absence from service for military duty and jury duty, the final regulations also permit compensation to be deemed to continue under this rule for other unpaid absence from service for a period not to exceed 6 months. No similar rule was necessary for absence from service due to long-term disability because any benefit based on deemed compensation credited during a disability period generally gives rise to a qualified disability benefit and thus is not included in nondiscrimination testing of benefit amounts. See section 411(a)(9)(B).

 The regulations impose certain restrictions on the compensation that may be credited during absence from service for purposes of section 414(s) in order to ensure that the method used is nondiscriminatory. Specifically, the final regulations require that the compensation credited not exceed the compensation that would have been credited under the plan if services had continued (e.g., actual compensation at the time the leave of absence began or the rate of pay in effect while the employee is absent from service that is applicable to the employee's specific job grade). In addition, the final regulations require that any provisions in the plan for crediting compensation must be applied uniformly to all similarly situated employees and that the provisions for crediting compensation satisfy the effective availability requirements under section 401(a)(4). See section 1.401(a)(4)-4(c).

5. NONDISCRIMINATION REQUIREMENT

 The final regulations, like the temporary regulations, provide that an alternative definition of compensation is nondiscriminatory under section 414(s) if the average percentage of total compensation included under the alternative definition for an employer's highly compensated employees as a group does not exceed by more than a de minimis amount the average percentage of total compensation included under the alternative definition for the employer's nonhighly compensated employees as a group. The preamble to the temporary regulations stated that any reasonable method could be used for this purpose. Several commentators suggested that the final regulations should provide more guidance on appropriate methodologies for determining the average percentage for each group.

 The final regulations continue to provide that any reasonable method may be used in determining the average percentages of total compensation included under the alternative definitions for the highly compensated employee group and the nonhighly compensated employee group, respectively. However, the final regulations also include a specific averaging calculation method that is treated as satisfying the reasonableness requirement. Under this method, an individual compensation percentage is calculated for each employee in the highly compensated employee group and in the nonhighly compensated employee group. An employee's compensation percentage is calculated by dividing the amount of the employee's compensation that is included in the alternative definition by the amount of the employee's total compensation. These individual compensation percentages are then averaged within the highly compensated and nonhighly compensated groups producing an average for each group. Any other reasonable method may be utilized to calculate the average- compensation percentages for either group provided the average percentage produced by the method is not reasonably expected to vary significantly from the average percentage using the individual- percentage method. Recognizing the factors that create a significant variance in the calculation of the average percentage may not be the same for both groups, the final regulations do not require that the same method must be used to calculate the average percentage for each group.

 In the case of a rate-of-pay definition of compensation or a definition of compensation that credits compensation during absence from service, the nondiscrimination requirement is modified to prevent distortions in the average percentage of total compensation included under the alternative definition for the highly compensated employee group and the nonhighly compensated employee group. A distortion may result if the imputed compensation credited to some employees for a year under the alternative definition exceeds actual compensation for those employees for the year. Therefore, the final regulations provide that, in the case of these definitions of compensation, solely for purposes of calculating the average percentages used in applying the nondiscrimination test, the compensation included for an employee under the alternative definition may not exceed the employee's total compensation.

6. EMPLOYEES TAKEN INTO ACCOUNT FOR NONDISCRIMINATION PURPOSES.

 The final regulations, like the temporary regulations, provide that the employees taken into account in determining whether a compensation definition is nondiscriminatory are the same employees taken into account in satisfying the applicable statutory provision. However, the temporary regulations permitted the nondiscrimination requirement to be satisfied taking into account all the nonexcludable employees of an employer unless use of that method could reasonably be expected to result in a distortion of the percentage that was more than de minimis given the compensation characteristics of the employer's work force. Concerns were raised that employers were reluctant to use this rule because of uncertainty as to whether their facts met the applicable standard. Thus, the rule has been modified to permit employers to take into account all employees in all plans of the employer for which the alternative definition is being used to determine whether the plan satisfies section 401(a)(4) for the plan year.

7. AVAILABILITY OF ELECTIVE, EMPLOYEE, AND MATCHING CONTRIBUTIONS.

 The temporary regulations contained a rule providing that, for the limited purposes of applying the nondiscriminatory availability requirements of the proposed regulations with respect to elective, employee, and matching contributions, any reasonable definition of compensation was treated as nondiscriminatory. This rule was deleted from the final regulations because the final section 401(k) and 401(m) regulations published in the Federal Register on August 15, 1991, and the final section 401(a)(4) regulations issued simultaneously with this regulation, clarify the application of the nondiscriminatory availability requirement under section 401(a)(4) to arrangements subject to sections 401(k) and 401(m), and make this rule unnecessary. See section 1.401(k)-1(a)(4)(iv) and section 1.401(m)-1(a)(2). Under these rules, employee, elective, and matching contributions are not required to be based on compensation determined under a definition that satisfies section 414(s). Rather, use of different definitions of compensation for purposes of the right to employee, elective, and matching contributions are treated as different benefits, rights, and features, each of which must separately satisfy the nondiscriminatory availability requirement of section 1.401(a)(4)-4. In addition, employee, elective, and matching contributions that use a definition of compensation that has the effect of restricting access by nonhighly compensated employees may not satisfy the nondiscriminatory availability requirement of the final section 401(a)(4) regulations, even where the same definition of compensation is used for all employees.

