SARSEP Amendment re: Eligible Employees

[Christine Roberts]

If a SARSEP is nearing the 25 eligible employee threshold, can it PROSPECTIVELY amend its eligibility requirements to exclude more employees (e.g., require service in 3 of previous 5 years, instead of only 1 year), and thus sidestep ineligibility for at least a few years?

[Gary Lesser]

There is nothing on point (law or other guidance). If one were, however, to borrow from the qualified plan nondiscrimation rule; then the answer would be yes, PROVIDED the prohibited group members could have met the plan's eligibility requirment (after the amendment) at the time the plan was originally established. Thus, a new business that establishes a SEP with a O-year service requirement could not ordinarily increase the requirement to one year (called "rolling eligibility") if any recently hired employees (other than prohibited group members) would be excluded as a result of the amendment. Assume an individual purchases a new business established in the prior year and adopts a SEP with a 1-year service requirement (thus the owner is ineligible). The owner could probably amend the plan for the current year to 0 years, thus allowing greater participation (since doing so would not result in discrimination, although the owner is the only new participant, and recently hired employees are not excluded).

aaSSUME ONE OWNER THAT

[Christine Roberts]

Gary, thanks for your response, however I am not sure I fully understand what you mean by the statement "PROVIDED the prohibited group members could have met the plan's eligibility requirment (after the amendment) at the time the plan was originally established." Shouldn't it be "provided the prohibited group members could NOT have met" the plan's post-amendment eligibility requirements at the time the plan was originally established? Or perhaps I misunderstand who you mean by "prohibited group members." Please provide clarification for me and other SARSEP-challenged individuals. Thanks.

[Gary Lesser]

[Christine, sorry it took so long to reply!]

No. If the the prohibited group members had performed service in the three plan years prior to the plan's adoption, the plan could be amended at any time. [incidently, we still have no guidance on this issue regarding SEPs and SIMPLE-IRAs.]

IMO, the IRS would argue that the SEP nondiscrimination rules would be interpreted the same way as the QP rules were. See guidance provided in following (pre-ERISA) revenue rulings:

Rev. Rul. 70-75

Advice has been requested whether an employees' pension plan that provides different eligibility requirements for present and future employees may meet the requirements of section 401(a)(3)(B) of the Internal Revenue Code of 1954.

A corporation established a pension plan that provided for the immediate participation of all its salaried employees. However, participation of salaried employees hired after the plan was established was limited to those who were over 30 years of age and had five or more years of service. At the time the plan was established, all employees who were officers, shareholders or highly compensated were over 30 years of age and had at least five years of service.

Coverage under the plan did not meet the percentage requirements of section 401(a)(3)(A) of the Code but the classification was not discriminatory within the meaning of section 401(a)(3)(B) in favor of employees who were officers, shareholders, supervisors, or highly compensated.

A plan that does not meet the percentage tests of section 401(a)(3)(A) of the Code may still meet the coverage requirements under section 401(a)(3)(B) if the classification of employees actually covered does not discriminate in favor of employees who are officers, shareholders, supervisors, or highly compensated.

A provision for different eligibility requirements for present and future employees is not, of itself, discriminatory within the purview of section 401(a)(3)(B) of the Code. However, where employees who are officers, shareholders, supervisors or highly compensated cannot meet the eligibility requirements for new employees at the time the plan is established, the prohibited discrimination is likely to arise in operation when new employees are added to the employer's work force.

It is held that the eligibility provision did not cause the plan in this case to fail to meet the requirements of section 401(a)(3)(B) of the Code, since at the time the plan was established, all employees who were officers, shareholders, supervisors, or highly compensated met the requirements for new employees.

Rev. Rul. 70-77

Advice has been requested whether an employees' pension plan that contains minimum age and service requirements for eligibility fails to qualify under section 401(a) of the Internal Revenue Code of 1954 because it provides past service benefits under the circumstances described below.

An employees' pension plan provides for immediate participation of all employees as of the time the plan was established. However, employees hired after the plan was established become eligible to participate only when they have reached 25 years of age and have at least five years of service.

