In December the IRS delivered an early holiday offering to IRC section 403(b) plans that provides some relief regarding the application of the “universal availability” rules. Notice 2018-95 (the “Notice) eases the rules for years generally prior to 2019, and also makes clear how the IRS intends to interpret the universal availability rule going forward. The Notice also sets out how some 403(b) plans will need to make changes to their plan documents prior to March 31, 2020 (see below for more details on deadlines).
Section 403(b) plans that permit employees to contribute elective deferrals are subject to the universal availability rule. This rule provides that with certain limited exceptions all employees must be allowed to contribute elective deferrals to a 403(b) plan if any employees are permitted to do so. One of the most commonly used of these exceptions covers part time employees. Under the regulations effective in 2009, an employee can be excluded from the opportunity to contribute elective deferrals as a part time employee if:
For the 12-month period beginning on the date the employee's employment commenced, the employer reasonably expects the employee to work fewer than 1,000 hours of service in such period, and
For each plan year ending after the close of the 12-month period beginning on the date the employee's employment commenced (or, if the plan so provides, each subsequent 12-month period), the employee worked fewer than 1,000 hours of service in the preceding 12-month period.
The 12-month period used by the plan to determine whether an employee has worked 1000 hours is the “exclusion year”.
The IRS has interpreted the second prong of this definition to mean that if an employee does not meet the definition of a part time employee in any exclusion year, the employee must be allowed to contribute elective deferrals in every subsequent year. This is the so-called “once in, always in” (“OIAI”) requirement: if an employee does not qualify as a part time employee in any year, he or she is eligible to contribute elective deferrals in every year thereafter regardless of how many hours worked in any subsequent exclusion year.
But the IRS has now recognized that many employers did not realize that its interpretation of part time employee included the OIAI requirement. Those plans administered the part time exclusion without applying the requirement. The IRS acknowledges in the Notice that it failed to highlight the requirement since the issuance of the regulations in 2009. Moreover, we think there is a reasonable interpretation of the regulation that does not lead to the conclusion that the OIAI rule must be applied to the part time exclusion, so without explicit guidance plans would not necessarily have reached the same conclusion as the IRS.
Given that history, the IRS has now issued the Notice providing some relief to sponsors of 403(b) plans that have been applying the part time exclusion without incorporating the OIAI requirement. The Notice provides transition relief for 403(b) plans for taxable years (the “Relief Period”) beginning after December 31, 2008 and ending either 1) on the last day of the last exclusion year that ends before December 31, 2019 if the plan uses the plan year as the exclusion year, or 2) on the last day of that employee’s last exclusion year that ends before December 31, 2019 if the plan uses the employee’s anniversary date as the exclusion year.
During the Relief Period, a plan will not be treated as failing to satisfy the conditions of the part time exclusion merely because the plan was not operated in compliance with the OIAI requirement. This means that if an employee was not allowed to contribute elective deferrals in a year because in the previous year the employee did not work 1000 hours, the plan won’t be treated as violating the universal availability requirements even though the employee had worked 1000 hours in any earlier year or was expected to work 1000 in the employee’s first year of employment. Without this relief, the OIAI rule would mean that the employee should have been allowed to contribute elective deferrals in all years after the one in which the employee worked (or was expected to work) 1000 hours.
The IRS also recognized that plans might also have compliance issues under OIAI in years after the Relief Period if the Plan had been operated without applying the OIAI rule during the years covered by the relief. To address those issues, the Notice provides a “fresh start opportunity”. The fresh start opportunity allows the plan to be operated as if the OIAI rule first became effective on January 1, 2018. This means that if the plan did not apply the OIAI rule in years prior to January 1, 2018, it can disregard a year (prior to January 1, 2018) during which the employee became eligible to contribute elective deferrals either because he or she was expected to work 1000 hours during the first year of service or actually worked 1000 hours in any subsequent year. This rule allows the plan to begin to apply the OIAI rule to part time employees in years beginning 2018 and later. Note that in order to take advantage of the fresh start opportunity, the plan must have been operated during the Relief Period in compliance with the OIAI exclusion or pursuant to the relief under the Notice.
Fortunately, the IRS realized that these rules are fairly complicated to explain and lend themselves well to examples. There are a number of helpful examples that demonstrate how the Relief Period and the fresh start work in the Notice(see:Notice 2018-95).
Plans that have adopted a 403(b) pre-approved volume submitter document do not need to be amended to take advantage of this relief. Individually designed plans (plans that have not adopted a 403(b) pre-approved plan) that did not apply the OIAI rule during the Relief Period have until March 31, 2020 to conform the language of the plan to its operation. But under the Notice, unless the plan language explicitly highlights the OIAI rule, the IRS will deem the language to provide that the OIAI rule was not applied. So, it is likely that many plans that did not apply the OIAI rule will not be required to adopt an amendment. However, you should check with the drafter of your plan document to determine if you need to take any action to bring your document into compliance.
One final note: the OIAI rule means that a plan administrator must allow any employee who was ever eligible to contribute elective deferrals to continue to have the opportunity to do so. This is not necessarily a bad result. While it may have the effect of increasing the number of plan participants (which could bring a smaller plan up to the level of participants that obligates it to be audited for the Form 5500), it may also ease plan administration. Once employees are permanently eligible the administrator no longer needs to track their hours year after year. All the administrator is required to do is to provide those employees with a notice, at some time during each year, informing them of their opportunity to make elective contributions to the plan. And as a practical matter, many part timers choose not to contribute elective deferrals to the plan even when given the opportunity, so it may not change actual participation very much.
If you would like further information about this issue, please contact any of the attorneys at Boutwell Fay, LLP.
© Boutwell Fay LLP 2019, All Rights Reserved.This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us.The information contained in this article is effective as of December 31, 2018.