IRS Employee Plans News Overview of Proposed Suspension Rules.

The proposed regulation will permit a safe harbor 401(k) plan that is using the guaranteed NEC formula to reduce or suspend the safe harbor NEC contribution if the business incurs a substantial business hardship as described in section 412(c). Thus, the proposed regulations propose an alternative to terminating the plan in order to stop the safe harbor guaranteed NEC.

The rules would be comparable to the rules for stopping the safe harbor matching contribution. Specifically, the proposed rules provide that:

1. all eligible employees be provided a supplemental notice of the reduction or suspension;
2. the reduction or suspension of the safe harbor NEC is effective no earlier than the later of 30 days after eligible employees are provided the supplemental notice and the date the amendment is adopted;
3. eligible employees are given a reasonable opportunity (including a reasonable period after receipt of the supplemental notice) prior to the reduction or suspension of the safe harbor NEC to change their CODA elections;
4. the plan is amended to provide that the ADP test will be satisfied for the entire plan year in which the reduction or suspension occurs, using the current year testing method; and
5. the plan satisfies the safe harbor NEC through the effective date of the amendment.

The proposed regulations also provide that the supplemental notice requirement is satisfied if each eligible employee is given a notice that explains:

1. the consequences of the amendment reducing or suspending future safe harbor NECs;
2. the procedures for changing CODA elections; and
3. the effective date of the amendment.

The reduction or suspension may be effective no earlier than 30 days after the notice is provided to all eligible employees. For a plan that is amended to reduce or stop the safe harbor contribution mid-year, when the safe harbor contribution is calculated for the portion of the year that it is to be provided (from the beginning of the plan year until 30 days after the notice is provided); the $245,000, 401(a)(17) compensation cap, must be prorated.

For example, a calendar year plan employer amends the plan to eliminate the safe harbor nonelective contribution, provids the supplemental notice to the employees and in this example the 30th day after the notice is June 30, 2009. The employer would have to make the safe harbor NEC from January 1, 2009 until June 30, 2009. When calculating the 3% safe harbor nonelective for the 6 months, the compensation cap for the calculation is to be prorated for the 6 of 12 months, thus the prorated compensation cap for this example is $122,500.

Further, since the safe harbor contributions were not made for 12 months, the plan will be subject to the top heavy rules of section 416. see below.  Also, to reiterate, the plan is subject to ADP and ACP testing for the entire year.

Effective Date
The proposed regulations are immediately effective as of the date it is published in the Federal Register (May 18, 2009) and taxpayers may rely upon the proposed regulations until the final regulations are issued (anything more restrictive in the final regulations will not be retroactively applicable). A public hearing is scheduled for September 23, 2009. Written comments on these proposed regulations are due by August 19, 2009.

Top heavy issue
If a plan is top heavy and is deemed exempt from the top heavy rules for this year because only deferrals and safe harbor permitted contributions are being made and the safe harbor contribution is suspended, then the plan is subject to the top heavy rules for the year. Thus, if a key employee has made a deferral and/or received a safe harbor allocation, the plan would still have a top heavy allocation requirement for the year. Therefore, suspending the safe harbor NEC may nonetheless leave the employer with a similar contribution requirement in order to satisfy the top heavy rules.

Further, the compensation definition for the safe harbor NEC may be different than the top heavy compensation definition. The top heavy definition is full year compensation with no exclusions. Thus, for an employer with a top heavy plan, it is important for the employer to consider whether stopping the safe harbor NEC is more cost effective than making the top heavy allocation.

412(c) "Determination of business hardship