NU Online News Service, July 17, 2003, 5:38 p.m. EST – The Internal Revenue Service has released proposed changes to the regulations that govern employee and employer contributions to 401(k) plans.

The IRS says it wants to reorganize and clarify existing regulations and put guidance given during the past nine years into the regulations.

The IRS also has proposed adding some restrictions. It would, for example, prohibit an employer from making matching contributions before paying employees for their work, or before the employees have elected to participate in the 401(k) plan, according to an explanation of the proposal prepared by the IRS.

The IRS also wants to block employers from trying to make contribution rates for ordinary employees look higher than they really are, to get around regulations that discourage employers from discriminating in favor of highly compensated employees.

Some employers try to boost contribution rates for ordinary employees by putting extra employer contributions, or “qualified nonelective contributions,” in the accounts of the lowest-paid workers.

Under the proposed regulation, the IRS “would generally treat a plan as providing impermissibly targeted QNECs if less than half of all [non-highly compensated employees] are receiving QNECs and would also treat a QNEC as impermissibly targeted if the contribution is more than double the QNECs other nonhighly compensated employees are receiving,” IRS officials write in an official explanation of the proposed regulation.

But the IRS would never treat QNECs that amounted to less than 5% of the employees’ compensation as targeted, the officials write.

IRS officials also warn sponsors and their advisors against trying to game the system by abusing IRS efforts to allow for flexibility.

“These proposed regulations are designed to provide simple, practical rules that accommodate legitimate plan changes,” the IRS officials write.

The IRS will take tax breaks away from employers that make repeated changes to plan testing procedures or plan provisions to create the impression that a plan is more generous to ordinary employees than it really is, the officials write.

The IRS will be taking written and electronic comments on the proposed regulatory changes until Oct. 22.

The text of the proposed regulation is posted at http://a257.g.akamaitech.net/7/257/2422/14mar20010800/edocket.access.gpo.gov/2003/03-17755.htm