EFFECTIVE DATE

 These regulations are effective for plan years beginning on or after January 1, 1987, except as set forth in section 1.414(s)-1(i).

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations and, therefore, a final Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations was submitted to the Administrator of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal authors of these regulations are Majorie Hoffman and David Fuller of the Office of the Assistant Chief Counsel (Employee Benefits and Exempt Organizations), Internal Revenue Service. However, personnel from other offices of the Service and Treasury Department participated in their development.

LIST OF SUBJECTS IN 26 CFR 1.401-0 THROUGH 1.419A-2T

 Bonds, Employee benefit plans, Income taxes, Pensions, Reporting and recordkeeping requirements, Securities, Trusts and trustees.

Treasury Decision 8361

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part I is amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority citation for part 1 is amended by removing the citation for section 1.414(s)-1T and adding the following citation to read as follows:

Authority: Sec. 7805, 68A Stat. 917; 26 U.S.C. 7805. * * * section 1.414(s)-1 also issued under 26 U.S.C. 414(s). * * *

Par. 2. New section 1.414(s)-1 is added to read as follows:

SECTION 61.414(s)-1 DEFINITION OF COMPENSATION.

(a) INTRODUCTION -- (1) IN GENERAL. Section 414(s) and this section provide rules for defining compensation for purposes of applying any provision that specifically refers to section 414(s) or this section. For example, section 414(s) is referred to in many of the nondiscrimination provisions applicable to pension, profit- sharing, and stock bonus plans qualified under section 401(a). In accordance with section 414(s)(1), this section defines compensation as compensation within the meaning of section 415(c)(3). It also implements the election provided in section 414(s)(2) to treat certain deferrals as compensation and exercises the authority granted to the Secretary in section 414(s)(3) to prescribe alternative nondiscriminatory definitions of compensation.

(2) LIMITATIONS ON SCOPE OF SECTION 414(s). Section 414(s) and this section do not apply unless a provision specifically refers to section 414(s) or this section. For example, even though a definition of compensation permitted under section 414(s) must be used in determining whether the contributions or benefits under a pension, profit sharing, or stock bonus plan satisfy a certain applicable provision (such as section 401(a)(4)), except as otherwise specified, the plan is not required to use a definition of compensation that satisfies section 414(s) in calculating the amount of contributions or benefits actually provided under the plan.

(3) OVERVIEW. Paragraph (b) of this section provides rules of general application that govern a definition of compensation that satisfies section 414(s). Paragraph (c) of this section contains specific definitions of compensation that satisfy section 414(s) without satisfying any additional nondiscrimination requirement under section 414(s). Paragraph (d) of this section provides rules permitting the use of alternative definitions of compensation that satisfy section 414(s) as long as the nondiscrimination requirement and other requirements described in paragraph (d) of this section are satisfied. Paragraph (e) of this section provides special rules permitting, under certain limited circumstances, the use of imputed compensation rather than actual compensation under a definition of compensation that satisfies section 414(s). Paragraph (f) of this section provides other special rules, including a special rule for determining the compensation of a self-employed individual under an alternative definition of compensation. Paragraph (g) of this section provides definitions for certain terms used in this section.

(b) RULES OF GENERAL APPLICATION -- (1) USE OF A DEFINITION. Any definition of compensation that satisfies section 414(s) may be used when a provision explicitly refers to section 414(s) unless the reference or this section specifically indicates otherwise.

(2) CONSISTENCY RULE. A definition of compensation selected by an employer for use in satisfying an applicable provision must be used consistently to define the compensation of all employees taken into account in satisfying the requirements of the applicable provision for the determination period. For example, although any definition of compensation that satisfies section 414(s) may be used for section 401(a)(4) purposes, the same definition of compensation generally must be used consistently to define the compensation of all employees taken into account in determining whether a plan satisfies section 401(a)(4). Furthermore, a different definition of compensation that satisfies section 414(s) is permitted to be used to determine whether another plan maintained by the same employer separately satisfies the requirements of section 401(a)(4). Although a definition of compensation must be used consistently, an employer may change its definition of compensation for a subsequent determination period with respect to the applicable provision. Rules provided under any applicable provision may modify the consistency requirements of this paragraph (b)(2).

(3) SELF-EMPLOYED INDIVIDUALS. Notwithstanding paragraph (b)(1) of this section, self-employed individuals' compensation can only be determined under paragraph (c)(2) of this section (with or without the modification permitted by paragraph (c)(4) of this section) or by using an equivalent alternative compensation amount determined in accordance with paragraph (f)(1) of this section. These limitations on self-employed individuals do not affect their common-law employees. Thus, the compensation of common-law employees of a partnership or sole proprietorship may be defined using an alternative definition, provided the definition otherwise satisfies paragraph (c)(3), (d), or (e) of this section. If an alternative definition of compensation under paragraph (c)(3), (d), or (e) of this section is used for other employees to satisfy an applicable provision, the consistency requirement is only met if paragraph (f) of this section is used for the self-employed individuals.

