Rev. Proc. 2003-86 Provides Guidance on PEOs
and Amplifies and Clarifies Issues Raised from Rev. Proc. 2002-21
Rev. 12/17/03, E-mail Alert 2003-24 Rev. 11/11/08

Rev. Proc. 2002-21 issued in April of 2002 required a Professional Employer Organization (PEO) to either terminate its existing plan prior to the last day of the 2003 plan year or submit it to the IRS for a determination letter as an individually designed Multiple Employer Retirement Plan (also referred to by the acronym MERP) effective as of the first day of the 2004 plan year. To terminate the Multiple Employer Retirement Plan would leave each of the PEO's Client Organization's (also referred to by some as a CO) the option of establishing their own retirement plan, although there may already be a plan. Rev. Proc. 2003-86 answers questions raised as to how to apply various rules and regulations through the changes brought about by the transition of these plans Amendments that may be required in accordance with Rev. Proc. 2003-86 are tied to the EGTRRA amendment deadline of 2005 or later.

Successor Plan Rule Waived
If the PEO plan is terminated in accordance with Rev. Proc. 2002-21, the plan has a distributable event and may distribute the plan's elective deferrals and other participant assets even if the Client Organization maintains or establishes a 401(k) immediately. The new Rev. Proc. makes it clear that the successor plan rules (1.401.(k)-1(d)(3)) do not apply in this particular situation.

Top Heavy Status of Account Balances in the Multiple Employer Retirement Plan
Each Client Organization within the Multiple Employer Retirement Plan can decide to either treat the account balances as provided by the Client Organization and use them in the top heavy test OR as provided by the PEO and exclude them from the top heavy test. The Client Organization's decision is effective as of the Rev. Proc. 2002-21 compliance date, and, it must remain in effect for all future years.

Whose employees are these and as of what date?
There are two options:

1. Until the last day of the 2003 plan year, the employees may be treated as employees of the Multiple Employer Retirement Plan of the PEO. Thereafter, it appears they would be treated as employees of the Client Organization. OR
   
2. The PEO Multiple Employer Retirement Plan will consider the employees to be employed by the Client Organization at all times.
   

ADP and ACP Testing for Multiple Employer Retirement Plan to be Treated as a New Plan
The Multiple Employer Retirement Plan is considered a new plan for ADP and ACP testing. Thus, prior year testing method may be selected regardless of what the PEO plan had been previously doing. In addition, the 3% deemed NHCE contribution for the first year of testing is also available.

Required Minimum Distribution for 5% Owners
Beginning in calendar year 2004, the Multiple Employer Retirement Plan must make distributions to 5% owners. A 5% owners who attained age 70½ prior to 2004 will have a required beginning date of April 1, 2005. The 5% ownership status may be determined as of the of the year the owner attained age 70½ or as of the first day after the conversion.

HCE Status
For the year after conversion, HCE status is determined by the compensation paid by the PEO for services rendered to the Client Organization during the Multiple Employer Retirement Plan's look-back year. Thus, for example, if an employee of the PEO performing services for the Client Organization in the 2009 year received compensation over $90,000 the employee would be considered an HCE of the Client Organization for 2010.

Bill Grossman, QPA