(b)lines Ask the Experts – ACP Testing After a Spin-Off

I read your recent Q&A regarding post-merger ACP testing with great interest, as our hospital has an ACP testing issue as well.
By PS

“However, it is the opposite of the issue you discussed in the previous article. Up until 2015, we were part of a two-hospital system, but effective 1/1/2015, the partnership was ended and we were spun off into a separate entity that is no longer part of the controlled group of the prior entity . Previously, we participated in a 403(b) matching plan with the other hospital; now, we have our own 403(b) matching plan that was established 1/1/2015. The plan covers the same employees of our hospital that it did previously, only under a new plan.     

“My question is related to the prior year average contribution percentage (ACP) for non-highly compensated employees (NHCEs) that we would use for 2015 testing, as our new plan uses the prior year testing method. I read somewhere that you can use an assumed ACP of 3% in the first year of a new plan. If this is true, this would be helpful since the ACP of the NHCEs in the prior plan for 2014 is only 2%. Or would we need to use the ACP of only the NHCEs of our hospital from the prior plan results? Any guidance you can provide would be greatly appreciated!” 

Michael A. Webb, vice president, Cammack Retirement Group, answers:

Well, you’ve come to the right place! First of all, let’s answer the easiest portion of your question first. Since all of employees in your new 403(b) plan participated in the 403(b) plan of the prior entity, your new 403(b) is considered what is called a “successor” plan to that 403(b) plan. Successor plans are ineligible to use the first-year testing rule that would assume a 3% ACP for NHCEs.

Now, the hard part. The rules that govern such situations are contained in Treas. Reg. §1.401(k)-2(c)(4), and if you’re interested in some light reading material, the Experts would certainly not suggest it! Even most of the examples, which are often an excellent method of clarifying complicated regulation, are quite complex as well. However, if you scroll to the end, there is a fairly straightforward example that would appear to apply to your situation, as follows:

Example 4. (i) Employer C maintains a calendar year plan, Plan Q, which includes a cash or deferred arrangement that uses the prior year testing method. Plan Q covers employees of Division A and Division B. In 2005, Plan Q had 500 eligible employees who were NHCEs, and the ADP for those NHCEs for 2005 was 2%. Effective January 1, 2006, Employer C amends the eligibility provisions under Plan Q to exclude employees of Division B effective January 1, 2006. In addition, effective on that same date, Employer C establishes a new calendar year plan, Plan R, which includes a cash or deferred arrangement that uses the prior year testing method. The only eligible employees under Plan R are the 100 employees of Division B who were eligible employees under Plan Q.

(ii) Plan R is a successor plan, within the meaning of paragraph (c)(2)(iii) of this section (because all of the employees were eligible employees under Plan Q in the prior year). Therefore, Plan R cannot use the first plan year rule set forth in paragraph (c)(2)(i) of this section.

(iii) The amendment to the eligibility provisions of Plan Q and the establishment of Plan R are plan coverage changes within the meaning of paragraph (c)(4)(iii)(A) of this section for Plan Q and Plan R. Accordingly, each plan must determine the NHCE ADP for the 2006 plan year under the rules set forth in paragraph (c)(4) of this section.

(iv) The prior year ADP for NHCEs under Plan Q is the weighted average of the ADPs for the prior year subgroups. Plan Q has only one prior year subgroup (because the only NHCEs who would have been eligible employees under Plan Q for the 2005 plan year if the amendment to the Plan Q eligibility provisions had occurred as of the first day of that plan year were eligible employees under Plan Q). Therefore, for purposes of the 2006 plan year under Plan Q, the ADP for NHCEs for the prior year is the weighted average of the ADPs for the prior year subgroups, or 2%, the same as if the plan amendment had not occurred.

(v) Similarly, Plan R has only one prior year subgroup (because the only NHCEs who would have been eligible employees under Plan R for the 2005 plan year if the plan were established as of the first day of that plan year were eligible employees under Plan Q). Therefore, for purposes of the 2006 testing year under Plan R, the ADP for NHCEs for the prior year is the weighted average of the ADPs for the prior year subgroups, or 2%, the same as that of Plan Q.

 

The boldface text would appear to be the most relevant to your situation, and it states that you should essentially use the prior year ACP (it says ADP, but ACP testing works the same way) for all of the NHCEs in the prior plan, which, in your case, is 2%.However, you should consult with outside benefits counsel well versed in such matter to confirm that your fact pattern matches the fact pattern in the example from the regulations.

Thank you reading the column, and for your question!

 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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