IRS Says Keep Those Class Exclusions Classy Under Long-Term, Part-Time Employee Rules

IRS Says Keep Those Class Exclusions Classy Under Long-Term, Part-Time Employee Rules


In this series of articles, we explore the implications of the long-term, part-time employee rules under the SECURE Act and SECURE 2.0 and the impact those rules have on employers and their workforces. Read the first article here.

Together, the SECURE Act and the SECURE 2.0 Act broaden the retirement plan minimum eligibility rulesi.e., the rules that govern how long employees can be asked to wait before joining an employer’s retirement plan—to ensure that long-term, part-time employees can participate in employer 401(k) and 403(b) plans.

Historically, to avoid violating the tax code, employers could not require employees to work more than 1,000 hours of service in a designated 12-month period before allowing them to participate in company retirement plans. However, the new laws modify this rule for 401(k) plans and 403(b) plans. Specifically, the new rule requires employers that maintain such plans to provide employees who work at least 500 hours for three consecutive years (reduced to two years in 2025) and are age 21 or older the opportunity to make elective deferrals under their 401(k) plans beginning in 2024 and under their 403(b) plans beginning in 2025.

This change has generated numerous questions about what employers need to do to comply with the new rule. Can an employer, for example, continue to exclude employees based on certain job-based classifications even if those employees would otherwise be eligible to participate in the plan by satisfying the long-term, part-time employee rules? The short answer is yes. However, employers should still revisit their existing eligibility rules and exclusions to ensure that those exclusions still make sense.

In Depth

Most employers exclude some employees from their 401(k) plans and, to a lesser extent given the strict universal availability requirements, their 403(b) plans. Doing so has always been permissible as long as the exclusions are reasonable and nondiscriminatory. As a result, exclusions based on bona fide, job-based classifications are typically permitted. However, things get a little more complicated when that job-based classification relates to the amount of time someone spends working for the business.

This is because the Internal Revenue Service (IRS) has indicated that it does not consider class-based exclusions of part-time, seasonal or temporary employees to be reasonable. Instead, the IRS views those exclusions as a proxy for imposing backdoor service-based conditions on plan participation that are not otherwise permitted under the tax code. Put another way, the IRS sees attempts to impose a class exclusion on these employees as a way to circumvent the rules that otherwise require employers to let employees in their plans after they perform a requisite period of service.

The new long-term, part-time employee rules under the SECURE Act and the SECURE 2.0 Act do not change this. This means employers can still exclude employees from their plans based on job function or location as long as the exclusion represents a bona fide and nondiscriminatory class exclusion and is not a proxy for imposing an otherwise impermissible service condition. For example, if most part-time-type employees are performing the same job function or work at the same location, an employer could theoretically exclude all employees who perform that same job function or work at the same location from its 401(k) plan without violating the tax code’s minimum service rules (as long as the plan can still pass required nondiscrimination testing). But—and this is a big but—some IRS representatives have indicated that even criteria like job function and work location that are not service-based may still violate the tax code if they merely disguise an improper service rule.

As a result, the new long-term, part-time employee rules have generated renewed interest in the application of the class exclusion rules, for example as they relate to groups like summer interns or co-op employees. This is especially true in situations where employers are using believed-to-be bona fide class exclusions but have also historically taken comfort in knowing the employees subject to any service-adjacent exclusions will never work more than 1,000 hours in a designated 12-month period. With the hours threshold for participation changing, it is as important as ever for employers to revisit their existing eligibility exclusions to ensure that they continue to be primarily job and not service-based.