(c) SPECIFIC DEFINITIONS OF COMPENSATION THAT SATISFY SECTION 414(s) -- (1) GENERAL RULES. The definitions of compensation provided in paragraphs (c)(2) and (c)(3) of this section satisfy section 414(s) and need not satisfy any additional requirements under section 414(s). Paragraph (c)(2) of this section describes definitions of compensation within the meaning of section 415(c)(3). Paragraph (c)(3) of this section provides a safe harbor alternative definition that excludes certain additional items of compensation. Paragraph (c)(4) of this section permits any definition provided in paragraph (c)(2) or (c)(3) of this section to include certain types of elective contributions and deferred compensation. Paragraph (c)(5) of this section permits certain modifications to a definition otherwise provided under this paragraph (c).

(2) COMPENSATION WITHIN THE MEANING OF SECTION 415(c)(3). A definition of compensation that includes all compensation within the meaning of section 415(c)(3) and excludes all other compensation satisfies section 414(s). Sections 1.415-2(d)(2) and (d)(3) provide rules for determining items of compensation included in and excluded from compensation within the meaning of section 415(c)(3). In addition, section 414(s) is satisfied by the safe harbor definitions provided in section 1.415-2(d)(10) and (d)(11) and any additional definitions of compensation prescribed by the Commissioner under the authority provided in section 1.415-2(d)(13) that are treated as satisfying section 415(c)(3).

(3) SAFE HARBOR ALTERNATIVE DEFINITION. Under the safe harbor alternative definition in this paragraph (c)(3), compensation is compensation as defined in paragraph (c)(2) of this section, reduced by all of the following items (even if includible in gross income): reimbursements or other expense allowances, fringe benefits (cash and noncash), moving expenses, deferred compensation, and welfare benefits.

(4) INCLUSION OF CERTAIN DEFERRALS IN COMPENSATION. Any definition of compensation provided in paragraph (c)(2) or (c)(3) of this section satisfies section 414(s) even though it is modified to include all of the following types of elective contributions and all of the following types of deferred compensation --

(i) Elective contributions that are made by the employer on behalf of its employees that are not includible in gross income under section 125, section 402(a)(8), section 402(h), and section 403(b);

(ii) Compensation deferred under an eligible deferred compensation plan within the meaning of section 457(b) (deferred compensation plans of state and local governments and tax-exempt organizations); and

(iii) Employee contributions (under governmental plans) described in section 414(h)(2) that are picked up by the employing unit and thus are treated as employer contributions.

(5) EXCLUSIONS APPLICABLE SOLELY TO HIGHLY COMPENSATED EMPLOYEES. Any definition of compensation that satisfies paragraph (c)(2) or (c)(3) of this section, with or without the modification permitted by paragraph (c)(4) of this section, may be modified to provide for exclusion of additional items or amounts (including, for example, any one or more of the types of elective contributions or deferred compensation described in paragraph (c)(4) of this section) on a uniform basis from the compensation of the employer's highly compensated employees. This paragraph (c)(5) only permits modifications that apply to the compensation of highly compensated employees. See paragraph (d) of this section for requirements with respect to any modifications in defining the compensation of nonhighly compensated employees.

(d) ALTERNATIVE DEFINITIONS OF COMPENSATION THAT SATISFY SECTION 414(s) -- (1) GENERAL RULE. In addition to the definitions provided in paragraph (c) of this section, any definition of compensation satisfies section 414(s) with respect to employees (other than self- employed individuals treated as employees under section 40l(c)(1)) if the definition of compensation does not by design favor highly compensated employees, is reasonable within the meaning of paragraph (d)(2) of this section, and satisfies the nondiscrimination requirement in paragraph (d)(3) of this section.

(2) REASONABLE DEFINITION OF COMPENSATION -- (i) GENERAL RULE. An alternative definition of compensation under this paragraph (d) is reasonable under section 414(s) if it is a definition of compensation provided in paragraph (c) of this section, modified to exclude any one or more of the types of compensation as permitted in paragraph (d)(2)(ii) of this section. See paragraph (e) of this section, however, for certain definitions of compensation that include amounts of imputed compensation that are not includible under any definition of compensation provided in paragraph (c) of this section.

(ii) ITEMS THAT MAY BE EXCLUDED. Subject to the applicable facts and circumstances, a reasonable definition of compensation is permitted, on a consistent basis, to exclude certain types of irregular or additional compensation, including (but not limited to) one or more of the following: any type of additional compensation for employees working outside their regularly scheduled tour of duty (such as overtime pay, premiums for shift differential, and call-in premiums); bonuses; or any one of the types of compensation excluded under the safe harbor alternative definition in paragraph (c)(3) of this section. A reasonable definition is also permitted to include, on a consistent basis, some, without being required to include all, of the types of elective contributions or deferred compensation described in paragraph (c)(4) of this section.

(iii) LIMITS ON THE AMOUNT EXCLUDED FROM COMPENSATION. A definition of compensation is not reasonable if it provides that each employee's compensation is a specified portion of the employee's compensation measured for the otherwise applicable determination period under another definition. For example, a definition of compensation that specifically limits each employee's compensation for a determination period to 95 percent of the employee's compensation using a definition provided in paragraph (c) of this section is not reasonable. Similarly, a definition of compensation that limits each employee's compensation used to satisfy an applicable provision with a 12-month determination period to compensation under a definition provided in paragraph (c) of this section for one month is not a reasonable definition of compensation. However, a definition of compensation is not unreasonable merely because it excludes all compensation in excess of a specified dollar amount.

