Employee Benefits & Executive Compensation Blog

The View from Proskauer on Developments in the World of Employee Benefits, Executive Compensation & ERISA Litigation

IRS Announces Transition Relief From The Once-In-Always-In Requirement For Excluding Part-Time Employees Under 403(b) Plans

The IRS recently issued Notice 2018-95 to provide transition relief to 403(b) plans that erroneously excluded part-time employees from eligibility to make elective deferrals when the employees should have been eligible to participate under the “once-in-always-in” requirement (“OIAI”). Under the OIAI requirement, once an employee is eligible to make elective deferrals, the employee may not be excluded from eligibility for making elective deferrals in any later year on the basis that the employee is a part-time employee. The IRS issued Notice 2018-95 to provide transition relief because many employers that sponsored 403(b) plans did not realize that the OIAI requirement applied to the part-time exclusion.

Background

403(b) plans are subject to a “universal availability requirement,” which generally requires that if any employee has the right to make elective deferrals under an employer’s 403(b) plan, the right to make elective deferrals must be universally available to all employees. However, there are certain narrow categories of employees that may be excluded from eligibility for making elective deferrals under 403(b) plans without violating the universal availability requirement. 403(b) plans may require that employees make annual contributions greater than $200, and may also exclude:

  1. employees who are eligible to make elective pre-tax contributions to certain other employer defined contribution plans;
  2. nonresident aliens with no U.S. source income;
  3. certain students (i.e., students providing services described in Section 3121(b)(10) of the Internal Revenue Code of 1986, as amended (the “Code”)); and
  4. part-time employees who normally work fewer than 20 hours per week, which is sometimes referred to as the “part-time exclusion.” The Notice 2018-95 transition relief only applies to plans that improperly applied the part-time exclusion.

In July 2007, the IRS issued final regulations under Code Section 403(b) (the “Final Regulations”) which included guidance regarding the part-time employee exclusion. According to the Final Regulations, 403(b) plans can only exclude this category of employees if all employees in that category are excluded (i.e., if the plan allows one employee who normally works fewer than 20 hours per week to make elective deferrals under the plan, all employees who qualify as part of that group must be eligible to make elective deferrals under the plan, which is referred to as the “consistency requirement”). Additionally, for purposes of excluding part-time employees, the Final Regulations impose three distinct conditions that employers must satisfy for an employee to be excluded.

  1. A “first-year” exclusion condition: Employers 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;
  2. A “preceding-year” exclusion condition: The employee actually worked fewer than 1,000 hours of service for the preceding measurement period (i.e., each plan year following the employee’s first year of employment, or, if the plan so provides, the plan can look to the 12-month periods based on the date the employee commenced employment instead of looking to plan years) (defined in Notice 2018-95 as an “Exclusion Year”); and
  3.  An 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 participate in making elective deferrals under his employer’s 403(b) plan. Then, once allowed to participate in making elective deferrals, the employee cannot later be excluded from eligibility to make elective deferrals on the basis that the employee’s hours significantly dropped, which is referred to as the “once-in-always-in” or OIAI requirement.

In practice, many 403(b) plan sponsors did not apply the OIAI requirement. 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 OIAI requirement 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 under Notice 2018-95

In response to requests from 403(b) plan sponsors, Notice 2018-95 provides for a transition relief period for plans that did not properly apply the OIAI requirement. This “Relief Period” provided under Notice 2018-95 begins with tax years beginning after December 31, 2008 (which is generally the effective date for the Code Section 403(b) Final Regulations). If a 403(b) plan provides that the preceding-year exclusion is determined on a plan year basis, the Relief Period ends on the last day of the last plan year that ends before December 31, 2019. If a 403(b) plan provides that the preceding-year exclusion is determined based upon an employee’s anniversary year, the Relief Period will end on different dates for different employees based upon the date of each employee’s anniversary of employment, but no later than December 31, 2019.

Notice 2018-95 provides the following transition relief from the OIAI requirement:

1. 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.

2Relief regarding plan language: Notice 2018-95 provides different relief for 403(b) plans that have adopted plan documents that are covered by an IRS opinion or advisory letter (i.e., prototype or volume submitter plans) versus 403(b) plans that use individually designed plan documents.

  • During the Relief Period, 403(b) plans that adopted an IRS pre-approved plan document will not be treated as failing to satisfy the conditions of the part-time exclusion, and the plans will not be treated as having failed to follow plan terms, merely because the plan document does not match plan operations with regard to the OIAI requirement.
  • During the Relief Period, 403(b) plan sponsors whose plan documents use individually designed plan documents must amend their plans’ language to reflect the plans’ operation with respect to the OIAI requirement prior to April 1, 2020. Thus, if during the Relief Period, a 403(b) plan did not properly apply the OIAI requirement, the plan must be amended to reflect how it was actually operated.

