Disregarded entity employees may participate in exempt entity’s plans
TAX ALERT |
In ILM 201634021, the IRS clarified that employees of a single-member limited liability company (LLC) can participate in the section 403(b) and section 457(b) retirement plans of a single member that is a tax-exempt entity. Employers may have had confusion over this area because single-member LLCs are not eligible to sponsor section 403(b) plans, and current regulations refer to subsidiaries and affiliates of the tax-exempt entity not being eligible employers if they are not eligible employers themselves. In addition, single-member LLCs are recognized for payroll tax purposes and retirement plans are linked to payroll.
The IRS stated that a single-member LLC that has not elected to be taxed as an association is treated as a branch or division of the tax-exempt entity, not a subsidiary or affiliate. Therefore, the reference in the regulation to eligible employers does not apply to single-member LLCs that are disregarded.
Section 403(b) plans must comply with universal availability rules, which generally require that if any employees are allowed to make deferrals into the plan, then all employees of the tax-exempt entity must be allowed. Therefore, because the LLC employees are viewed as employees of the tax-exempt entity itself, they not only may participate, they must be allowed to participate in the single member’s section 403(b) plan unless they meet an exception provided in the universal availability regulations. For example, employees who normally work fewer than 20 hours per week, among other groups, may be excluded from the plan if the plan so provides.
The universal availability rules do not apply to section 457(b) plans, which are top hat plans typically available only to a small group of executives so LLC employees do not have to be allowed to participate in these plans. However, it is still true that those employees are treated as employees of the tax-exempt entity, and are permitted to participate in the tax-exempt entity’s 457(b) plan if they meet the eligibility requirements.
Tax-exempt entities with disregarded LLCs should review their retirement plan participation to ensure the LLC employees are being treated appropriately.