Employee Stock Ownership Plans;
Section 411(d)(6) Protected Benefits (Taxpayer Relief Act of 1997);
Qualified Retirement Plan Benefits

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [TD 8806] RIN 1545-AV94

TITLE: Employee Stock Ownership Plans; Section 411(d)(6) Protected
Benefits (Taxpayer Relief Act of 1997); Qualified Retirement Plan
Benefits

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains final and temporary regulations
providing for changes to the rules regarding qualified retirement
plan benefits that are protected from reduction by plan amendment,
that have been made necessary by the Taxpayer Relief Act of 1997
(TRA '97). The final regulations change the existing final
regulations to conform with the TRA '97 rules regarding in-kind
distribution requirements for certain employee stock ownership
plans, and specify the time period during which certain plan
amendments for which relief has been granted by TRA '97 may be made
without violating the prohibition against plan amendments that
reduce accrued benefits. These final regulations affect sponsors of
qualified retirement plans, employers that maintain qualified
retirement plans, and qualified retirement plan participants. The
amendments to the temporary regulations remove previously issued
temporary regulations on the same subject.

DATES: These regulations are effective January 8, 1999. FOR FURTHER
INFORMATION CONTACT: Linda S. F. Marshall, (202) 622-6030 (not a
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the Income Tax Regulations (26
CFR part 1) under section 411(d)(6). These regulations change the
rules under section 411(d)(6) regarding qualified retirement plan
benefits that are protected from reduction by plan amendment, to
take into account amendments made by the Taxpayer Relief Act of 1997
(TRA '97), Public Law 105-34, 111 Stat. 788 (1997). On September 4,
1998, temporary regulations (TD 8781) under section 411(d)(6) were
published in the Federal Register (63 FR 47172). A notice of
proposed rulemaking (REG-101363-98), cross-referencing the temporary
regulations, was published in the Federal Register (63 FR 47214) on
the same day. The temporary regulations conform the regulations to
the TRA '97 amendments to section 409 regarding the general
requirement that employee stock ownership plans offer distributions
in the form of employer securities.

In addition, the temporary regulations specify the time period
during which certain plan amendments for which relief has been
granted by TRA '97 may be made without violating section 411(d)(6).

One written comment responding to the notice of proposed rulemaking
was received. No public hearing was requested or held. The proposed
regulations under section 411(d)(6) are adopted by this Treasury
decision, and the corresponding temporary regulations are removed.
Explanation of Provisions Section 411(d)(6) provides that a plan is
not treated as satisfying the requirements of section 411 if the
accrued benefit of a participant is decreased by a plan amendment.
Under section 411(d)(6)(B), a plan amendment that eliminates an
optional form of benefit is treated as reducing accrued benefits to
the extent that the amendment applies to benefits accrued as of the
later of the adoption date or the effective date of the amendment.
Sections 1.411(d)-4, Q&A-1(b)(1) and 1.401(a)(4)-4( e) specify that
different optional forms of benefit within the meaning of section
411(d)(6)(B) result from differences in the medium of a distribution
(e.g., cash or in-kind) from a plan. Section 411(d)(6)(C) provides
that any tax credit employee stock ownership plan or any employee
stock ownership plan is not treated as failing to meet the
requirements of section 411(d)(6) merely because it modifies
distribution options in a nondiscriminatory manner.

Special Rules Regarding Medium of Distribution from ESOPs Section
409(h) contains requirements relating to distributions from tax
credit employee stock ownership plans. Section 4975(e)(7) extends
the requirements of section 409(h) to other employee stock ownership
plans as well, and section 401(a)(23) extends the requirements of
section 409(h) to qualified plans that are stock bonus plans. Under
section 409(h)(1)(A), an employee stock ownership plan or other
stock bonus plan generally is required to make distributions
available in the form of employer securities. Prior to its amendment
by TRA '97, section 409(h)(2) provided an exception to this rule in
the case of an employer whose charter or bylaws restrict the
ownership of substantially all outstanding employer securities to
employees or to a trust described in section 401(a).

Under section 1361, certain small business corporations that do not
have more than 75 shareholders are eligible to elect treatment as S
corporations whose tax attributes generally flow through to
shareholders in accordance with the rules of subchapter S of chapter
1 of subtitle A of the Internal Revenue Code. Prior to the Small
Business Job Protection Act of 1996 (SBJPA), Public Law 104-188, 110
Stat.

1755 (1996), an S corporation could not maintain an employee stock
ownership plan because an S corporation could not have a qualified
trust described in section 401(a) as a shareholder. SBJPA amended
the requirements for S corporations, effective for tax years
beginning after December 31, 1996, to permit certain tax-exempt
organizations, including qualified trusts described in section
401(a), to be S corporation shareholders.

TRA '97 made an additional change to the rules governing qualified
plans holding securities of an S corporation employer, to make it
easier for S corporation employers to facilitate employee ownership
of employer securities through qualified plans. Section 1506 of TRA
'97 extends the exception of section 409(h)(2) to cover S
corporations, effective for taxable years beginning after December
31, 1997. Pursuant to this change, tax credit employee stock
ownership plans, employee stock ownership plans, and other stock
bonus plans established and maintained by S corporation employers
are not required to offer distributions in the form of employer
securities. Section 1.411(d)-4, Q&A-2(d)(2)(ii) provides an
exception from the requirements of section 411(d)(6) for plan
amendments that eliminate optional forms of benefit from a tax
credit employee stock ownership plan, an employee stock ownership
plan, or a stock bonus plan, for certain employers. Section
1.411(d)-4, Q&A-2(d)(2)(ii) applies to employers that become
substantially employee-owned, if the employer otherwise meets the
requirements of section 409(h)(2) with respect to restrictions on
the ownership of outstanding employer stock. These regulations
retain the provision in the temporary regulations to expand the
exception of §1.411(d)-4, Q&A-2(d)(2)(ii) from the requirements of
section 411(d)(6) to apply to S corporations as well, to reflect the
TRA '97 changes to section 409(h).

