The IRS on December 4 released Notice 2018-95, which provides transition relief to tax-exempt 403(b) plan sponsors that may not have complied with the “universal availability” rule for part-time employees.
Background on Universal Availability Rule. Code Section 403(b) contains a “universal availability” eligibility rule, which generally provides that all of a tax-exempt employer’s employees must be eligible to make elective deferrals to the employer’s 403(b) plan. This rule only applies to employee elective deferrals and does not require that a tax-exempt employer make employer non-elective or matching contributions available to all employees. There are limited exceptions to the universal availability rule such that an employer can still exclude certain groups of employees from the opportunity to make elective deferrals – including non-resident aliens, students, and employees who normally work fewer than 20 hours per week. However, the exclusions must be applied consistently and to all similarly situated employees. So, for example, if one or more part-time employees who work fewer than 20 hours per week are permitted to make employee elective deferrals, then all similarly situated part-time employees must be given the same opportunity.
Part-Time Employee Exclusion. The Code Section 403(b) regulations contain specific rules describing the part-time employee exclusion. These rules provide that a part-time employee is considered normally to work fewer than 20 hours a week and can be excluded if
- the employee is reasonably expected to work fewer than 1,000 hours in the 12-month period following the commencement of employment (the First Year Exclusion Condition); and
- for each plan year (or anniversary year if the plan so provides) ending after that initial 12-month period, the employee worked fewer than 1,000 hours in the immediately preceding 12-month period (the Preceding Year Exclusion Condition).
The First Year Exclusion Condition is straightforward to apply and is based on the employer’s reasonable expectation of the employee’s level of work in the first 12 months. The Preceding Year Exclusion Condition is more nuanced. Specifically, it requires not only that an employee work less than 1,000 hours in the immediately preceding 12-month period, but that the employee work less than 1,000 hours in each and every preceding 12-month period. The effect of this rule is that if an employee works more than 1,000 hours in any applicable 12-month period, the Preceding Year Exclusion Condition cannot be relied on to exclude the employee and the employee must be eligible to make elective deferrals for all subsequent periods. This is sometimes referred to as the “Once-in Always-in” rule (OIAI).
Operational Errors Applying the Part-Time Employee Exclusion. In applying the part-time employee exclusion, some tax-exempt employers may have failed to interpret and apply the OIAI rule correctly. That is, some employers may have looked only to the immediately preceding 12-month period when applying the Preceding Year Exclusion Condition and excluded employees who had less than 1,000 hours in the immediately preceding 12-month period even if the employees had worked more than 1,000 hours in some earlier 12-month period. For example, suppose an employee worked:
- 1,000 hours in Year 1
- 500 hours in Year 2
- 500 hours in Year 3
- 500 hours in year 4
- 500 hours in year 5
Some employers may have applied the Preceding Year Exclusion Condition to exclude the employee from making elective deferrals in years 3, 4, and 5 because the employee worked less than 1,000 hours in the immediately preceding years 2, 3, and 4. However, because the employee worked 1,000 hours in year 1, the OIAI rule provides that the employee should have been eligible to make elective deferrals during every year after year 1.
Transition Relief. Recognizing that the regulations and limited past guidance regarding the OIAI rule may not have been clearly understood and applied by some employers, the IRS issued Notice 2018-95 to provide limited transition relief. Specifically, the notice provides three types of relief:
- Operational Relief. Tax-exempt employers who may not have operated their plans correctly to comply with the OIAI rules are entitled to operational relief for the period beginning with the first tax year after December 31, 2008 (when the 403(b) regulations first became effective) and through the last 12-month exclusion period that ends before December 31, 2019. So, for calendar year plans that use the calendar year as the exclusion period, the operational transition relief ends as of December 31, 2018, and such plans must start complying with the OIAI rule and allowing eligible part-time employees to start making elective deferrals to 403(b) plans starting as of January 1, 2019 (but see the Fresh Start Relief point below).
- Plan Document Relief. Tax-exempt employers who sponsor individually designed plans that exclude part-time employees and do not contain (or incorrectly state) the OIAI rule have until March 31, 2020, to amend their plans to correct the error. Preapproved documents should already contain the OIAI rule and should not need to be amended.
- Fresh-Start Relief. The IRS notice provides “fresh start” relief and permits an employer to apply the OIAI rule prospectively without regard to employees’ past work history. Specifically, if the employer starts complying with the OIAI rule as of January 1, 2018, and an employee hired before 2018 did not work 1,000 or more hours in 2018, the employer does not need to offer the employee the opportunity to make elective deferrals in 2019. This is the case even if the employee worked 1,000 or more hours in some prior period (e.g., 2017 or some earlier year). This fresh start rule potentially reduces the administrative burden of starting to comply with the OIAI rules by limiting the past periods the employer must evaluate for operational compliance/noncompliance with the OIAI rules.
The rules for applying this transition relief vary slightly for fiscal year plans and plans that apply the universal availability rules using anniversary year exclusion periods.
If you have any questions about this transition relief, please feel free to reach out to the authors or your Morgan Lewis contact.