On April 5, 2007, the Internal Revenue Service (IRS) issued final regulations under Internal Revenue Code Section 415. The IRS last issued final regulations in 1981. These final regulations reflect the numerous IRS notices and revenue rulings issued since 1981 and the 2005 proposed regulations. Among other things, the final regulations address how post severance amounts paid to employees are to be treated under a 401(k) plan, an issue which frequently arises in the administration of a plan.

Code Section 415, among other things, defines “compensation" for plan qualification purposes and limits the annual additions that can be allocated to each employee’s 401(k) account. Generally, annual additions include the sum of employee elective pre-tax and after-tax contributions, employer matching contributions, and profit sharing contributions. For 2007, the maximum allocation limit under a 401(k) plan is the lesser of $45,000 or 100% of an employee’s compensation.

In general, under the final regulations, in order for an amount to be taken into account for the limitation year under the plan, the compensation must actually be paid within the limitation year. There are exceptions for some minor timing differences and the final regulations continue to provide relief for certain payments which are made after severance of employment.

The final regulations provide that certain types of payments that are paid within 2 ½ months after an employee’s severance from employment, or the end of the limitation year that includes the date of severance from employment, will not fail to be compensation merely because it is paid after the employee’s severance. The final regulations extend the period from the 2 ½ month period previously allowed under the proposed regulations. There are certain conditions which must be met for this rule to apply, namely the payment (1) must be regular compensation for services during the employee’s regular working hours, or compensation for services outside the employee’s regular working hours (such as overtime or shift differential), commissions, bonuses or other similar payments and (2) would have been paid to the employee prior to severance from employment if the employee had continued employment with the employer.

In addition, the final regulations allow, but do not require, plans to specify that other post severance payments be included for Section 415 compensation purposes. Plans may include as Section 415 compensation (1) unused, accrued bona fide sick, vacation, or other leave payments, but only if the employee would have been able to use the leave if employment had continued or (2) certain nonqualified deferred compensation payments, but only if the payment would have been paid to the employee at the same time if the employee had continued employment with the employer and only to the extent that the payment is includable in the employee’s gross income.[i]

Any other payment that does not fall within this definition is not considered compensation if paid after severance from employment, even if paid within the time frames above following severance from employment. Thus, compensation does not include amounts paid after severance from employment that are severance pay or parachute payments.


The final regulations were effective on April 5, 2007, and apply to plan limitation years beginning on or after July 1, 2007. For a calendar-year 401(k) Plan, this means that the changes will first apply to plan years beginning January 1, 2008. As with the proposed regulations, however, certain post-severance compensation rules permit earlier application of the new regulations.

Because plan amendments reflecting any necessary changes as a result of these final regulations must be made prior to the end of a plan’s remedial amendment period, employers should check with their 401(k) plan provider to determine if and when plan amendments or payroll system adjustments are needed to comply with these final regulations.