(3) NONDISCRIMINATION REQUIREMENT -- (i) IN GENERAL. An alternative definition of compensation under this paragraph (d) is nondiscriminatory under section 414(s) for a determination period if the average percentage of total compensation included under the alternative definition of compensation for an employer's highly compensated employees as a group for the determination period does not exceed by more than a de minimis amount the average percentage of total compensation included under the alternative definition for the employer's nonhighly compensated employees as a group.

(ii) TOTAL COMPENSATION. For purposes of this paragraph (d)(3), total compensation must be determined using a definition of compensation provided in paragraph (c)(2) of this section, with or without the modification permitted by paragraph (c)(4) of this section. Total compensation taken into account for each employee (including, if added, the elective contributions and deferred compensation described in paragraph (c)(4) of this section) may not exceed the annual compensation limit of section 401(a)(17).

(iii) EMPLOYEES TAKEN INTO ACCOUNT -- (A) GENERAL RULE. In applying the requirement of this paragraph (d)(3), the employees taken into account are the same employees taken into account in satisfying the requirements of the applicable provision for the determination period. For example, in determining whether an alternative definition used to determine whether a plan satisfies section 40l(a)(4) satisfies this paragraph (d)(3), all employees in the plan for the plan year are generally taken into account. If an employer is using the same alternative definition of compensation to determine whether more than one separate plan satisfies section 401(a)(4), the employer is permitted to take into account all the employees in all the plans in determining whether the alternative definition of compensation being used satisfies this paragraph (d)(3).

(B) EXCLUSION OF SELF-EMPLOYED INDIVIDUALS. In applying the requirement of this paragraph (d)(3), self-employed individuals are disregarded.

(iv) CALCULATION OF AVERAGE PERCENTAGES -- (A) GENERAL RULE. To determine the average percentages described in paragraph (d)(3)(i) of this section, an individual compensation percentage must be calculated for each employee in a group, and then the average of the separately calculated compensation percentages for each employee in the group must be determined. The individual compensation percentage for an employee is calculated by dividing the amount of the employee's compensation that is included under the alternative definition by the amount of the employee's total compensation.

(B) OTHER REASONABLE METHODS. Notwithstanding paragraph (d)(3)(iv)(A) of this section, any other reasonable method is permitted to be used to determine the average percentages described in paragraph (d)(3)(i) of this section for either or both of the groups (i.e., highly compensated employees and nonhighly compensated employees), provided that the method cannot reasonably be expected to create a significant variance from the average percentage for that group determined using the individual-percentage method provided in paragraph (d)(3)(iv)(A) of this section. The same method is not required to be used for calculating the two average percentages. For example, to determine the average percentage for nonhighly compensated employees as a group, an employer may calculate an aggregate compensation percentage by dividing the aggregate amount of compensation of nonhighly compensated employees that is included under the alternative definition by the aggregate amount of total compensation of nonhighly compensated employees, provided the resulting percentage is not reasonably expected to vary significantly from the average percentage produced using the individual-percentage method provided in paragraph (d)(3)(iv)(A) of this section because of the extra weight given employees with higher compensation.

(v) FACTS AND CIRCUMSTANCES DETERMINATION. The determination of whether the average percentage of total compensation included for the employer's highly compensated employees as a group for a determination period exceeds by more than a de minimis amount the average percentage of total compensation included for the employer's nonhighly compensated employees as a group is based on the applicable facts and circumstances. The differences between the percentages for prior determination periods may be considered in determining whether the amount of the difference between the percentages is more than de minimis. In addition, an isolated instance of a more than de minimis difference between the compensation percentages that is due to an extraordinary unforeseeable event (such as overtime payments to employees of a public utility due to a major hurricane) will be disregarded if the amount of the difference in prior determination periods was de minimis.

(e) Imputed compensation -- (1) IN GENERAL -- (i) OVERVIEW. Notwithstanding paragraph (d)(2)(i) of this section, a definition of compensation satisfies section 414(s) as a reasonable alternative definition of compensation under section 414(s) even though it includes imputed compensation that is not includible in compensation under any definition described in paragraph (c) of this section, but only if the definition satisfies the requirements of paragraph (e)(2) or (e)(3) of this section, or both paragraphs if applicable. Paragraph (e)(2) of this section specifies the requirements for alternative definitions of compensation that include compensation based on an employee's basic or regular rate of compensation. Paragraph (e)(3) of this section specifies the requirements for alternative definitions of compensation that credit imputed compensation during certain periods of absence from service. As an alternative definition of compensation, a definition of compensation that includes imputed compensation must satisfy the nondiscrimination requirement of paragraph (d)(3) of this section. Paragraph (e)(4) of this section provides special rules for determining whether a definition of compensation that includes imputed compensation satisfies the nondiscrimination requirement under paragraph (d)(3) of this section.

(ii) NOT APPLICABLE TO CERTAIN CONTRIBUTIONS. This paragraph (e) does not apply to a definition of compensation used in determining whether elective deferrals (as defined in section 402(g)(3)), matching contributions (as defined in section 401(m)(4)), or employee contributions subject to section 401(m) satisfy any applicable provision. Thus, for example, a definition of compensation that includes imputed compensation may not be used to measure compensation for purposes of determining if a qualified cash or deferred arrangement satisfies the actual deferral percentage test in section 401(k)(3).