The plan provides a retirement benefit of one percent of each participant's average annual compensation multiplied by the number of years of his participation in the plan. In addition, the plan provides that employees who become participants at the time the plan is established will be given credit for each year of past service performed after they have reached 25 years of age and completed five years of service.

All employees who were officers, stockholders, supervisors, or highly compensated were more than 25 years of age and had more than five years of service at the time the plan was established.

Section 401(a)(4) of the Code provides that, in order for a plan to qualify, contributions or benefits must not discriminate in favor of employees who are officers, stockholders, supervisors, or highly compensated.

A plan that contains a minimum age or service requirement for eligibility and provides credits for all prior service of original, but not subsequent, participants will generally be considered discriminatory within the purview of section 401(a)(4) of the Code unless it can be demonstrated that such credits do not result in the prohibited discrimination. However, where there is a one year waiting period for eligibility, but original participants are given credit for all prior service, including the one year waiting period, and new participants do not receive credit based on the one year, such a provision will not, of itself, be considered discriminatory.

Provision may be made, as in this case, for credits on account of past services rendered after attainment of a specified age or completion of minimum service, if applied to original as well as subsequent participants. Such a provision does not give original participants more favorable treatment, with respect to past service benefits, than is accorded to subsequent participants.

Accordingly, it is held that this plan, which contains minimum age and service requirements for eligibility, does not fail to qualify under section 401(a) of the Code because of the provision for past service benefits.

Rev. Rul. 73-382

Advice has been requested whether an employees' pension plan containing the eligibility provisions described below may meet the requirements of section 401(a)(3)(B) of the Internal Revenue Code of 1954.

One year after its incorporation a corporation established a pension plan that provides for the participation of all full-time salaried employees who have at least one year of credited service as of the date the plan was established. Employees not eligible to participate on that date, and employees subsequently added to the work force, are covered as of the first entry date (i.e. the anniversary of the date on which the plan was established) as of which they satisfy the plan's eligibility requirements.

On the plan's anniversary date, an analysis is made to determine the list of eligible employees and to compute the plan costs for the year.

On the date that the plan was established, a fair cross section of employees, including all who were officers, shareholders, supervisors, or highly compensated, had been full-time employees for exactly one year. These employees immediately commenced to participate. However, at that time several full-time salaried employees who were not in the group enumerated above had less than one year of credited service with the corporation and, therefore, could not participate until the next entry date under the plan.

A plan that does not meet the percentage requirements of section 401(a)(3)(A) of the Code may still meet the coverage requirements under section 401(a)(3)(B), if the classification of employees actually covered does not discriminate in favor of employees who are officers, shareholders, supervisors, or highly compensated.

Rev. Rul. 70-75, 1970-1 C.B. 94, holds that a provision for different eligibility requirements for present and future employees is not necessarily discriminatory within the purview of section 401(a)(3)(B) of the Code. If present employees who are officers, shareholders, supervisors, or highly compensated can meet the requirements for new employees, there is no objection to the dual requirements. However, Rev. Rul. 70-75 points out that, where the employees enumerated above cannot meet the eligibility requirements for new employees at the time the plan is established, the prohibited discrimination is likely to arise in operation when new employees are added to the employer's work force.

In this case, employees who did not meet the stated eligibility requirements at the time the plan was established, and new employees added to the work force after the plan's inception, are covered under the plan on the first entry date on which such eligibility requirements are met. Thus, for example, a full-time salaried employee hired six months after the plan was established must wait 18 months before commencing to participate under the plan.

However, under the plan, the eligibility requirements, including the entry date and length of service requirements, are uniform for all employees. Thus, both present and future full-time salaried employees need have only one year of credited service on any entry date. Therefore, the provision that employees may enter the plan only on the date it was established and on subsequent anniversary dates is not a dual eligibility requirement as described in Rev. Rul. 70-75. Furthermore, the facts indicate that the entry date requirement is based on administrative feasibility.

Accordingly, the eligibility provisions of this plan will not result in prohibited discrimination in operation in future years if new employees are added to the employer's work force, and coverage thereunder otherwise meets the requirements of section 401(a)(3) of the Code.