Pension & Benefits News IRS provides relief from once-in-always-in condition for excluding part-time employee deferrals under 403(b) plans
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Monday, January 7, 2019

IRS provides relief from once-in-always-in condition for excluding part-time employee deferrals under 403(b) plans

By Pension and Benefits Editorial Staff

The IRS has issued transition relief from the “once-in-always-in” condition for excluding part-time employees under IRS Reg. §1.403(b)-5(b)(4)(iii)(B). Under the “once-in-always-in” exclusion condition, once an employee is eligible to make elective deferrals to a 403(b) plan that provides for the exclusion of part-time employees from making elective deferrals, the employee may not be excluded from making elective deferrals in any later exclusion year on the basis that the employee is a part-time employee.

Part-time employee exclusion conditions under final 403(b) regs. Under IRS final 403(b) regulations that were generally effective starting after 2008, IRS Reg. §1.403(b)-5(b)(4)(iii)(B) covers the conditions that an employer must satisfy before excluding a part-time employee from the plan. The IRS states that these regulations to impose three separate conditions for an employee to be excluded—

  • a “first-year” exclusion condition under which the employer must reasonably expect the employee to work fewer than 1,000 hours during the employee’s first year of employment;
  • a “preceding-year” exclusion condition under which, after the first year of employment, the employee must have actually worked fewer than 1,000 hours in the preceding 12-month period; and
  • the “once-in-always-in” exclusion condition, under which the employee may be excluded under the part-time exclusion if and only if, in the employee’s first year of employment, the employee meets the first-year exclusion condition, and, in each exclusion year ending after the first year of employment, the employee has met the preceding-year exclusion condition.

The effect of the once-in-always-in exclusion condition is that once an employee does not meet the part-time exclusion conditions, whether in the initial year of employment or for any exclusion year, the employee may no longer be excluded from making elective deferrals under the part-time exclusion.

Employers surprised by once-in-always-in condition. Commenters have requested transition relief because many employers were unaware that the part-time exclusion included the once-in-always-in exclusion condition. 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 exclusion year, but did not apply the once-in-always-in exclusion condition to prevent an employee who failed to meet either the first-year exclusion condition or the preceding-year exclusion condition from being excluded in all subsequent exclusion years.

Transition relief for once-in-always-in condition. In response to the comments, the IRS is providing transition relief, including—

  • plan operations relief for a transition period referred to as the “Relief Period,”
  • relief regarding plan language, and
  • a fresh-start opportunity after the “Relief Period” ends.

The plan operations “Relief Period” begins with tax years beginning after December 31, 2008. For plans with exclusion years based on plan years, the “Relief Period” ends for all employees on the last day of the last exclusion year that ends before December 31, 2019. For plans with exclusion years based on employee anniversary years, the “Relief Period” ends, with respect to any employee, on the last day of that employee’s last exclusion year that ends before December 31, 2019.

Plan operations. 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 once-in-always-in exclusion condition. However, the IRS will not provide relief from the other conditions of the part-time exclusion: (1) the first-year exclusion condition, and (2) the preceding-year exclusion condition. Relief is also not provided from the consistency requirement as described in IRS Reg. §1.403(b)-5(b)(4)(i). Under this consistency requirement, if any employee who meets the conditions of the part-time exclusion may make elective deferrals, then no employee who meets those conditions may be excluded under the part-time exclusion.

Plan language. Under the transition relief provided, a 403(b) pre-approved plan adopted by an employer will not be treated as failing to satisfy the conditions of the part-time exclusion, and the plan will not be treated as having a failure to follow plan terms, merely because the form of the pre-approved plan for the Relief Period does not match the plan’s operation concerning the once-in-always-in exclusion condition during the Relief Period. Thus, if the above operational relief applies, a 403(b) pre-approved plan is not required to be amended to reflect that the plan failed to apply the once-in-always-in exclusion condition during the Relief Period.

For individually designed plans, under the transition relief provided, if the above operational relief applies, an employer may amend plan language, through March 31, 2020, to reflect that the once-in-always-in exclusion condition was not applied for all exclusion years, and that amendment will be treated as a correction of a form defect during the remedial amendment period.

Fresh-start opportunity. In general, for exclusion years beginning on or after January 1, 2019, a plan that provides for the part-time exclusion must apply the once-in-always-in exclusion condition in both form and operation. However, the IRS provides a fresh-start opportunity under which a plan will not be treated as failing to satisfy the conditions of the part-time exclusion for periods after the Relief Period, if the once-in-always-in exclusion condition is applied as if the once-in-always-in exclusion condition first became effective January 1, 2018. Thus, a plan may apply the once-in-always-in exclusion condition by disregarding the fact that the first-year exclusion condition was not met for an employee if the employee began employment before January 1, 2018, or the fact that the preceding-year exclusion condition was not met for an employee in any exclusion year before the first exclusion year beginning on or after January 1, 2018. However, even if a plan applies this fresh-start opportunity with respect to the once-in-always-in exclusion condition, the plan must have been operated during the Relief Period in compliance with the once-in-always-in exclusion or pursuant to the above plan operations relief. Also, a 403(b) pre-approved plan or an individually designed plan is not required to be amended to reflect the use of this fresh-start opportunity in applying the once-in-always-in exclusion condition.

SOURCE: IRS Notice 2018-95.

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