(2) RATE OF COMPENSATION -- (i) GENERAL RULE. An alternative definition that defines compensation for a specified period (or series of specified periods) within a determination period based on the basic or regular rate of compensation of each employee as of a designated date in the specified period (or in each of the specified periods in the series) satisfies section 414(s) as a reasonable alternative definition if the definition satisfies the requirements specified in paragraph (e)(2)(ii) of this section and otherwise satisfies the requirements of paragraph (d) of this section, including the nondiscrimination test in paragraph (d)(3) of this section as applied in paragraph (e)(4) of this section.

(ii) REQUIREMENTS FOR DEFINITIONS OF COMPENSATION BASED ON RATE OF COMPENSATION -- (A) BENEFIT DETERMINATION. The alternative definition of compensation must actually be used to calculate the benefits or contributions that are subject to the applicable provision. For example, the alternative definition may not be used to determine whether a plan satisfies section 401(a)(4) with respect to the amount of benefits or contributions, unless the benefits or contributions for each employee in the plan are determined using the alternative definition of compensation.

(B) RATE OF COMPENSATION. The employee's rate of compensation must be based on an hourly pay scale, weekly salary, or similar unit of base or regular compensation applicable to the employee.

(C) SPECIFIED PERIOD. The specified period may be a week, month, year, or other period provided that the period does not exceed 12 months or the determination period, if shorter.

(D) DATE FOR DETERMINING RATE OF COMPENSATION. Any date during the specified period may be designated as the date on which the rate of compensation is determined provided that the same date is used for all employees taken into account in satisfying the applicable provision. In addition, the date selected, by itself, must not cause the portion of total compensation included for any employee (or group of employees) to vary significantly from the portion of total compensation included for any other employee (or group of employees).

(E) PERIODS WITHOUT COMPENSATION OR WITH REDUCED COMPENSATION. An employee's compensation may generally only be determined using the employee's rate of compensation for employment periods during which the employer actually compensates the employee. However, if an employee terminates employment or is absent from service either without compensation or with reduced compensation (such as for a leave of absence, layoff, or similar event), the employer may continue to credit the employee with compensation based on the employee's rate of compensation for a period of up to 31 days after the event, provided the 31-day period does not extend into a subsequent determination period with respect to the applicable provision. Paragraph (e)(3) of this section contains special rules for crediting compensation during periods of absence from service extending beyond 31 days.

(3) ABSENCE FROM SERVICE -- (i) GENERAL RULE. Solely for purposes of determining whether a defined benefit plan, as defined in section 1.410(b)-9, satisfies section 401(a)(4) or 410(b), an alternative definition that includes imputed compensation credited to employees during a period of absence from service that is not otherwise includible in compensation within the meaning of section 415(c)(3) satisfies section 414(s) as a reasonable alternative definition if the definition satisfies the requirements specified in paragraph (e)(3)(ii) of this section. In addition, the definition must otherwise be described in paragraph (c) of this section or must otherwise satisfy the requirements of paragraph (d) or (e)(2) of this section for alternative definitions of compensation, including the nondiscrimination test in paragraph (d)(3) of this section as applied by paragraph (e)(4) of this section.

(ii) REQUIREMENTS FOR DEFINITIONS OF COMPENSATION CREDITING COMPENSATION DURING ABSENCE FROM SERVICE -- (A) ABSENT FROM SERVICE. For the period during which compensation is credited to an employee, the employee must be absent from service for a reason other than termination from employment with the employer maintaining the plan. If an employee continues to perform any services for the employer during the period, the employee is not absent from service.

(B) BENEFIT DETERMINATION. The alternative definition of compensation must actually be used to calculate the benefits under the plan. For example, the alternative definition may not be used to determine whether a plan satisfies section 401(a)(4) with, respect to the amount of benefits or equivalent allocations unless the benefits for each employee in the plan are determined using the alternative definition of compensation.

(C) UNIFORMITY. Any provisions in the plan for crediting imputed compensation while an employee is absent from service must be applied uniformly to all similarly situated employees in the plan.

(D) EFFECTIVE AVAILABILITY. For purposes of applying the effective availability requirement of section 1.401(a)(4)-4(c) to the right to imputed compensation credited under the plan, the manner in which the employer grants absences from service that give rise to imputed compensation is taken in into account.

(E) PERIOD OF CREDITED COMPENSATION. In the case of compensation credited for a period during which an employee is absent from service for any reason other than military duty or jury duty, the maximum period for which the compensation may be credited under the alternative definition is the shorter of 6 months or the duration of the absence. If an employee is absent from service for military duty or jury duty, compensation may be credited to the employee for the entire period of the military duty or jury duty, even if the period exceeds 6 months.

(iii) REASONABLE METHOD. Any reasonable method may be used to determine the amount of compensation to be credited during an absence from service, provided that the following requirements are satisfied --

(A) The terms of the alternative definition of compensation for imputing credited compensation during an absence from service (when applied to the compensation described in paragraph (e)(3)(iii)(B) of this section) are not more inclusive than the terms of the alternative definition as applied to compensation for actual service.

