Tax regulations must follow the terms of the Internal Revenue Code and must be internally consistent. These rules were violated in 2007 tax regulations defining a “one-time irrevocable election” for purposes of 403(b) plans. The 2007 regulations require an employee to make the election “on or before … first becoming eligible to participate under the employer’s plans.” This wording is more restrictive than the Internal Revenue Code and previously issued regulations, which allow an employee to make an irrevocable 403(b) election “at the time of initial eligibility to participate in the agreement.” The IRS should address this error in the 2007 regulations as part of the guidance the IRS is expected to provide for 403(b) plans in 2013. The following paragraphs explain the issue in more detail.
Use of the “One-Time Irrevocable Election” Definition. The “one-time irrevocable election” offers a useful option in retirement plan design. It allows an employee to commit to making employee pre-tax contributions to a retirement plan without regard to complex rules and limits that apply to “elective” 403(b) or 401(k) contributions. A “one-time irrevocable election” under a 403(b) plan may be a particularly attractive option for government 403(b) plans, where contributions are not subject to discrimination testing. Defining a “one-time irrevocable election” is critical to the use of this approach to 403(b) plan contributions.
Code Section 402(g) and Regulations Clearly Defined a “One-Time Irrevocable Election” for 403(b) Plans Before the 2007 Regulations. Internal Revenue Code section 402(g)(3) includes the following definition of a “one-time irrevocable election” for 403(b) plans:
…[a contribution to a 403(b) plan] shall not be treated as an elective deferral…if under the salary reduction agreement such contribution is made pursuant to a one-time irrevocable election made by the employee at the time of initial eligibility to participate in the agreement [emphasis added] or is made pursuant to a similar arrangement involving a one-time election specified in regulations.
Treasury Regulation section 1.402(g)-1(c) follows the Code provision, stating:
(c) Certain one-time irrevocable elections. An employer contribution is not treated as an elective deferral under paragraph (b) of this section if the contribution is made pursuant to a one-time irrevocable election made by the employee:
(1) In the case of an annuity contract under section 403(b), at the time of initial eligibility to participate in the salary reduction agreement [emphasis added].
2007 Regulations Contradict the Code and Prior Regulations. In contrast to the Code and regulations cited above, 403(b) regulations issued in 2007 redefine a “one-time irrevocable election” under a 403(b) plan. The 2007 regulations state that a “one-time irrevocable election” must be made “on or before the employee’s first becoming eligible to participate under the employer’s plans” [emphasis added]. Treasury Regulation 1.402(g)(3)-1(b). The 2007 regulations incorrectly use the same definition for 403(b) plans as Treasury Regulation 1.401(k)-1(a)(3), which defines a “one-time irrevocable election” for purposes of 401(k) plans. Applying the 401(k) definition to 403(b) plans contradicts the clear terms of Internal Revenue Code section 402(g)(3). Treasury Regulation 1.402(g)(3)-1(b) is invalid and should be corrected to state that a one time irrevocable election must be made “at the time of initial eligibility to participate” in the 403(b) agreement, not before eligibility to participate “under the employer’s plans.”
marybrauerlaw 