The Internal Revenue Service has issued guidance and relief for certain tax-exempt employers and public schools and universities that maintain 403(b) plans (tax-sheltered retirement programs) that exclude part-time employees.
In general, a 403(b) plan must permit all employees to make tax-deferred contributions if any employees are permitted to make such contributions. However, the statute provides that "employees who normally work less than 20 hours per week" may be excluded from making such contributions.
Issues often arise in determining which employees "normally" work less than 20 hours a week. For example, a substitute teacher might work full-time for some weeks, but not at all for others.
To deal with this issue, the regulations (26 CFR § 1.403(b)-5(b)(4)(iii)(B)) provide as follows:
[A]n employee normally works fewer than 20 hours per week if and only if -
(1) 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 (as defined in section 410(a)(3)(C)) in such period; and
(2) 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.
Many employers have assumed that paragraph (2) above meant that for each plan year after the first, an employee could be excluded from making pre-tax contributions if that employee had worked fewer than 1,000 hours in the preceding plan year. However, in 2015, the IRS issued pre-approved plan language indicating that if an employee had ever satisfied either of these conditions, he or she could no longer be excluded as a part-time employee for any later year.
Notice 2018-95 – Clarifying the IRS Position and Providing Relief
Notice 2018-95 clarifies the IRS position that an employee who either (a) is initially expected to work at least 1,000 hours a year, or (b) works at least 1,000 hours in any plan year cannot be excluded in any subsequent plan year, even if the employee never again works 1,000 hours in any one year. This is referred to as the "once-in-always-in" (OIAI) rule. Notice 2018-95 also provides relief for plan sponsors who had not understood the IRS position in this regard.
Example 1: Jane is initially hired as a full-time teacher, is expected to work at least 1,000 hours a year, and thus is permitted to make pre-tax contributions. However, she quickly decides to convert to part-time status. Jane can never be excluded from making pre-tax contributions to the 403(b) plan, even if she never works as much as 1,000 hours in any year.
Example 2: John is a substitute teacher. When hired, John is expected to work only about 500 hours in any one year. John need not be offered the opportunity to make pre-tax contributions to the school's 403(b) plan in the first year.
However, a teacher dies soon after John is hired, and John substitutes for that teacher for the entire year, working more than 1,000 hours. After a year, a new permanent teacher is hired, and John goes back to working about 500 hours a year. John can never again be excluded from making pre-tax contributions to the 403(b) plan.
Example 3: Sally is a receptionist for a tax-exempt entity and works part-time. Sally's husband is laid off and Sally requests to work in a full-time capacity. In lieu of hiring temps, Sally works full-time hours with the expectation that she will work more than 1,000 hours for the year. Sally returns to part-time hours after 7 months. Sally can never be excluded from making pre-tax contributions to the 403(b) plan.
Recognizing that many employers did not read the regulations in this way, Notice 2018-95 provides transitional rules, applicable to a "Relief Period." 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.
During the Relief Period, several types of relief are provided, to allow plan sponsors to correct plan operations and/or plan language inconsistent with the IRS position clarified in Notice 2018-95. Of special interest to many employers, under certain circumstances, there is a one-time "fresh start" opportunity. This may allow a plan to disregard periods before January 1, 2018 in which a (current) part-time employee had previously satisfied the criteria for full-time employee status, and keep the employee in part-time status.
By the end of the Relief Period, an employer must permit all employees covered by the OIAI rule to make pre-tax contributions to its 403(b) plan, unless the one-time "fresh start" exception applies. By March 31, 2020, an employer must either adopt a pre-approved plan that incorporates the OIAI rule, or amend its individually designed plan to incorporate the OIAI rule.
If you have any questions about the information above or whether your 403(b) plan qualifies for relief provided by the Notice, please contact the authors or any member of the Employee Benefits and Executive Compensation Group at Venable LLP.