(B) The amount credited is based on compensation that is reasonably representative of the compensation the employee would have received during the period if the employee had continued to perform services. Except as otherwise required by law, the compensation that the employee was receiving immediately before the absence from service began, or the rate of compensation in effect while the employee is absent from service that is applicable to the employee's specific job grade immediately before the absence from service began, will be the most representative compensation. For example, if an employee's compensation is determined under paragraph (c)(2) of this section for periods of actual service, the compensation credited for the employee during a period of absence from service might reasonably be based on the employee's compensation determined under paragraph (c)(2) of this section immediately before the absence began.

(4) APPLICATION OF THE NONDISCRIMINATION REQUIREMENT TO IMPUTED COMPENSATION -- (i) SAFE HARBOR DEFINITIONS. If the definition of compensation is otherwise described in paragraph (c) of this section, and the imputed compensation credited for periods of absence from service satisfies paragraph (e)(3) of this section, then the definition is deemed to satisfy paragraph (d) of this section (i.e., it is deemed to be nondiscriminatory), and thus need not satisfy any other nondiscrimination test under section 414(s).

(ii) OTHER DEFINITIONS. The amount of each employee's compensation for a determination period (determined under an alternative definition that includes imputed compensation) that is taken into account in determining the average percentages in the nondiscrimination requirement of paragraph (d)(3) of this section must be limited to 100 percent of the employee's total compensation for that period. This rule applies even if the amount of compensation actually credited to the employee for the determination period under the alternative definition and, thus, used as compensation within the meaning of section 414(s), exceeds the employee's total compensation for the period.

(f) SPECIAL rules -- (1) SELF-EMPLOYED INDIVIDUALS -- (i) GENERAL RULE. If an alternative definition of compensation under paragraph (c)(3), (d), or (e) of this section is used to satisfy an applicable provision, an equivalent alternative compensation amount must be determined for any self-employed individual who is in the group of employees for whom paragraph (b) of this section requires a single definition of compensation to be used. This equivalent alternative compensation amount is determined by multiplying the self-employed individual's total earned income (as defined in section 401(c)(2)) for the determination period by the percentage of total compensation (as defined in paragraph (d)(3)(ii) of this section) included under the alternative definition for the employer's nonhighly compensated common-law employees as a group (determined in a manner consistent with the rules in paragraph (d)(3)(iii) of this section and, if applicable, paragraph (e)(4)(ii) of this section). Thus, for purposes of this determination, highly compensated common- law employees must be disregarded. This equivalent alternative compensation amount will be treated as the self-employed individual's compensation under the alternative definition of compensation for the determination period.

(ii) INCLUSION OF ELECTIVE CONTRIBUTIONS. If the alternative definition of compensation includes any types of elective contributions described in paragraph (c)(4) of this section, the self-employed individual's earned income for this determination must be increased by the amount of elective contributions made by the employer on behalf of the self-employed individual, and the definition of total compensation for this determination must include all the types of elective contributions described in paragraph (c)(4) of this section made by the employer on behalf of common-law employees (other than highly compensated employees).

(2) LEASED EMPLOYEES. [Reserved]

(g) DEFINITIONS. The following definitions apply for purposes of this section:

(1) APPLICABLE PROVISION. "Applicable provision" means a provision that specifically refers to section 414(s) or this section.

(2) DETERMINATION PERIOD. "Determination period" means a period during which the amount of compensation is measured for use in determining whether the requirements of an applicable provision are satisfied. If no period is provided under the applicable provision for measuring compensation, the determination period is the period for which the applicable provision must be satisfied. The applicable provision may provide additional rules concerning the determination period to be used for satisfying the nondiscrimination requirement in paragraph (d) of this section.

(3) HIGHLY COMPENSATED EMPLOYEE. "Highly compensated employee" means an employee who is a highly compensated employee as defined in section 414(q).

(4) NONHIGHLY COMPENSATED EMPLOYEE. "Nonhighly compensated employees" means an employee who is not a highly compensated employee.

(5) SELF-EMPLOYED INDIVIDUAL. "Self-employed individual" means self-employed individual as defined in section 401(c)(1).

(h) ADDITIONAL RULES. The Commissioner may in revenue rulings, notices, and other guidance of general applicability provide additional rules for defining compensation within the meaning of section 414(s), including additional definitions of compensation that satisfy section 414(s).

(i) EFFECTIVE DATE -- (1) GENERAL EFFECTIVE DATE. This section 1.414(s)-1 applies to years beginning on or after January 1, 1987.

(2) OPTIONAL USE OF PRIOR REGULATIONS. For years beginning before September 19, 1991, employers may, in defining compensation for purposes of section 414(s), comply with the prior regulation provisions of section 1.414(s)-1T. See section 1.414(s)-1T as contained in the CFR edition revised as of April 1, 1991.

Par. 3. Section 1.414(s)-1T is removed.

Par. 4. Section 1.415-2 is amended by revising paragraph (d) to read as follows:

SECTION 1.415-2 DEFINITIONS AND SPECIAL RULES.

