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Tax-exempts' new sec. 401(k) plan eligibility may jeopardize affiliates' plans.

A legislative development providing employees of tax-exempt entities with greater access to retirement plans may threaten the qualified status of plans of those entities, for-profit affiliates. The Small Business job Protection Act of 1996 (SBJPA) repealed the Code provision that prohibits nongovernmental tax-exempt employers from maintaining Sec. 401 (k) plans; however, affiliated for-profit companies with cash or deferred arrangements under Sec. 401 (k) run the risk of violating the Sec. 410 (b) coverage tests after the SBJPA's effective date.

Under the Sec. 410 (b) coverage tests, a qualified plans coverage of an employer's nonhighly compensated employees must meet certain percentage requirements to be considered nondiscriminatory tory. In applying these tests, "employer" means the controlled group for affiliated service group) of employers. Treasury regulations provide that, for purposes of determining whether a Sec. 401(k) plan satisfies the percentage coverage tests under Sec. 410(b) for a particular year, employees of governmental or exempt entities not eligible to participate in a Sec. 401(k) plan may be treated as exclucible employees, provided that more than 95% of the employees eligible to participate m a Sec. 401 (k) plan benefit under die plan for that plan year.

Thus, prior to the effective date of the SBJPA, if a for-profit entity is a member of a controlled group for an affiliated service group) in which all other employers are exempt from tax, and such entity maintains a Sec. 410 (k) plan, for purposes of applying the Sec. 410(b) tests to the Sec. 401(k) plan, die employees of the tax-exempt entities can be excluded if more than 95% of the for-profit entity's employees benefit under die plan.

Under the SBJPA, however, employees of tax-exempt entities win be eligible to participate in Sec. 401 (k) plans for plan years beginning after 1996, and will no longer be excludible under the Sec. 410(b) coverage test. For those plan years, it is likely that a Sec. 401(k) plan such as the one described will fail to satisfy Sec. 410(b), unless coverage is expanded to allow employees of affiliated tax-exempt entities to also benefit under a Sec. 410(k) plan.

Expansion of coverage may be prohibitive given the effective date of the change. In addition, many tax-exempt entities already maintain other retirement plans, such as Sec. 410 (b) annuity programs, and will not want to change to a Sec. 401(k) plan. Because satisfying Sec. 401(b) is a condition of a Sec. 401(k) plans tax qualification, the impact of this change could be severe. In response to these concerns, the IRS has given affected employers an additional year to adjust to the change. In Notice 96-64, the IRS provides that, through the 1997 plan year only, these employers may continue to disregard employees of tax-exempt entries when testing a Sec. 401(k) plan of a taxable entity in accordance with the Treasury regulations.

Thus, any for-profit company affliated with a tax-exempt organization that either already maintains or intends to establish a Sec. 401 (k) plan should be aware that it will have to address this issue by the end of its 1997 plan year.
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Author:Wells, Jennifer
Publication:The Tax Adviser
Date:Jan 1, 1997
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