Guidance for Part-time Employee Exclusions Under 401(k) Plans
JULY 2007 - The
IRS issued guidance regarding the exclusion of part-time, temporary,
seasonal, and project employees under qualified plans, including
401(k)s. Plan provisions that are improperly drafted to exclude
part-time and other non–full-time employees, as well as
plans excluding part-time employees in actual operation without
any provisions excluding these employees, may cause disqualification.
A qualified plan that is disqualified would lose its tax-favorable
treatment and the tax-exempt status of the trust established as
a part thereof, regardless of whether the qualified plan is the
subject of a favorable determination letter.
401(k) plans have become increasingly popular with plan sponsors
and participants. Eligibility requirements have been lowered from
the traditional one-year waiting period to less than 1,000 hours
of service during 12 consecutive months. Indeed, many employers
have permitted entry into their 401(k) plans after six months
of work, or as of the employee’s date of hire, with respect
to the 401(k) deferral feature.
period less than 12 consecutive months may not include as a condition
the performance of 1,000 hours of service. That is, a six-month
waiting period would mean that an employee must perform six months
of service without any minimum number of hours. Accordingly, such
a plan provision would allow part-time, seasonal, and project
employees to enter the plan.
would rather not cover part-time employees because of the adverse
impact on the special nondiscrimination test, which may result
in the refund of excess 401(k) deferrals to highly compensated
employees. Furthermore, many employers do not intend to provide
retirement plan benefits for their part-time and other non–full-time
employees. Federal pension law under the Employee Retirement Income
Security Act (ERISA) does not require that a qualified plan cover
all employees when determining compliance with coverage requirements.
service requirement a qualified plan may impose upon common-law
employees is one year of service (or two years of service for
non–401(k) plans). A qualified plan may not exclude part-time
employees whose customary schedule is not more than 20 hours per
week, because such an employee may perform more than 1,000 hours
of service. That is, a qualified plan may not have a waiting period
of more than 1,000 hours in more than 12 consecutive months.
letters include a caveat advising that a determination letter
may not be relied upon with respect to whether the plan’s
exclusion classifications, if any, violate the IRC’s minimum
age and service requirements. Furthermore, an exclusion from coverage
of part-time and other non–full-time employees is not a
matter of a determination letter, but rather an audit issue that
directly affects the qualification of the plan and the tax-exempt
status of the trust.
The IRS will
not challenge an exclusion classification that is defined without
reference to hours of service. In other words, an exclusion classification
may be defined by reference to job title or job functionality,
even if such exclusion may effectively exclude part-time and other
non–full-time employees. Any exclusion classification must
be clearly defined and will be examined by an IRS specialist when
a plan is submitted for a favorable determination, or when it
should carefully examine plan documents to properly exclude any
otherwise eligible employee, part-time or otherwise. If a plan
does not have a properly drafted exclusion, the plan sponsor should
consider using the IRS’s Voluntary Correction Program to
cure the document defect.
a qualified plan may exclude part-time employees by having a one-year
eligibility provision and, thus, exclude any employee who does
not perform at least 1,000 hours of service in 12 consecutive
months. If a plan has a waiting period of less than one year,
the plan might design a part-time employee exclusion through a
provision that excludes an employee scheduled to work less than
1,000 hours of service annually. Such a provision may be valid
only if it also includes language that employees who perform more
than the scheduled 1,000 hours of service during their relevant
period are eligible for plan participation.
this example, a plan would have two eligibility conditions: immediate
entry for full-time employees and one year of service for part-time
employees. Excludable part-time employees who work more than the
scheduled 1,000 hours must be eligible in order for the plan to
qualify for favorable tax treatment under the IRC. That is, even
though a part-time job description may include less than 20 hours
of services performed weekly, if the plan admits all employees
who work more than 1,000 hours to be eligible for the plan, they
will qualify under the IRC. This fail-safe language protects the
integrity of the plan and excludes part-time employees who do
not complete the 1,000 hours of service requirements during the
plan must cover at least 70% of its otherwise eligible non–highly
compensated employees if it covers 100% of its eligible highly
compensated employees. Thus, a qualified plan may not exclude
more than 30% of its eligible non–highly compensated employees
who are part-time and other non–full-time employees. Employees
who do not satisfy the plan’s minimum age and service requirement
are statutorily excludable and not taken into account when determining
the 70% coverage test.
may draft plans that exclude part-time, seasonal, temporary, and
project employees without reference to hours of service and within
the required coverage tests. Plan sponsors who have failed to
cover part-time and other non–full-time employees in the
absence of a properly drafted exclusion provision may wish to
review their plan documents and actual plan operation to either
cover these employees or properly draft an exclusion provision
that includes fail-safe language beneficial to the employer.
may design their plans to take advantage of this part-time employee
guidance to reach their objectives regarding the classification
of employees covered by their 401(k) plans.
M. Geller, Esq., is managing director of the Geller Group
LLC, a member of Focus Financial Partners, New York, N.Y. He is
a member of The CPA Journal Editorial Board.