Post-Severance Compensation – “Compensation for purposes of section 415(c)(3) can include Post-Severance Compensation if it’s paid within 2½ months after separation from service. But this is only for payments that would have been paid if the participant had continued in employment or if they are for bona fide sick, vacation and other leave. The leave-related severance payments can be included only if employee could have used the leave had employment continued. Conforming amendments are made to regulations under sections 401(k), 403(b), and 457. This portion of the regulations is proposed effective for limitation years beginning on or after January 1, 2005. Taxpayers can rely on this portion of the regulations until final regulations are issued.”

For example, this means that an employee who terminated on June 10, 2005 with entitlement to three weeks of unused vacation time who is paid for that unused vacation time, may make elective deferrals on those dollars and is entitled to have that payment included in plan compensation for employer contribution purposes. The 2½ month limit is an absolute limit. Thus, if the company had provided a 6-month severance package, only such pay that qualifies as bona fide sick pay, vacation pay and similar paid leave during the first 2½ months after separation may be used for qualified plan purposes. Any compensation paid after 2½ month period is not eligible for inclusion. This guidance is effective immediately and until final regulations are issued. Thus, lump-sum settlements in which an employee waives potential claims against the employer may not be used.

As a rule of thumb, compensation for qualified plan purposes does not include amounts unless the employee would have received them anyway if the employment relationship continued (such as regular compensation, and payments for overtime, commissions and bonuses), or if they represent vacation the employee would have been entitled to take. With the exception of the 2½ months, this is consistent with the position McKay Hochman consulting staff has taken over the last couple of years.

Document Amendments Timeframes for 415 Changes
IRS will require plans to be amended after the regulations are finalized. Most of the 415 changes apply to defined benefit plans. Thus, the IRS intends to finalize the balance of the regulations before defined benefit prototype and volume submitter users submit for opinion and advisory letters starting on February 1, 2007. Individually designed plans will be required to be amended to comply with the new 415 regulations once they are finalized. It appears that the final regulations may be included in the Cumulative List of Guidance to be issued later this year.

Pre-approved defined contribution plan documents will not be required to be amended until the 2011 restatements.

Click here for the IRS Special Edition, which contains a link to the 415 proposed regulations.