Coverage Exemption for 501(c)(3) Employees
Rev. 03/30/04, E-mail Alert 2004-7

Where a 501(c)(3) (tax-exempt) employer offers a 401(k) plan and the employees in that plan are also eligible to participate in a 403(b) arrangement, the IRS has clarified in proposed regulations how the coverage rules apply. EGTRRA required the IRS to issue these regulations.

The Proposed Coverage Exemption
Employees of a 501(c)(3) organization who are eligible to make salary reduction contributions to a 403(b) plan may be excluded from the coverage testing of a 401(k) and 401(m) plan. However, in order to use this exemption, two rules must be satisfied:

• No employee of the tax-exempt organization may be eligible to participate in the 401(k) or 401(m) plan, and
  
• At least 95 percent of the employees of the employer who are not employees of the tax-exempt organization are eligible to participate in the Section 401(k) or 401(m) plan.

An illustration will help to explain.
In a recent client call, a controlled group consists of a 501(c)(3) hospital and a for-profit pharmacy. The hospital maintains a 403(b) plan and the pharmacy maintains a 401(k) plan for all its employees. The proposed regulations would permit the pharmacy's 401(k) plan to exclude the hospital employees, who are covered by the 403(b) plan, from the 401(k) coverage test.

Governmental Entities
The proposed regulations do not change the treatment of governmental entities under the current regulations.

These Proposed Regulations May Be Relied Upon Immediately
The proposed regulations state that taxpayers may rely on the proposed regulations for guidance pending the final regulations. In addition, the regulations state that if future guidance is more restrictive, it will not be retroactively applied.

Request for Comments
The IRS and Treasury are requesting comments, due by June 14, 2004, on the clarity of the proposed rules and how they can be made easier to understand. Submissions may be sent to CC:PA:LPD:PR (REG-149752-03), Room 5203, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044.

More details for sending comments and the Proposed Regulation on Coverage Exemption for 501(c)(3).

Bill Grossman, QPA