Both pre-approved 403(b) plans and individually designed 403(b) plans that provide for the part-time exclusion must include explicit language concerning the OIAI requirement prior to April 1, 2020.

3. A “fresh-start opportunity” for plans: Notice 2018-95 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 January 1, 2018.

Employers that sponsor 403(b) plans that exclude part-time employees for purposes of eligibility for elective deferrals should carefully consider how the OIAI requirement applies to their plans and whether any changes will be necessary to either their procedures or plan documents.

Massachusetts Health Insurance Responsibility Disclosure Form Must Be Filed by November 30 and Annually Thereafter

Massachusetts recently published guidance regarding its new Health Insurance Responsibility Disclosure (HIRD) annual filing, which is due for the first time on November 30, 2018 and then annually thereafter. This new HIRD form replaces one that was suspended in 2014 because it became unnecessary due to the ACA’s reporting requirements.

The new HIRD requirement consists of a relatively simple employer filing requirement (i.e., employees are no longer required to complete a form) and is intended to help Massachusetts determine who might be eligible for premium assistance under the state’s MassHealth Program. The filing requirement applies to every employer that has (or had) six or more Massachusetts-based employees during any month in the 12 months prior to November 30 of the filing year. An individual is considered an employee for this purpose if the employer including the individual in the quarterly wage report filed with the Massachusetts Department of Unemployment Assistance. Similar to the ACA reporting forms, HIRD forms are filed on an EIN-by-EIN basis. This means that a separate form must be filed for each company with its own EIN.

The HIRD disclosure form requests information regarding health plan eligibility requirements (such as cumulative service requirements or waiting periods), health plan design, and costs associated with maintaining the health plan. Although employers can hire their current payroll providers, insurance providers, or consultants to complete these forms, ultimate responsibility for completing the forms is on the employers. For employers with a unionized workforce receiving coverage through a union plan (which likely is intended to include a multiemployer plan), it appears that the HIRD firm simply requires identification of the union. Additionally, Massachusetts has provided some guidance related to professional employer organizations (PEOs), which often file payroll reports with Massachusetts on behalf of their client employers. Though PEOs may assist their client employers, the guidance makes clear that the client employers themselves are ultimately responsible for completing the HIRD forms.

Most payroll providers operating in Massachusetts already file reports through Massachusetts’ MassTaxConnect system, so employers with Massachusetts-based employees should consider contacting their provider to determine what assistance is available. To the extent that employers need assistance completing the forms, employers should consider contacting benefits consultants or legal counsel.

Treasury and IRS Issue Eagerly-Awaited Guidance on Hardship Distributions – with a Few Surprises

Last Friday, the IRS issued eagerly-awaited proposed regulations regarding hardship distributions under section 401(k) and 403(b) plans (the “Proposed Regulations”). The Proposed Regulations primarily address hardship distribution issues raised by the Bipartisan Budget Act of 2018 (the “Budget Act”). (For our earlier blog entry summarizing these issues, click here.) At the same time, the Proposed Regulations address related hardship distribution issues implicated by the 2018 Tax Cuts and Jobs Act (the “Tax Act”) and recent disaster relief guidance. Plan sponsors should review the Proposed Regulations carefully. Even before the Proposed Regulations are finalized, plan sponsors will need to consider administrative and plan amendment changes to conform to the new rules.

As a general rule, there are two key components for a permissible hardship distribution: (1) the withdrawal must be made due to an immediate and heavy financial need; and (2) the amount of the withdrawal must be limited to the amount necessary to satisfy that financial need. Existing regulations provide detailed rules for how plan participants can prove each requirement is met when requesting a withdrawal. The Proposed Regulations would modify and relax many of these rules to conform to new law changes.

Elimination of Six-Month Contribution Suspension Requirement

Under current “safe harbor” hardship distribution regulations, participants who take a hardship distribution are prohibited from making future contributions to the plan and other employer-sponsored plans for six months. Congress determined that this rule prevents participants from replenishing their accounts after a hardship distribution and directed the IRS to issue regulations to fix the problem. As directed by the Budget Act, the Proposed Regulations eliminate the six-month contribution suspension requirement.

