Otherwise Excludable Employees and Entry Dates
In a recent Chief Counsel Advice Memorandum, the IRS responded to a request regarding the application of the “otherwise excludable employees” for purposes of coverage testing. Specifically the request was whether it was permissible to apply the maximum statutory requirements to determine the population of excludable employees if a plan had an earlier entry date. The example was for a calendar year plan that allowed for immediately eligibility for employee deferrals. If an employee, age 24, was hired in August 2015, they would be in the otherwise excludable group for 2015, but could they also be in the otherwise excludable group for 2016 since the earliest they would have to enter the plan is Jan. 1, 2017?
In their analysis, the IRS cited Section 1.410(b)-7(C)(3) which describes otherwise excludable employees as “employees who satisfy age and service conditions under the plan that are lower than the greatest minimum age and service conditions permissible under section 410(a).” The use of the word “greatest” can be read to include the maximum waiting period of entry to the plan of the earlier of the first day of the plan year or 6 months after the date the employee has attained age 21 and completed 1 year of service in the determination of the otherwise excludable employee group.
They also looked at the legislative history accompanying Section 410(b)(4)(C), which included the statement: “For purposes of the separate testing of excludable employees, employees who have not attained the statutorily permitted entry dates may be considered excludable employees.” This further supports the application of the maximum waiting period in the determination.
However, when you review how separate testing under 410(b)(4)(B) works, Example 4 in 1.410(b)-6(b)(4) does not explicitly provide the waiting period be tacked on to the age 21 and 1 year of service requirement to determine the otherwise excludable group, and therefore does not support the application of the waiting period on top of the age 21 and 1 year of service requirement.
While the IRS agreed it was acceptable to apply the maximum age and service requirements, including the maximum waiting period, it was not the only acceptable application. The IRS cited two other acceptable positions: (1) an employee is an otherwise excludable employee only until the date they meet the age 21 and 1 year of service requirement (there is no waiting period tacked onto that); and (2) an employee is an otherwise excludable employee only until the plan’s entry date after they meet the age 21 and 1 year of service requirement.
For example, assume we have a calendar year plan with eligibility requirements of 3 months with an entry date of the first of the month following completion of the requirements. If an employee, age 24, is hired on Sept. 1, 2014, they would enter the plan on Dec. 12, 2014 and would be an otherwise excludable employee for 2014. However, for 2015 it would depend on our application of the entry dates as to whether they would be considered an otherwise excludable employee for 2016. If we use the statutory requirements of age 21 and 1 year of service, with the maximum waiting period they would be excludable until Jan. 1, 2017. If we use either of the alternative options of not imposing a waiting period, or use the plan’s monthly entry dates, they would not be excludable for 2016. Depending on the demographics of our group, a different application of the determination of the otherwise excludable employees could impact our nondiscrimination testing.