The IRS recently issued Notice 2018-95 (the Notice), which clarifies the circumstances under which part-time employees must be given the opportunity to make deferral elections under their employers’ 403(b) plans. In particular, the Notice provides transition relief from the once-in-always-in (OIAI) condition for excluding part-time employees. Tax-exempt and governmental employers who sponsor 403(b) plans will want to confirm that they are including and excluding part-time employees correctly under this latest guidance.
Background—the universal availability rule
To understand the OIAI condition, it is first important to understand the “universal availability” nondiscrimination requirement for eligibility to make deferral elections under a 403(b) plan. The universal availability requirement provides that if any employee is permitted to make elective deferrals to a 403(b) plan, the right to make elective deferrals must be universally available to all employees. Universal availability often results in more employees being allowed to make deferral elections under 403(b) plans than they would under other types of plans that are governed only by the Internal Revenue Code (Code) Section 410 coverage requirements (e.g., 401(k) plans).
Even so, the universal availability regulations carve out certain narrow categories of employees that may be excluded from eligibility for making elective deferrals under 403(b) plans. For example, part-time employees may be excluded from making elective deferrals despite the universal availability requirement.
Requirements to exclude part-time employees under universal availability
The final Code Section 403(b) regulations imposed three conditions for an employee to be excluded from making the deferrals under the part-time exclusion:
- A “first-year” exclusion condition. An employer must reasonably expect the employee to work fewer than 1,000 hours for the 12-month period beginning on the date the employee’s employment commenced;
- A “preceding-year” exclusion condition. 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 actually worked fewer than 1,000 hours of service in the preceding 12-month period; and
- The OIAI requirement. Once the employee fails to meet the first-year exclusion, or has been credited with at least 1,000 hours of service in any applicable 12-month measurement period, the employee must be allowed to make elective deferrals under his employer’s 403(b) plan. Further, once allowed to make elective deferrals under the plan, the employer may no longer exclude the employee from eligibility to make deferral elections on the basis of being a part-time employee, even if the employee’s hours have declined below 1,000 hours for a plan year.
In practice, many employers did not apply the OIAI requirement as described in the regulations. Instead, many employers applied the first-year exclusion condition for an employee’s first year and applied the preceding-year exclusion condition separately for each succeeding year, effectively disregarding the OIAI requirement. In other words, if an employee worked 1,000 hours or more in a plan year, the employee would become eligible to make deferral elections for the next plan year. If the employee’s hours in a future plan year fell below 1,000 hours, the employee would become excluded from being allowed to make deferral elections in the subsequent year, which is not consistent with the OIAI requirement.
To be fair to these employers, the regulations did not clearly explain the requirement. Commenters noted that the OIAI condition was not specifically described in writing until the IRS published its List of Required Modifications (LRMs) in 2015, and even then, the LRMs were directed at drafters of pre-approved plans and not adopting employers or sponsors of individually designed 403(b) plans. As a result, the commenters requested transition relief regarding the OIAI exclusion condition, stating that many employers were not aware that the part-time exclusion included the OIAI requirement. Thus, Treasury and the IRS issued the Notice to describe the OIAI condition and also provide transition relief from the OIAI requirement.
The transition relief in the Notice includes relief regarding plan operations for a transition period (relief period), relief regarding plan language, and a fresh-start opportunity after the relief period ends.
The relief period begins with tax years beginning after Dec. 31, 2008. For plans with exclusion years (generally, a 12-month period in which an employee’s hours of service were fewer than 1,000) based on plan years, the relief period ends for all employees on the last day of the last exclusion year that ends before Dec. 31, 2019. For plans with exclusion years based on employee anniversary years, the relief period ends, for any employee, on the last day of that employee’s last exclusion year that ends before Dec. 31, 2019.
The Notice provides the following transition relief from the OIAI requirement:
- Relief regarding plan operations: During the relief period, 403(b) plans will not be treated as failing to satisfy the conditions of the part-time exclusion if the plans were not operated in compliance with the OIAI requirement. However, this relief does not apply to 403(b) plans’ failure to properly apply other conditions of the part-time exclusion (i.e., the “first-year” and “preceding-year” exclusion conditions) nor to the consistency requirement.
- Relief regarding plan language: During the relief period, a section 403(b) pre-approved plan will not be treated as failing to satisfy the conditions of the part-time exclusion or as failing to follow plan terms in light of a failure to follow the OIAI exclusion condition, and is not required to be amended to reflect that the plan failed to apply the OIAI exclusion condition. For individually designed plans, an employer has until March 31, 2020, the end of the current remedial amendment period, to amend plan language to reflect the actual application of the OIAI exclusion condition.
- A “fresh-start opportunity” for plans: The Notice provides a fresh-start opportunity under which 403(b) plans will not be treated as failing to satisfy the conditions of the part-time exclusion if the OIAI requirement is applied as if it first became effective Jan. 1, 2018, and the plan was operated during the relief period in compliance with the OIAI requirement or pursuant to the relief provided under the Notice.
Employers that sponsor 403(b) plans that exclude part-time employees for purposes of eligibility for elective deferrals should (1) carefully consider how the OIAI requirement applies to their plans, (2) determine whether administrative changes are needed for 2019, and (3) consider if/when to amend their plans to address the OIAI requirements.