IRS Notice 2018-95 Provides Relief Regarding Part-Time Employee Exception to Universal Availability Requirement for Section 403(b) Plans

Practical Law Legal Update w-017-9420 (Approx. 5 pages)

IRS Notice 2018-95 Provides Relief Regarding Part-Time Employee Exception to Universal Availability Requirement for Section 403(b) Plans

by Practical Law Employee Benefits & Executive Compensation

Background

Code Section 403(b) plans must comply with a universal availability requirement, which requires plans to permit all employees of the sponsoring employer to make salary deferrals to the plan (26 U.S.C. § 403(b); 26 C.F.R. § 1.403(b)-5(b); see Practice Note, Code Section 403(B) Plans: Overview: Universal Availability Requirement and Eligible Employees). There are limited exceptions to the universal availability requirement, including one for part-time employees working fewer than 20 hours each week (26 C.F.R. § 1.403(b)-5(b)(4)(ii)). For an employee to be excluded from making elective deferrals under the part-time employee exclusion, three conditions must be met:

The employer must reasonably expect the employee to work fewer than 1,000 hours during the employee's first year of employment (the first-year exclusion condition).
To exclude the employee from making elective deferrals in an exclusion year ending after the first year of employment, the employee must have actually worked fewer than 1,000 hours in the preceding 12-month period (the preceding-year exclusion condition).
To continue excluding an employee from making elective deferrals, the employee must meet:
- the first-year exclusion condition in the first year of employment; and
- the preceding-year exclusion condition in each exclusion year ending after the first year of employment.

This third condition is known as the once-in-always-in (OIAI) exclusion condition, meaning that once an employee does not meet the first-year and preceding-year exclusion conditions, the employee cannot be excluded from making elective deferrals going forward.

Code Section 403(b) plans must also comply with a consistency requirement (26 U.S.C. § 410(b)(4); 26 C.F.R. § 1.403(b)-5(b)(4)(i)). Under this requirement, if an employee is permitted to make elective deferrals despite meeting the conditions of the part-time employee exclusion, then other employees who meet the conditions must also be allowed to make elective deferrals.

Relief Under Notice 2018-95

Notice 2018-95 provides transition relief regarding the OIAI exclusion condition for plans that have not complied with the OIAI exclusion condition. This includes plans that excluded part-time employees from participation after they became eligible to participate, which resulted in participants being improperly excluded from making elective deferrals.

The IRS is providing this relief in response to comments indicating that many employers did not apply the OIAI exclusion condition when an employee failed to meet the first-year or preceding-year exclusion condition.

The relief period starts with taxable years beginning after December 31, 2008 and ends on the last day of:

The last exclusion year that ends before December 31, 2019, for plans with exclusion years based on plan years.
That employee's last exclusion year that ends before December 31, 2019, for plans with exclusion years based on employee anniversary years.

Notice 2018-92 also provides for plan document relief for pre-approved plans and individually designed plans:

Pre-Approved Plans. For pre-approved Section 403(b) plans that did not properly apply the OIAI exclusion condition, the plan has an operational error. However, Notice 2018-95 provides relief from this error and no plan amendment is required during the relief period. Plan language should already be correct since the IRS presumably pre-approved the language in the Section 403(b) plan.
Individually Designed Plans. Individually designed plans that did not properly apply the OIAI exclusion condition have until the end of the remedial amendment period in Rev. Proc. 2013-22 (March 31, 2020) to amend the plan to reflect that the OIAI exclusion condition was not applied for all exclusion years, and that the amendment will be treated as a correction during the remedial amendment period.

Fresh-Start Opportunity

The Notice provides for a "fresh start opportunity" for plans after the relief period ends for exclusion periods beginning on or after January 1, 2019. Under the "fresh start opportunity" plans may apply the OIAI exclusion condition as if it first became effective on January 1, 2019, if certain conditions are met.

Practical Implications

Plan sponsors as well as practitioners who advise tax-exempt employers with Section 403(b) plans should review their practices to determine whether the OIAI exclusion condition has been properly applied. Plans should also be reviewed to ensure operational compliance with the first-year and preceding-year exclusion conditions. Individually designed plans that did not properly apply the OIAI exclusion condition should be amended before the end of the remedial amendment period (March 31, 2020). Plans should ensure that these rules are applied properly moving forward.

IRS Notice 2018-95 Provides Relief Regarding Part-Time Employee Exception to Universal Availability Requirement for Section 403(b) Plans | Practical Law