New IRS guidance on multiple-employer 401(k) plans
IRS proposes to relax the “One Bad Apple Rule”
TAX ALERT |
A multiple-employer plan (MEP) is an employee benefit plan maintained by two or more employers. Many such plans are sponsored by companies that are not members of a common control group but do have a degree of common ownership. There is also the so-called “Open MEP” arrangement that allows completely unrelated employers, usually small businesses, to create a single 401(k) plan in the hopes of achieving better pricing on administrative and investment fees, as well possibly reducing the fiduciary responsibility that comes with maintaining a single plan.
However, thoughtful employers have been reluctant to join Open MEP arrangements because of concerns with U.S. Department of Labor (Department) and Internal Revenue Service (IRS) regulations. As an aside, the IRS has authority with respect to the tax status of retirement plans while the Department enforces the employee protection aspects of the Employee Retirement Income Security Act of 1974 (ERISA).
The first obstacle is that the Department has long considered an Open MEP not to be one plan for ERISA reporting and disclosure purposes, rather the Department considers many of these arrangements to be a collection of single-employer plans that are using a common administrative and funding platform. In the Department’s view, an Open MEP does not meet the requirement for a multiple-employer plan to be one plan for reporting purposes. To be one plan, the plan must be for a bona fide group or association of employers acting in the interests of its employer members to provide benefits to their employees.
The second obstacle is the IRS’ “One Bad Apple Rule,” technically referred to as the unified plan rule. Under this rule, if one employer violates the tax qualification requirements, that can put the qualified status of the entire plan at risk. For example, an employer could fail to include an eligible employee because of its misunderstanding of the rules on the eligibility of part-time employees to participate. That operational failure, and others like it, are a real risk that any employer considering an Open MEP should consider.
At the urging of the Trump administration (in the form of an Executive Order), the Department and the IRS have reconsidered their respective positions on Open MEPs.
For its part, the Department provides clarity regarding the types of “bona fide” groups or associations of employers and professional employer organizations that are permitted to sponsor MEPs.
The U.S. Treasury and the IRS have issued proposed regulations that allow an Open MEP to throw the one bad apple away. Specifically, under the proposed regulation a defined contribution MEP could be eligible for an exception to the unified plan rule.
The exception, if applicable, would allow the MEP administrator to take unilateral action to deal with a participating employer that either fails to satisfy a qualification requirement or is unresponsive to requests for information.
To qualify for the exception, the MEP must:
- Have established practices and procedures to promote compliance and the relevant plan documents must have plan language authorizing the MEP administrator to act.
- Provide the participating employer with a notice regarding the compliance issue and an opportunity for the otherwise unresponsive participating employer to take remedial action with respect to its failure.
If the participating employer continues to fail to take appropriate remedial action with respect to its failure, the MEP administrator can implement a spinoff of that employer’s portion of the plan. In other words, throw the bad apple out.
However, the spinoff process is not as easy as throwing away a real bad apple. The MEP administrator must provide three notices:
- The first notice must (i) describe the failure(s), (ii) tell the participating employer what it must do to fix the problem(s), and (iii) notify the participating employer that it has an option to initiate a spin off. In addition, this notice must explain that the MEP could decide to spin off the assets and account balances attributable to the employees of that employer into a separate single-employer plan, followed by a termination of that plan.
- If 90 days have passed and the participating employer has not acted, the MEP must issue a second notice (within 30 days of the end of the 90-day period). That second notice must inform the participating employer that a continued failure will result in the MEP sending notices to the participants and beneficiaries of the plan as well as the Department.
- If another 90 days pass, the MEP must provide a third notice to the unresponsive participating employer, and to the participants who are employees of that employer (and their beneficiaries), and to the Department of Labor. The third notice must include a deadline for employer action and an explanation of any adverse consequences to participants if a spinoff-termination occurs.
Once the notice period ends with no employer response, the MEP can notify employees that the MEP is no longer accepting contributions to their account and that the MEP will transfer those accounts to a separate plan that it will then terminate.
Taxpayers cannot rely on these regulations
Until the Treasury issues final regulations, taxpayers may not rely on the rules set forth in the proposed regulations.