IRS Proposes Rules on Long-Term, Part-Time Employee Eligibility

On November 27, 2023, the IRS issued Long-Term, Part-Time Employee Rules for Cash or Deferred Arrangements Under Section 401(k). As a reminder, the Setting Every Community Up for Retirement Enhancement (SECURE) Act required employers to deem part-time employees eligible for the 401(k) plan once they had completed three consecutive 12-month periods with 500 hours of service or more. The SECURE 2.0 Act followed that up by reducing the number of consecutive periods to two consecutive 12-month periods.

While the SECURE Act provision for long-term, part-time eligibility took effect on January 1, 2021, service that was completed before that date was not taken into account. As such, the first long-term, part-time employees that may become eligible under this provision will become effective as of January 1, 2024 (if they have completed three consecutive years with 500 hours of service each).

Given the impending effective date of the long-term, part-time (LTPT) employee provision, the IRS released the proposed rule to provide clarity on a number of subjects. The proposed rules define “long-term, part-time employee,” confirm participation and vesting requirements, speak to employer nonelective and matching contributions, and discuss employer elections.

“Long-Term, Part-Time Employee” Defined
LTPT employees are eligible to participate in 401(k) plans once they’ve completed 500 hours of service in each of three consecutive 12-month periods (or two consecutive 12-month periods beginning in 2025). The proposed rule clarifies that LTPT employees must still satisfy the age requirement (age 21) by the close of the last 12-month period with 500 hours. Additionally, the requirement to extend eligibility to LTPT employees does not apply to employees who are covered by a collective bargaining agreement or are nonresident aliens with no US-source income. Governmental plans and church plans are not exempt from the requirement, but the IRS is requesting comments on the application of these rules to those entities.

The IRS also clarified that employees who become eligible through some other framework of eligibility are not considered LTPT employees. Specifically, where an employer provides immediate entry into the 401(k) plan or implements another permissible service requirement, employees who become eligible are not LTPT employees even if they work 500 hours in the requisite number of years. Likewise, an employee who becomes eligible under a plan with an elapsed time method of crediting service (such that employees are eligible after a certain time period, regardless of hours worked) would not be considered an LTPT employee.

Participation
The IRS also provided guidance on the entry date for LTPT employees. Specifically, as for any other employee that becomes eligible for a 401(k) plan, LTPT employees’ participation in the plan must occur no later than the earlier of the first day of the plan year following satisfaction of the eligibility requirements or the date that is six months after the date the LTPT employee satisfied the eligibility requirements.

The IRS goes on to confirm that 12-month periods with 500 hours must be consecutive. So, if an ineligible employee has a year with less than 500 hours of service after a year where they completed 500 hours, the three consecutive year count starts over. On the other hand, LTPT employees who become eligible under these rules are locked in and will not lose eligibility to participate if they have a subsequent year with less than 500 hours of service.

The IRS also explained that while an employee’s initial 12-month period would begin on date of hire, subsequent 12-month periods could be counted based on the first day of the plan year.

Vesting
Although employers aren’t required to provide employer contributions to LTPT employees who become eligible for the plan, they will have to follow vesting rules if they choose to provide them. For these purposes, each 12-month period during which the LTPT employee is credited with at least 500 hours of service will be treated as a year of vesting. However, no service before January 1, 2021, will be counted towards LTPT employees’ service for vesting purposes.

The IRS also introduced the concept of former LTPT employees, who are LTPT employees who subsequently complete one year of service with 1000 hours (i.e., “normal” eligibility). These formal LTPT employees would cease to be considered LTPT employees such that they would be included in nondiscrimination and top-heavy testing. For vesting purposes, former LTPT employees will still be credited with a year of service even if they only work 500 hours in subsequent years.

Nonelective and Matching Contributions
Employers may choose not to provide nonelective or matching contributions to LTPT employees (with the exception of “former LTPT employees”). While the proposed rules would allow employers to elect to exclude LTPT employees for purposes of nondiscrimination testing, minimum coverage, and top-heavy testing, the IRS will not allow an employer sponsoring a SIMPLE 401(k) to exclude LTPT employees from matching or nonelective contributions.

Employer Elections
If employers choose to exclude LTPT employees from nondiscrimination testing, then they will be excluded from every nondiscrimination and coverage testing provision. Employers that have adopted a safe harbor plan must amend their documents to elect to exclude LTPT employees from the safe harbor (and related nondiscrimination testing). They must do the same to exclude LTPT employees from top-heavy testing. Employers may elect to exclude LTPT employees from nondiscrimination and top-heavy testing even if they decide to provide an employer contribution to them.

The proposed rules also confirmed that LTPT employees are eligible to make catch-up and Roth contributions. However, if an employer elects to exclude LTPT employees from nondiscrimination and coverage testing, they may choose to exclude LTPT employees from making catch-up and Roth contributions.

The proposed rules are set to apply to plan years beginning on or after January 1, 2024. The IRS is soliciting comments through January 26, 2024. They have also scheduled a public hearing on the proposed rule for March 15, 2024.

Employers should work with their retirement advisors, recordkeepers, and payroll or tracking vendors to ensure compliance with LTPT eligibility requirements.

Long-Term, Part-Time Employee Rules for Cash or Deferred Arrangements Under Section 401(k) »