IRS Confirms Long-Term, Part-Time Employees Excludible From Certain Nondiscrimination Testing

This Is Not a Test! IRS Confirms Long-Term, Part-Time Employees Excludible From Certain Nondiscrimination Testing


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. 

Under the SECURE Act and the SECURE 2.0 Act, employers must provide long-term, part-time employees the opportunity to make elective deferrals under their 401(k) plans and, beginning in 2025, their 403(b) plans. When this occurs, certain special rules apply to such employees that impact whether they must be included in annual nondiscrimination testing or receive required top-heavy vesting and benefits. As a result, it is important for employers to understand these requirements, as they may impact how annual testing is performed and the results.

In Depth

Employers are required to perform certain annual tests on their retirement plans to confirm that the plans do not violate the tax code by favoring highly paid employees over their lower-paid counterparts. In doing so, the tests evaluate various areas of plan operation. This includes:

  • Assessing who is and is not eligible to receive benefits under the plan (coverage testing);
  • Reviewing the relative amounts contributed on behalf of higher- and lower-paid workers under the plan (Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) testing);
  • Analyzing the extent to which benefits, rights or features available under the plan differ for higher- and lower-paid workers (benefits, rights and features testing); and
  • Determining whether a vastly disproportionate amount of the benefits payable under the plan go to a very select group of key individuals (top-heavy testing).

To reduce some of this testing burden, the tax code also allows employers to adopt so-called safe harbor plans that, by design, are deemed to satisfy certain required tests (specifically, ADP/ACP testing).

These testing rules and requirements have been around for some time. And, like any test, passing is ultimately all about the numbers. Employers care not only about whether their plans pass testing but also by how much and whether a shift in plan design or employee demographics might change that in the future. As a result, who must be included in testing can become very important—so important, in fact, that pages and pages of the tax code are devoted to explaining exactly who must be, can be and can’t be included in running the various tests. Any time new rules change this (as is the case under the new long-term, part-time employee rules), it is important to consider if and how that might impact passage rates and testing margins in the future.

The recently proposed regulations issued by the Internal Revenue Service (IRS) confirm that employees who enter a plan as long-term, part-time employees may be excluded from coverage testing, ADP/ACP testing, and benefits, rights and features testing. The rules also confirm that, for employers with safe harbor plans, choosing to exclude long-term, part-time employees from receipt of safe harbor contributions (i.e., only making them eligible for elective deferrals) will not jeopardize a plan’s safe harbor status. In addition, the rules explain that while such long-term, part-time employees must be counted for purposes of completing top-heavy testing, they are not required to receive enhanced top-heavy vesting or benefits (which applies when plans fail to pass such testing).

However, the rules also explain that employers cannot choose to exclude long-term, part-time employees from some types of testing but not others (or to exclude some long-time, part-time employees from testing but not the rest). It’s all or nothing. If an employer elects to exclude long-time, part-time employees from one test (e.g., coverage, ADP/ACP, or benefits, rights and features), they must exclude them—all of them—from other testing as well. The IRS does draw one distinction for this purpose, though, explaining that the decision to include or exclude such employees from coverage, ADP/ACP, and benefits, rights and features testing is distinct from the decision regarding whether they receive enhanced top-heavy vesting or benefits. Put another way, employers can choose to exclude employees from coverage, ADP/ACP, and benefits, rights and features testing but not from receipt of top-heavy vesting and benefits (or vice versa).

Importantly, though, when employees are no longer considered to be long-term, part-time (e.g., because they transitioned into full-time roles), the former long-term, part-time employees can no longer be excluded from testing or from enhanced top-heavy vesting and benefits.

Because most employers rely heavily on their recordkeepers or other service providers to assist with annual nondiscrimination testing, the intricate implementation (yes, the math, the math!) around this will be largely driven by those service providers. However, it is important for employers to understand the general contours of the rules, as excluding long-term, part-time employees from testing will require that internal and external systems (e.g., human resources information systems and recordkeeping) are appropriately updated to track who may be excluded and when their status as excludible changes, if ever. In addition, the proposed regulations indicate that compliance with these rules will be more than just operationalized in the testing process. Instead, most plan documents will need to be updated to include specific language addressing the potential application of these rules. So, it will be important for employers to know what is being done so it can be properly incorporated into the plan.

For any questions regarding the proposed regulations or SECURE 2.0, please contact your regular McDermott lawyer or one of the authors.


Read First Article: A Long-Term, Part-Time Employee or Not a Long-Term, Part-Time Employee, That Is the Question

Read Second Article: A Long-Term, Part-Time Employee or a Former Long-Term, Part-Time Employee, That Is the Question

Read Third Article: Under Long-Term, Part-Time Employee Rules, Some Things Change, and Some Things Stay the Same

Read Fourth Article: IRS Confirms Same Hours-Counting Rules Still Add Up for Long-Term, Part-Time Employees

Read Fifth Article: When It Comes to Vesting, IRS Says Once a Long-Term, Part-Time Employee, Always a Long-Term, Part-Time Employee

Read Seventh Article: New Rules Make Tracking Long-Term, Part-Time Employee Service a Full-Time Job