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Aside from tightening up the application of the universal availability rules, most 403(b) plans will now be subject to nondiscrimination rules on employer contributions and after-tax employee contributions, giving rise to the possible need for tax-exempt entities to modify their plans’ contribution formulas.
Provisions of the 403(b) regulations regarding nondiscrimination rules, as outlined by the Groom Law Group, follow:
Repeal of Notice 89-23 Safe Harbor
Consistent with the proposed regulations, the final regulations repeal the nondiscrimination safe harbors of IRS Notice 89-23, and generally impose the qualified plan nondiscrimination rules on all employer contributions (other than elective deferrals) and after-tax employee contributions to 403(b) plans. Thus, minimum coverage, nondiscrimination in contributions, and section 401(m) testing will generally apply to tax-exempt employer plans (other than churches). However, the final regulations clarify that, in certain cases, students and employees working less than 20 hours per week may still be excluded in applying the qualified plan nondiscrimination rules.
Governmental 403(b) plans are only subject to the nondiscrimination rules that limit the maximum amount of compensation taken into account for a year ($225,000 in 2007). Church plans are exempt from the nondiscrimination testing rules (including the “universal availability” rules) entirely. Many tax-exempt entities will need to revisit and possibly modify their contribution formulas by 2009.
A "universal availability" rule has long applied to all 403(b) plans with elective deferrals, excluding church plans, but including plans of governmental employers. The "universal availability" rule requires that, with certain exceptions, all employees normally working more than 20 hours a week must be able to make salary reduction contributions of at least $200. The rules go on to require that employees have an "effective opportunity" to participate at least on an annual basis. Lack of guidance in this area, and the dire consequences of error, have caused many employers to apply the test fairly conservatively in the past.
The final regulations clarify that certain employees who work less than a threshold established by the employer that is less than 20 hours worked per week may be excluded from the application of the "universal availability" rule.
The regulations eliminate the following Notice 89-23 safe harbor exclusions from the universal availability rule, including:
- Employees who make a one-time election to participate in a governmental plan instead of a 403(b) plan,
- Employees covered by a collective bargaining agreement,
- Visiting professors for up to one year under certain circumstances, and
- Employees affiliated with a religious order who have taken a vow of poverty.
To address some of the comments it received, the IRS notes that:
- An individual who has taken a vow of poverty who works for a church-controlled organization, and whose compensation from the organization is not treated as wages for income tax reporting purposes, may be excluded from the universal availability rule in certain cases because they have no compensation.
- A visiting professor who continues to receive compensation from his or her home university, and who continues to make elective deferrals under his or her home university plan, may be excluded from the visiting university's application of the universal availability rule.
Delayed effective date rules are provided for the elimination of the IRS Notice 89-23 safe harbor exclusions (generally January 1, 2010 or, in the case of the IRS Notice 89-23 collective bargaining safe-harbor, a date between January 1, 2009 and July 26, 2010). Also, 403(b) plans maintained by governmental entities where a legislative body has the ability to amend the plan must be amended to comply by the earlier of the close of the legislative session that begins on or after January 1, 2009, or January 1, 2011.
These exceptions, and the delayed effective date rules, provide limited comfort to 403(b) plan sponsors that they will not need to rush to revise their "universal availability" provisions by January 1, 2009. Significant changes may be necessary for certain organizations, especially educational organizations, to comply with these new rules. In this regard, the IRS is stepping up its audit activities in this area, so caution is indicated.
"Anti-Conditioning" Rule
Despite an apparent lack of statutory authority, the final regulations retain a rule similar to the statutory 401(k) rule that rights or benefits under other employer plans (e.g., health benefits) cannot be conditioned directly or indirectly on an employee's participation (or non-participation) in the 403(b) plan.
Controlled Group Rules
The final regulations include rules governing the determination of a tax-exempt entity's controlled group that supersede the "reasonable, good faith" interpretation rules in IRS Notice 96-64, generally effective for the 2009 plan year. These rules generally apply to all tax-exempt entities (including their for-profit subsidiaries), although certain church entities and state or local government public schools are permitted to continue to apply the IRS Notice 89-23 rules for determining their controlled groups. Also, a helpful "common payroll" rule applies to the universal availability rule under governmental plans.
The final regulations are generally consistent with the proposed regulations and retain the rule (reflected in Notice 96-64, Notice 89-23, and Code section 512(b)(13)) that common control exists where 80% or more of the directors or trustees of one entity are either representatives of, or directly or indirectly controlled by, the other organization. However, in response to comments on the proposed regulations, the IRS notes:
- The open-ended anti-abuse rule in the proposed regulations is clarified by an example that provides additional insight into when the anti-abuse rule might be used to aggregate two less-than-80% controlled organizations.
- The IRS is granted authority to issue guidance on aggregating entities in other situations not addressed by the regulations where there are "substantial business reasons" that do not violate the anti-abuse rule for aggregating two entities, such as where two entities are highly integrated in their operations.
- The power to appoint or remove a trustee or director is based on the facts and circumstances of a situation such that a legally required trusteeship for a labor union does not necessarily establish control of an organization.
- Groom Law Group, Chartered
This feature is to provide general information only, does not constitute legal advice as part of an attorney-client relationship, and cannot be used or substituted for legal or tax advice.