IRS Issues Proposed Comparability Regs

October 6, 2000 ( - The Internal Revenue Service has issued proposed regulations that new comparability plans must satisfy to use the cross-testing method in meeting nondiscrimination requirements.

The proposal preserves the existing cross-testing rules and would not affect “cross-tested” defined contribution plans that provide “broadly available allocation rates.” However, it would also create a minimum allocation “gateway” for those plan designs with the greatest disparity of benefits between highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).

Comparability plans are generally utilized by doctors, accounting offices, law firms, and small closely held businesses that want to provide the owner and management team higher benefits than those available under a traditional plan arrangement.

Testing Benefits

In February, the IRS and Treasury published Notice 2000-14, and requested public comments on use of the cross-testing method by “new comparability plans”. These plans are defined contribution plans that have built-in disparities between the allocation rates for HCEs and the allocation rates for other employees. For example, the IRS notes that HCEs in such a plan might receive an allocation of 18-20% of compensation compared with 3% for NHCEs.

Defined contribution plans generally satisfy nondiscrimination regulations by demonstrating that contributions are nondiscriminatory in amount. A defined contribution plan may, however, satisfy the nondiscrimination regulations on the basis of benefits by using “cross-testing.”  This process converts contributions to equivalent benefits payable at normal retirement age, and testing based on those benefits, similar to the tests used under a defined benefit plan.

These plans are able to meet the nondiscrimination requirements by testing the actuarially projected value of employer contributions for younger employees with the projection of higher contributions, but for a shorter period of time, by the older HCEs. The IRS and Treasury expressed concerns that this approach is not consistent with the basic purpose of the 401(a)(4) nondiscrimination rules.

Clearing the Hurdle

Under the proposed rules, a plan satisfies the allocation rate requirement if

  • each rate is currently available to a group of employees that satisfies tax code Section 410(b) without regard to the average benefit percentage test
  • the plan provides allocation rates that increase “smoothly” as an employee ages or accumulates additional service

If a plan does not provide broadly available allocation rates, certain “gateway” requirements must be satisfied in order to use the current cross-testing rules. Generally speaking, each NHCE must have an allocation rate that is at least one-third of the highest highly compensated employee allocation rate with a maximum NHCE allocation rate of 5% of NHCE compensation

The proposed rules also provide guidance for nondiscrimination testing and aggregating of plans where an employer provides multiple plans.

A public hearing on the proposed rules is scheduled for Jan. 25, 2001, at 10 a.m. in the auditorium of the Internal Revenue Building, 1111 Constitution Ave. N.W., Washington, D.C. Written and electronic comments ( ) are due by Jan. 5, 2001.

The regulations are proposed to be applicable for plan years beginning on or after January 1, 2002.

The proposed regulations are online at: .

– Nevin Adams