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Proposed Regs Address 401(k) Plans for Long-Term Part-Time Employees
(Parker Tax Publishing December 2023)
The IRS issued proposed regulations that amend the rules applicable to plans that include cash or deferred arrangements under Code Sec. 401(k) to provide guidance with respect to long-term, part-time employees. The proposed regulation reflects statutory changes made by the SECURE Act of 2019 (Pub. L. 116-94) and the SECURE 2.0 Act of 2022 (Pub. L. 117-328) that relate to long-term, part-time employees. REG-104194-23.
Background
Code Sec. 401(k)(1) provides that a profit-sharing, stock bonus, pre-ERISA money purchase, or rural cooperative plan will not fail to qualify under Code Sec. 401(a) merely because it includes a cash or deferred arrangement (CODA) that is a qualified CODA. Under Code Sec. 401(k)(2), a CODA (generally, an arrangement providing for an election by an employee between contributions to a plan or payments directly in cash) is a qualified CODA only if it satisfies certain requirements.
Code Sec. 401(k)(2)(B) provides that contributions made pursuant to a qualified CODA (referred to as elective contributions) may not be distributed before the occurrence of certain events, and Code Sec. 401(k)(2)(C) provides that amounts attributable to the elective contributions must be nonforfeitable at all times. Code Sec. 401(k)(2)(D) limits the period of service that a plan may require an employee to complete with the employer or employers maintaining the plan in order to be eligible to participate in the qualified CODA.
Prior to the enactment of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) (Pub. L. 116-94), Code Sec. 401(k)(2)(D) provided that a qualified CODA was not permitted to require, as a condition of participation, that an employee complete a period of service that extended beyond the period permitted under Code Sec. 410(a)(1) (disregarding Code Sec. 410(a)(1)(B)(i)). In general, the period permitted under Code Sec. 410(a)(1) is the later of attainment of age 21 or completion of a 12-month period during which the employee has at least 1,000 hours of service.
Section 112 of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) (Pub. L. 116-94) amended Code Sec. 401(k)(2)(D) to provide that a qualified CODA must permit certain employees to participate in the CODA even if they do not have at least 1,000 hours of service in a 12-month period. Under Code Sec. 401(k)(2)(D) (as added by Section 112(a)(1) of the SECURE Act, but prior to amendment by the SECURE 2.0 Act), a qualified CODA may not require, as a condition of participation, that an employee complete a period of service that extends beyond the close of the earlier of: (1) the period permitted under Code Sec. 410(a)(1) (disregarding Code Sec. 410(a)(1)(B)(i)); or (2) subject to Code Sec. 401(k)(15), the first period of three consecutive 12-month periods during each of which the employee is credited with at least 500 hours of service.
Sections 125 of the SECURE 2.0 Act of 2022 (SECURE 2.0 Act) (Pub. L. 117-328) generally expands upon the rules set forth in Section 112 of the SECURE Act. Among other provisions, Section 125(c) of the SECURE 2.0 Act amends the period of service under Code Sec. 401(k)(2)(D)(ii) by replacing "3" with "2." Thus, as amended by Section 125(c) of the SECURE 2.0 Act, Code Sec. 401(k)(2)(D) provides that a qualified CODA may not require, as a condition of participation, that an employee complete a period of service that extends beyond the close of the earlier of: (1) the period permitted under Code Sec. 410(a)(1) (disregarding Code Sec. 410(a)(1)(B)(i)); or (2) subject to Code Sec. 401(k)(15), the first period of two consecutive 12-month periods during each of which the employee is credited with at least 500 hours of service.
Proposed Regulations
On November 27, the IRS issued proposed regulations that amend Reg. Sec. 1.401(k)-5 to set forth rules and definitions applicable to long-term, part-time employees under the SECURE Act and SECURE 2.0 Act.
Code Sec. 401(k)(15) provides special rules for "long-term, part-time employees," but does not define the term. The rules in Code Sec. 401(k)(15) apply to employees who are eligible to participate in a qualified CODA solely by reason of Code Sec. 401(k)(2)(D)(ii), or by reason of Code Sec. 401(k)(2)(D)(ii) and Section 202(c)(1)(B) of ERISA. Under Section 112(b) of the SECURE Act, Code Sec. 401(k)(2)(D)(ii) generally is effective for plan years beginning after December 31, 2020, but, pursuant to Section 125(c) of the SECURE 2.0 Act, Code Sec. 401(k)(2)(D)(ii) is amended to replace "3" with "2" effective for plan years beginning after December 31, 2024. Thus, Code Sec. 401(k)(15) applies to employees who are eligible to participate in a qualified CODA solely by reason of completing two consecutive 12-month periods or, with respect to a plan year beginning before 2025, three consecutive 12-month periods during each of which the employee is credited with at least 500 hours of service. However, Code Sec. 401(k)(15)(A) provides that Code Sec. 401(k)(2)(D)(ii) does not apply to an employee unless the employee has satisfied the age requirement of Code Sec. 410(a)(1)(A)(i) by the close of the last of the 12-month periods described in Code Sec. 401(k)(2)(D)(ii). In addition, section 401(k)(15)(C) provides that Code Sec. 401(k)(2)(D)(ii) does not apply to employees described in Code Sec. 410(b)(3).
Based on the provisions of Code Sec. 401(k)(15), Prop. Reg. Sec. 1.401(k)-5(b)(1)(i) generally defines a "long-term, part-time employee" as an employee who is eligible to participate in a qualified CODA solely by reason of having: (1) completed two consecutive 12-month periods (under Prop. Reg. Sec. 1.401(k)-5(b)(1)(iii), "three consecutive 12-month periods" is substituted for "two consecutive 12-month periods" with respect to a plan year beginning in 2024) during each of which the employee is credited with at least 500 hours of service; and (2) attained the age specified in Code Sec. 410(a)(1)(A)(i) by the close of the last of those 12-month periods.
Prop. Reg. Sec. 1.401(k)-5 also requires, with respect to each long-term, part-time employee, a qualified CODA to satisfy the participation requirements of Prop. Reg. Sec. 1.401(k)-5(c) and requires the plan that includes the CODA to satisfy the vesting requirements of Prop. Reg. Sec. 1.401(k)-5(d). Prop. Reg. Sec. 1.401(k)-5(e) provides guidance regarding nonelective and matching contributions made to the plan on behalf of long-term, part-time employees, and Prop. Reg. Sec. 1.401(k)-5(f) provides guidance regarding certain elections that the employer or employers maintaining the plan may make with respect to long-term, part-time employees.
Prop. Reg. Sec. 1.401(k)-5 is proposed to apply to plan years that begin on or after January 1, 2024. Prior to the date a Treasury decision revising Reg. Sec. 1.401(k)-5 to implement rules for long-term, part-time employees is published in the Federal Register, taxpayers may rely on the rules set forth in the proposed regulations.
For a discussion of employee eligibility requirements for Section 401(k) plans, see Parker Tax ¶131,130.
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
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