The elimination has an interesting effective date. It may be applied on the first day of the first plan year beginning after December 31, 2018 (January 1, 2019 for a calendar year plan) even if the distribution was made in the prior plan year. For example, assume a calendar-year plan provides for hardship distributions under the pre-2019 safe harbor standards and a participant took a hardship distribution in the second half of the 2018 plan year. The plan may be amended either to end the suspension period for contributions as of January 1, 2019 or to continue the suspension for the originally-scheduled six months.

Separately, the Proposed Regulations indicate that for distributions made on or after January 1, 2020 (regardless of the plan year), a 401(k) plan may not provide for a suspension of contributions as a condition to obtaining the distribution. In other words, after 2019 the suspension period is not available even as an optional design matter.

Practice Point on 409A Implications: Plan sponsors should consider the potential impact of this new rule on their nonqualified deferred compensation plans subject to Code Section 409A. Under the Section 409A regulations a nonqualified deferred compensation plan is allowed to cancel a participant’s nonqualified plan deferral election if a participant takes a 401(k) hardship distribution. This Section 409A rule was intended to allow nonqualified deferred compensation plans to conform to the six-month suspension rule. Depending on when a plan sponsor eliminates the 401(k) suspension period, there could be related consequences for administration of the nonqualified deferred compensation plan.

No Need to Take Available Plans Loans Before a Hardship Distribution

Another existing safe harbor rule to demonstrate that a requested hardship distribution is necessary is that the participant must take all plan loans otherwise available before taking the hardship distribution. Consistent with the Budget Act, the Proposed Regulations would remove this requirement effective for hardship distributions made in plan years beginning after December 31, 2018. Unlike the elimination of the six-month suspension period, however, the elimination of this requirement is not mandatory. Plans could continue to impose a requirement that participants take plan loans before being eligible for a hardship distribution.

New Circumstances for Hardship Distributions

Under current IRS hardship distribution safe harbor regulations, an employee is considered to have an immediate and heavy financial need if the need falls into one of six categories of hardship events. The Proposed Regulations modify the permitted safe harbor events in several ways that participants and plan administrators will likely find helpful:

  • Before the Tax Act, a participant could take a hardship distribution for expenses to repair damage to the participant’s principal residence if the damage qualified for a casualty loss deduction under Code Section 165. Through 2025, the Tax Act eliminated the casualty loss deduction unless the loss was due to a federally-declared disaster. In what many believed to be an unintended consequence, this change resulted in many participants being ineligible to take a hardship distribution if their homes were damaged for reasons other than federally-declared disasters. The Proposed Regulations would restore the casualty loss hardship distribution event to the pre-Tax Act standard.
  • Hardship distributions for qualifying medical, educational, and funeral expenses include those expenses incurred by a participant’s “primary beneficiary” (someone named as a beneficiary and who has an unconditional right, upon the employee’s death, to all or part of the employee’s plan account). This modification incorporates the prior guidance issued by the IRS in Notice 2007-7 that permitted plans to allow hardship distributions for medical, tuition, and funeral expenses incurred on behalf of a primary beneficiary.
  • Under a new category of permitted hardship distribution events, participants could take a hardship distribution due to expenses and losses (including loss of income) incurred after federally-declared disasters (as long as the participant’s home or principal place of business at the time of the disaster was located in an area designated for federal assistance). This change would allow many plans to offer immediate assistance to affected participants without having to wait for the IRS or Congress to take specific action in response to the disaster.

These changes generally apply for distributions made in post-2018 plan years; however, they may be applied to hardship distributions made on or after a date as early as January 1, 2018. This allows plan sponsors to conform their plans retroactively to actual operational activity. For example, if a plan continued to allow for casualty loss hardship distributions without regard to the changes imposed by the Tax Act, it could be retroactively amended to conform to the new Proposed Regulation rule.

Expansion of Sources for Hardship Distributions

Consistent with the Budget Act, the Proposed Regulations expand the sources available for hardship distributions to include earnings on elective deferrals, QNECs, QMACs, and earnings on QNECs and QMACs. The preamble to the Proposed Regulations also confirms that safe harbor 401(k) employer contributions (and earnings thereon) are also available sources for hardship distribution.

Plan sponsors would not be required to expand the available sources for hardship distributions. Instead, they could continue to limit the amounts available for hardship distributions consistent with the prior rules. However, plan sponsors should coordinate with their recordkeepers to make sure their design decisions will be implemented properly.

Special Consideration for 403(b) Plans: Under the Proposed Regulations, earnings on pre-tax deferrals made to a 403(b) plan continue to be ineligible for hardship distributions. However, QNECs and QMACs would be eligible for hardship distributions in a section 403(b) plan that is not in a custodial account. QNECs and QMACs in a section 403(b) plan that is held in a custodial account would continue to be ineligible for hardship distributions.

