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IRS Issues Guidance on Part-Time Employee Exception for 403(b) Plans

January 10, 2019

On December 4, 2018, the Internal Revenue Service (IRS) issued Notice 2018-95, which provides guidance and temporary relief for 403(b) plans from the “once-in-always-in” (OIAI) eligibility rule.  The Notice generally provides transition and “fresh-start” rules for a 403(b) plan that improperly excluded part-time employees from making elective deferrals to the plan.

Background.  Section 403(b) plans must comply with what is called the “universal availability rule.”  This rule requires that all employees must be permitted to make elective deferrals if any employee is allowed to make them.  The regulations include a few exclusions, including a rule that a plan may exclude part-time employees who normally work fewer than 20 hours per week (1,000 hours per year).  If an employee moves from part-time to full-time status, the employee must be allowed to make elective deferral contributions to the plan.

Some 403(b) plans have historically interpreted the part-time exclusion rule to allow the plan to exclude an employee who was previously eligible to participate in the plan but who later had a reduction in hours.  The IRS’s view, however, is that the 403(b) regulations require that an employee may only be excluded from the plan under the part-time exclusion rule if the employee was part-time in each and every prior year.  This is what the IRS calls the OIAI rule because an employee who becomes eligible must always be eligible even if the employee has a reduction in hours to part time.

When the IRS first released model language for 403(b) plans in 2013 (called “listings of required modifications” or “LRMs”), the language did not include the OIAI rule.  In 2015, the IRS released updated model language and added a sentence that specifically highlights the OIAI rule.  This development alerted a number of 403(b) plans to the OIAI rule.

Transition Relief.  Notice 2018-95 reiterates the OIAI rule.  The Notice provides relief regarding plan operations, relief regarding plan language, and a fresh-start opportunity after the relief period ends.  The relief period begins with tax years beginning after December 31, 2008 (the general effective date for the section 403(b) regulations).  For most plans, the relief period ends on the last day of the last exclusion year that ends before December 31, 2019.  The “fresh-start” relief allows a plan to begin compliance with the OIAI rule for exclusion years beginning on or after January 1, 2019.

Source:  Davis & Harman LLP; January 2019

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