TAM blesses plan "inoculation" language.

• Author: Masnik, Robert H.
• Position: IRS technical advice memorandum - Eligibility for employee benefits

In 1989 and 1990, the IRS examined Microsoft's employment records and found that under Rev. Rul. 87-41, certain workers Microsoft considered to be independent contractors were actually employees. After learning of the IRS's finding, some of these employees sued Microsoft for benefits, even though Microsoft told them on hire that they were not eligible.

Based on the terms of Microsoft's plans, the Ninth Circuit found that the employees were entitled to benefits (Vizcaino v. Microsoft, 97 F3d 1187 (1996)). As a result, several employers have attempted to amend plan language to exclude a class of people they viewed as independent contractors. This intended to "inoculate" the plan against what became known as the "Microsoft issue."

Employees in the IRS's Cincinnati field office believed that the inoculation plan provisions violated Sec. 410(a)'s minimum eligibility requirements and Regs. Sec. 1.401-1(a)(2)'s requirement that a plan be a "definite written program." The IRS National Office disagreed with the Cincinnati field office and issued a technical advice memorandum (TAM) on July 28, 1999.

The IRS has made extraordinary efforts to disseminate the TAM, and National Office officials have expressed strong support for it in meetings with benefits associations. Despite this, the IRS will not issue official guidance this year, due to other important business.

How to Meet the Requirements

Under Section 5.01(2)(b) of Rev. Proc. 2001-17, a plan not operated according to its terms is not qualified. Microsoft's plan covered "employees" and thus required the company to cover reclassified employees. Because the plan did not cover them, technically it was not qualified.

Plan qualifications. An employer who runs afoul of the Microsoft issue risks not only losing an ERISA suit to its employees, but also having the IRS disqualify its plan. As a general rule, the correction for failing to cover employees who were supposed to be eligible is to cover them retroactively. In a defined-benefit plan, this may not be a problem, although the correction may change the plan's funding status. In a defined-contribution plan, however, an employer generally contributes to the plan for the "unexpected" employees. It also contributes an amount equal to the earnings the so-called employees would otherwise have received in the plan. If part of the plan is a Sec. 401(k) plan, the employer would contribute an amount that approximates the amounts that the employees would have...