Rules for Plan Amendments Pursuant to TRA '97

Section 1541 of TRA '97 contains provisions relating to plan
amendments that are adopted as a result of TRA '97. If section 1541
applies to a plan amendment, section 1541(a) provides that the plan
will be treated as operated in accordance with its terms and will
not fail to satisfy the requirements of section 411(d)(6) by reason
of the amendment. Section 1541 applies to a plan amendment that is
made pursuant to a legislative change in the pension and employee
benefit provisions of TRA '97, provided the following conditions are
satisfied. First, the plan amendment must be adopted before the
first day of the first plan year beginning on or after January 1,
1999 (2001, in the case of a governmental plan, as defined in
section 414(d)). Second, the plan must be operated in accordance
with the terms of the plan amendment, beginning on the date the
legislative change takes effect, or, if the amendment is not
required by the legislative change, the effective date of the
amendment specified by the plan. Third, the plan amendment must be
made retroactively effective.

The remedial amendment period for adopting plan amendments to which
section 1541 of TRA '97 applies was extended pursuant to the rules
of section 401(b) in Rev.

Proc. 98-14 (1998-4 I.R.B. 22). To provide a uniform time for plan
amendment, these regulations add a new §1.411(d)-4, Q&A-11 to retain
the rule of §1.411(d)-4T, Q&A-11 of the temporary regulations
extending the time for the section 411(d)(6) relief provided by
section 1541 of TRA '97 to the end of the remedial amendment period
for these plan amendments.

The sole commentator raised a concern regarding whether this
extension of the time period for section 411(d)(6) relief originally
provided under section 1541 of TRA '97 restricts the time during
which any plan amendment can be made to eliminate in-kind
distributions of employer securities from employee stock ownership
plans of S corporations. The extension of the time period for this
section 1541 statutory relief pursuant to §1.411(d)-4, Q&A-11 does
not restrict the time period during which a plan amendment can be
made to eliminate these in-kind distributions as permitted under
§1.411(d)-4, Q&A-2(d)(2)(ii); to the contrary, the §1.411(d)-4,
Q&A-11 extension of this statutory relief period provides an
additional time period for the adoption of certain plan amendments
to eliminate these in-kind distributions after these in-kind
distributions have been eliminated in operation. Under the ongoing
rule of §1.411(d)-4, Q&A-2( d)(2)(ii), a plan amendment to eliminate
these in-kind distributions that is effective with respect to
distributions payable after the date the amendment is adopted can be
made at any time during taxable years of the employer beginning
after December 31, 1997.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 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.
chapter 5) does not apply to these regulations, and because the
regulation does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does
not apply. Pursuant to section 7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking preceding these regulations was
submitted to the Small Business Administration for comment on its
impact on small businesses.

Drafting Information

The principal author of these regulations is Linda S. F. Marshall,
Office of the Associate Chief Counsel (Employee Benefits and Exempt
Organizations). However, other personnel from the IRS and Treasury
Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations Accordingly, 26 CFR part 1
is amended as follows:

PART 1--INCOME TAXES Paragraph

1. The authority citation for part 1 is amended by adding an entry
in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

§1.411(d)-4T also issued under 26 U.S.C. 411(d)(6). * * *

Par. 2. Section 1.411(d)-4 is amended by:

1. Revising Q&A-2(d)(2)(ii).

2. Removing the last sentence of Q&A-2(d)(3).

3. Adding Q&A-11.

The additions and revisions read as follows:

§1.411(d)-4 Section 411(d)(6) protected benefits.

* * * * *

Q-2: * * *

A-2: * * *

(d) * * *

(2) * * *

(ii) Employer becomes substantially employee-owned or is an S
corporation.

The employer eliminates, or retains the discretion to eliminate,
with respect to all participants, optional forms of benefit by
substituting cash distributions for distributions in the form of
employer stock with respect to benefits subject to section 409(h) in
the circumstances described in paragraph (d)(1)(ii)(A) or (B) of
this Q&A-2, but only if the employer otherwise meets the
requirements of section 409(h)(2)-- (A) The employer becomes
substantially employee-owned; or ( B) For taxable years of the
employer beginning after December 31, 1997, the employer is an S
corporation as defined in section 1361.

* * * * *

Q-11: To what extent may a plan amendment that is made pursuant to
the Taxpayer Relief Act of 1997 (TRA '97) (Public Law 105-34, 111
Stat. 788), reduce or eliminate section 411(d)(6) protected
benefits?

A-11: A plan amendment does not violate the requirements of section
411(d)(6) merely because the plan amendment reduces or eliminates
section 411(d)(6) protected benefits as of the effective date of the
plan amendment, provided that--

(a) The plan amendment is made pursuant to an amendment made by
title XV, or subtitle H of title X, of TRA '97; and

(b) The plan amendment is adopted no later than the last day of any
remedial amendment period that applies to the plan pursuant to
§§1.401(b)-1 and 1.401(b)-1T for changes under TRA '97. §
1.411(d)-4T [Removed]

Par. 3. Section 1.411(d)-4T is removed.

Robert E. Wenzel
Deputy Commissioner of Internal Revenue
Approved:
Donald C. Lubick
Assistant Secretary of the Treasury

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