Academic journal article Journal of Accountancy

Small Business Tax Solutions

Academic journal article Journal of Accountancy

Small Business Tax Solutions

Article excerpt

Q. May an employer exclude part-time employees from participating in an Internal Revenue Code section 401(k) savings plan or from other qualified plans the employer maintains?

A. The answer depends on the definition of "part-time." Any qualified plan may be written to require that an employee work at least 1,000 hours in a 12-month period to enter a plan. The 1,000-hour requirement can be shortened to 500 hours, for example, but not lengthened. Thus, employees who work less than 19 hours a week would never be credited with enough hours during a year to enter such a 1,000-hour plan (52 X 19 = 988).

The 1,000-hour requirement is available only under certain conditions:

* The measurement period cannot be shortened to less than 12 months without losing the ability to count hours. For example, a plan can require only six months of employment as a condition for entering the plan but cannot require a minimum number of hours of service during those months--not even 500 hours.

* The employer must keep records that show the employees' hours of service.

A plan cannot exclude part-time employees as a class even if actual plan coverage, after excluding part-time employees, would meet the minimum coverage test of IRC section 410(b). An employer might want to draft a definition of employee to exclude workers scheduled to work fewer than 40 hours per week. Even if the plan covers 70% of all non-highly-compensated employees (counting part-timers as employees but not as benefiting under the plan), excluding part-timers here would, in the view of the Internal Revenue Service, violate section 410(a).

Some believe section 410(a) regulates the maximum length of service that can be required, rather than preventing a plan from excluding a class of employees (such as part-timers) based on rate of service (less than 40 hours per week). Many favorable determination letters have been issued to qualified plans even though their terms excluded part-time employees as a class. A November 28, 1994, IRS field directive says plan sponsors cannot rely on those letters and should apply to the IRS for "relief" under IRC section 7805(b), which generally prevents the IRS from retroactively disqualifying a plan if it was operated according to terms that were the subject of a favorable determination letter. …

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