IRS Key District raises qualification issues.

• Author: Elinsky, Peter I.
• Position: Dallas Key District Office

A newsletter issued by the IRS's Dallas Key District Office warns plan administrators of two plan practices that may result in violations of the plan qualification rules: (1) disregarding years of service in which an employee does not make elective deferral in determining the vesting of matching contributions in a Sec. 401(k) plan and (2) classifying employees as "part-time" and excluding them from participation in the plan on that basis.

Vesting matching contributions in Sec. 401(k) plans

In determining years of service for the vesting of matching contributions under Sec. 401(k) plans, some plans exclude any year in which an employee does not make an elective deferral. In a newsletter directed at plan administrators, the Dallas Key District has advised that this practice is not permissible--and that plans that continue to disregard years of service under such circumstances may be subject to severe sanctions, up to and including disqualification.

The position that Sec. 401(k) plans should be able to disregard those years of service in which an employee makes no elective deferrals is apparently based on Sec. 411(a)(4)(B). That section provides that, for vesting purposes, a plan requiring employee contributions can exclude any years of service during which the employee declines to contribute to the plan. Similarly, Regs. Sec. 1.411-5(b)(2) provides that a year of service under a plan that requires mandatory employee contributions for that year can be excluded for vesting purposes if the employee does not participate for that year due to his failure to make the mandatory contributions. For this purpose, mandatory contributions are amounts an employee is required to contribute to the plan as a condition of employment, as a condition of participation in the plan or as a condition of obtaining benefits under the plan attributable to employer contributions (Sec. 411(c)(2)(C); Regs. Sec. 1.411(c)-1(c)(4)).

The Dallas Key District newsletter points out, however, that the regulations under Sec. 401(k) provide that elective contributions to a Sec. 40(k) plan are considered employer contributions for various purposes--including Sec. 411 purposes. Since elective Sec. 401(k) contributions are treated as employer contributions for Sec. 411 purposes, Sec. 401(k) plans cannot rely on Sec. 411(a)(4)(B) (which relates to mandatory employee contributions) to disregard a year of service due to the...