* * * * *

(d) COMPENSATION -- (1) GENERAL DEFINITION. Except as otherwise provided, compensation within the meaning of section 415(c)(3) includes all remuneration described in paragraph (d)(2) of this section and excludes all other forms of remuneration. Paragraph (d)(3) of this section provides examples of types of remuneration not includible in compensation within the meaning of section 415(c)(3). Paragraphs (d)(4) and (d)(5) of this section provide rules regarding the payment of compensation in the limitation year. Paragraph (d)(6) of this section provides a special rule for determining the compensation of employees of controlled groups or affiliated service groups. Paragraph (d)(7) of this section provides a special rule for applying the limitations of section 415(c) when a section 403(b) annuity is aggregated with a qualified plan of a controlled employer. Paragraphs (d)(8) and (d)(9) of this section are reserved for special rules for leased employees and for permanent and total disability, respectively. Paragraphs (d)(10) and (d)(11) of this section provide additional definitions of compensation that are treated as satisfying section 415(c)(3). Paragraph (d)(12) of this section permits optional use of prior regulations. Paragraph (d)(13) of this section provides authority to the Commissioner to provide further additional definitions of compensation that satisfy section 415(c)(3).

(2) ITEMS INCLUDIBLE AS COMPENSATION. For purposes of applying the limitations of section 415, the term "compensation" includes all of the following --

(i) The employee's wages, salaries, fees for professional services, and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the employer maintaining the plan to the extent that the amounts are includible in gross income (including, but not limited to, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits, and reimbursements or other expense allowances under a nonaccountable plan (as described in section 1.62-2(c)).

(ii) In the case of an employee who is an employee within the meaning of section 401(c)(1) and the regulations thereunder, the employee's earned income (as described in section 401(c)(2) and the regulations thereunder).

(iii) Amounts described in sections 104(a)(3), 105(a), and 105(h), but only to the extent that these amounts are includible in the gross income of the employee.

(iv) Amounts paid or reimbursed by the employer for moving expenses incurred by an employee, but only to the extent that at the time of the payment it is reasonable to believe that these amounts are not deductible by the employee under section 217.

(v) The value of a non-qualified stock option granted to an employee by the employer, but only to the extent that the value of the option is includible in the gross income of the employee for the taxable year in which granted.

(vi) The amount includible in the gross income of an employee upon making the election described in section 83(b).

Paragraphs (d)(2)(i) and (d)(2)(ii) of this section include foreign earned income (as defined in section 911(b)), whether or not excludable from gross income under section 911. Compensation described in paragraph (d)(2)(i) of this section is to be determined without regard to the exclusions from gross income in sections 931 and 933. Similar principles are to be applied with respect to income subject to sections 931 and 933 in determining compensation described in paragraph (d)(2)(ii) of this section.

(3) ITEMS NOT INCLUDIBLE AS COMPENSATION. The term "compensation" does not include items such as --

(i) Contributions made by the employer to a plan of deferred compensation to the extent that, before the application of the section 415 limitations to that plan, the contributions are not includible in the gross income of the employee for the taxable year in which contributed. In addition, employer contributions made on behalf of an employee to a simplified employee pension described in section 408(k) are not considered as compensation for the taxable year in which contributed. Additionally, any distributions from a plan of deferred compensation are not considered as compensation for section 415 purposes, regardless of whether such amounts are includible in the gross income of the employee when distributed. However, any amounts received by an employee pursuant to an unfunded non-qualified plan is permitted to be considered as compensation for section 415 purposes in the year the amounts are includible in the gross income of the employee.

(ii) Amounts realized from the exercise of a non-qualified stock option, or when restricted stock (or property) held by an employee either becomes freely transferable or is no longer subject to a substantial risk of forfeiture (see section 83 and the regulations thereunder).

(iii) Amounts realized from the sale, exchange or other disposition of stock acquired under a qualified stock option.

(iv) Other amounts which receive special tax benefits, such as premiums for group-term life insurance (but only to the extent that the premiums are not includible in the gross income of the employee), or contributions made by an employer (whether or not under a salary reduction agreement) towards the purchase of an annuity contract described in section 403(b) (whether or not the contributions are excludable from the gross income of the employee).

(4) COMPENSATION IN LIMITATION YEAR. The compensation (as defined in paragraph (d)(2) of this section) actually paid or made available to an employee within the limitation year is the compensation used for purposes of applying the limitations of section 415.

(5) ELECTION TO USE COMPENSATION ACCRUED DURING LIMITATION YEAR. -- (i) YEARS BEGINNING AFTER DECEMBER 31, 1991. For limitation years beginning after December 31, 1991, an employer may not use accrued compensation. Any election previously made to use accrued compensation is not valid for limitation years beginning after December 31, 1991.

(ii) DE MINIMIS ACCRUED COMPENSATION. Notwithstanding paragraph (d)(5)(i) of this section, an employer may include in compensation amounts earned but not paid in a year because of the timing of pay periods and pay days if these amounts are paid during the first few weeks of the next year, the amounts are included on a uniform and consistent basis with respect to all similarly situated employees, and no compensation is included in more than one limitation period. No formal election is required to include the accrued compensation permitted under this de minimis rule. The rule described in this paragraph (d)(5)(ii) does not apply to a section 403(b) annuity contract or to an individual retirement plan (as defined in section 7701(a)(37)).