Plan Administrators May Rely Solely on New Participant Representation

The Proposed Regulations would eliminate the current rule that the determination of whether a distribution is necessary to satisfy a financial need is based on all the participant’s relevant facts and circumstances. Instead, for hardship distributions made on and after January 1, 2020, a participant must represent (in writing or by electronic means) that the participant has insufficient cash or liquid assets to satisfy the financial need. A plan administrator could rely on the representation in the absence of actual knowledge to the contrary.

Applicability Date and Deadline to Amend Plans

The Proposed Regulations generally apply to hardship distributions made in plan years starting after December 31, 2018, unless an exception otherwise applies (for example, the revised list of safe harbor expenses may be applied to distributions made on or after January 1, 2018 and the elimination of the six-month suspension could be applied to suspension periods in place as of the beginning of the 2019 plan year).

Special Note – Plan Amendment Required: Plans that permit hardship distributions will need to be amended to reflect these new hardship distribution rules once the regulations are finalized. These amendments would be treated as qualification requirement amendments and subject to an extended due date for plan amendments. The final date is to be determined; however, the general rule is that plans have until the end of the second calendar year beginning after the issuance of an IRS-issued “Required Amendments List” reflecting the new rules. That is the outside date for amendments, however. Plan sponsors should consider plan amendments well in advance of any final deadline.

[Podcast]: Key Considerations for ERISA Investors in Private Investment Funds

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In this episode of The Proskauer Benefits Brief, partner Ira Bogner and senior counsel Adam Scoll discuss the key considerations for ERISA investors in private investment funds, as well as a plan fiduciary’s overarching fiduciary duties and responsibilities that are related thereto. One of the first key considerations is to determine the plan asset status of the private investment fund. Tune in and listen as we break down the material ERISA issues for ERISA investors to consider when investing in private investment funds.


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[Podcast]: Nuts and Bolts on a Management Buyout (Part 7 of 7)

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In the final episode of a seven-part series for The Proskauer Benefits Brief, partners Michael Album and Josh Miller talk about employment agreements in the context of a management buyout. They go over the key terms and issues that management should focus on when reviewing and negotiating their go-forward employment arrangements, compensation structure, severance protection and restrictive covenants with the buyer following the sale. Tune in and listen for the latest insights on management buyouts.


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[Podcast]: Nuts and Bolts on a Management Buyout (Part 6 of 7)

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In this episode of The Proskauer Benefits Brief, partners Michael Album and Josh Miller discuss the incentive equity package that management will be offered in the buyout, including the structure of the incentive pool, vesting, and favorable tax treatment of incentive grants. Tune in and listen for the latest insights and perspective on management buyouts in this sixth of a seven part series.


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[Podcast]: Nuts and Bolts on a Management Buyout (Part 5 of 7)

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In this episode of The Proskauer Benefits Brief, partners Michael Album and Josh Miller are back to continue their discussion of the rights that management gets when it “rolls” old equity into new equity in the buyout vehicle and then introduce incentive equity awards for management. Be sure to tune in and listen for the latest on management buyouts in this fifth of a seven part series.


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[Podcast]: Nuts and Bolts on a Management Buyout (Part 4 of 7)

proskauer benefits brief podcast

In this episode of The Proskauer Benefits Brief, partners Michael Album and Josh Miller return to discuss how management can use a “template” to have a bidder identify the way compensation issues will be addressed in an MBO. They also discuss the “rollover” by management of their equity in an MBO. Be sure to tune in and listen for the latest insights and perspective on management buyouts in this fourth of a seven part series.


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[Podcast]: Nuts and Bolts on a Management Buyout (Part 3 of 7)

proskauer benefits brief podcast

In this episode of The Proskauer Benefits Brief, partners Michael Album and Josh Miller return to discuss the nuts and bolts of a management buyout, and in particular, how management deals with the selling sponsor and the bidder, and starts to develop their own compensation packages post-closing and consider deal bonuses from the selling sponsor. Be sure to tune in and listen for the latest insights and perspective on management buyouts in this third of a seven part series.


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[Podcast]: Nuts and Bolts on a Management Buyout (Part 2 of 7)

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In this episode of The Proskauer Benefits Brief, partners Michael Album and Josh Miller return to discuss the nuts and bolts on a management buyout. As part of their discussion they highlight the different types of transactions (single bidder vs. multi-bidder) and the various tasks that management faces in handling the process and as a first step inventorying their own compensation arrangements. Be sure to tune in and listen for the latest insights and perspective on management buyouts in this second of a seven part series.


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