(iii) YEARS BEGINNING BEFORE JANUARY 1, 1992. For limitation years beginning before January 1, 1992, instead of using the compensation actually paid or made available to an employee during the limitation year, an employer may elect to use the compensation accrued for an entire limitation year for purposes of applying the limitations of section 415. In the case of a group of employers that constitute either a controlled group of corporations (within the meaning of section 414(b) as modified by section 415(h)) or trades or businesses (whether or not incorporated) that are under common control (within the meaning of section 414(c) as modified by section 415(h)), the election to use accrued compensation must be made by all members of the group that maintain a qualified plan. Once an election is made, it remains in effect until it is revoked by the employer or group of employers. The rule described in this paragraph (d)(5)(iii) does not apply to a section 403(b) annuity contract or to an individual retirement plan (as defined in section 7701(a)(37)). If, in a particular limitation year beginning before January 1, 1992, a previously effective election to use accrued compensation is revoked or an election to use accrued compensation is made, any amounts taken into account for compensation purposes for any preceding limitation year may not be counted again in determining compensation for the particular limitation year.

(6) SPECIAL RULE FOR EMPLOYEES OF CONTROLLED GROUPS OF CORPORATIONS, ETC. In the case of an employee of two or more corporations which are members of a controlled group of corporations (as defined in section 414(b) as modified by section 415(h)), the term "compensation" for such employee includes compensation from all employers that are members of the group, regardless of whether the employee's particular employer has a qualified plan. This special rule is also applicable to an employee of two or more trades or businesses (whether or not incorporated) that are under common control (as defined in section 414(c) as modified by section 415(h)), to an employee of two or more members of an affiliated service group as defined in section 414(m), and to an employee of two or more members of any group of employers who must be aggregated and treated as one employer pursuant to section 414(o).

(7) SPECIAL RULE WHEN SECTION 403(b) ANNUITY IS AGGREGATED WITH QUALIFIED PLAN OF CONTROLLED EMPLOYER. If a section 403(b) annuity contract is combined or aggregated with a qualified plan of a controlled employer in accordance with either section 1.415-7(h)(2)(i) or section 1.415-8(d)(2), the following rules apply:

(i) In applying separately the limitations of section 415(b) or (c) to the qualified plan and the limitations of section 415(c) and the exclusion allowance of section 403(b)(2)(A) to the section 403(b) annuity, compensation from the controlled employer may not be aggregated with compensation from the employer purchasing the section 403(b) annuity.

(ii) However, in applying the limitations of section 415(c) in connection with the combining of the section 403(b) annuity with a qualified defined contribution plan or section 415(e) in connection with the aggregating of the section 403(b) annuity with a qualified defined benefit plan, the total compensation from both employers may be taken into account.

(8) SPECIAL RULES FOR LEASED EMPLOYEES. [Reserved]

(9) SPECIAL RULES FOR PERMANENT AND TOTAL DISABILITY. [Reserved]

(10) SAFE HARBOR RULE WITH RESPECT TO PLAN'S DEFINITION OF COMPENSATION. If a plan defines compensation for purposes of applying the limitations of section 415 to include only those items specified in paragraph (d)(2)(i) of this section and to exclude all those items listed in paragraph (d)(3) of this paragraph, if applicable, the plan will automatically be considered to be using a definition of compensation which satisfies section 415(c)(3).

(11) ALTERNATIVE DEFINITION OF COMPENSATION. In lieu of defining compensation in accordance with paragraphs (d)(2) and (d)(3) of this section, for purposes of applying the limitations of section 415 in the case of employees other than self-employed individuals treated as employees within the meaning of section 401(c)(1), a plan may define compensation using either of the following definitions used for wage reporting purposes, as modified herein, and the definition will be considered automatically to satisfy section 415(c)(3):

(i) INFORMATION REQUIRED TO BE REPORTED UNDER SECTIONS 6041 AND 6051. Compensation is defined as wages within the meaning of section 3401(a) and all other payments of compensation to an employee by his employer (in the course of the employer's trade or business) for which the employer is required to furnish the employee a written statement under sections 6041(d) and 6051(a)(3). See sections 1.6041-1(a), 1.6041-2(a)(1) and 31.6051-1(a)(1)(i)(c). This definition of compensation may be modified to exclude amounts paid or reimbursed by the employer for moving expenses incurred by an employee, but only to the extent that at the time of the payment it is reasonable to believe that these amounts are deductible by the employee under section 217. Compensation under this paragraph (d)(11)(i) must be determined without regard to any rules under section 3401(a) that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in section 3401(a)(2)).

(ii) SECTION 3401(a) WAGES. Compensation is defined as wages within the meaning of section 3401(a) (for purposes of income tax withholding at the source) but determined without regard to any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in section 3401(a)(2)).

(12) OPTIONAL USE OF PRIOR REGULATIONS. For years beginning before September 19, 1991, employers are permitted, in defining compensation for purposes of section 415(c)(3), to comply with either the provisions of this section 1.415-2(d) or the prior regulation provisions of section 1.415-2(d). See section 1.415-2(d) as contained in the CFR edition revised as of April 1, 1991.

(13) ADDITIONAL RULES. The Commissioner may in revenue rulings, notices, and other guidance of general applicability provide additional definitions of compensation that are treated as satisfying section 415(c)(3).