Question 347: What is the rule for counting service prior to becoming a member of related group?
Count it. That's as simple as it gets.
There are folks who disagree with me on this, so let's take a moment and see if we can't narrow our disagreement. Let me provide an example we can analyze:
Sandy has worked for SubCo since 2014. December 31, 2017, she has 4 years of vesting service in the SubCo 401(k) plan, which has an employer matching contribution.
January 2, 2018, ParentCo buys 100% of the stock of SubCo, therefore forming a controlled group. Parker has worked many years for ParentCo and participates in the ParentCo 401(k) plan. The ParentCo plan requires one year of service and allows entry on January 1 and July 1. Prior to the transaction, the ParentCo plan covers only the employees on the ParentCo payroll.
With these facts, consider the following questions and scenarios: When I discuss disregarding service, I refer to service before the January 2, 2018 acquisition.
- SubCo continues to sponsor its existing plan for its employees. Can SubCo disregard Sandy's service? Of course not.
- ParentCo continues to sponsor its existing plan for its employees. Can ParentCo disregard Parker's service? Of course not.
- SubCo establishes a new profit sharing plan July 1, 2018. Can SubCo disregard Sandy's service? Of course not. In fact, I hope we can all agree that there is no justification for SubCo disregarding Sandy's service with SubCo (including service prior to the acquisition) for any plan SubCo sponsors.
- SubCo merges its plan into the ParentCo plan and becomes a cosponsor of the ParentCo plan. Can the plan, which SubCo cosponsors, and which is a continuation of the old SubCo plan, disregard Sandy's service? No. If SubCo cosponsors the plan, there is no authority to disregard any service with SubCo. Sandy becomes a participant on the day the plan is amended to include the SubCo employees.
- SubCo terminates its plan and transfers the assets of the plan to the ParentCo plan. SubCo then becomes a cosponsor of the ParentCo plan. We still can't disregard Sandy's service. See 4.
- Assume the same facts as 5, except SubCo does not cosponsor the ParentCo plan. Can ParentCo disregard Sandy's service? No. 414(a) requires ParentCo to count the predecessor service if the money follows the participants, regardless of the controlled group rules. Sandy becomes a participant on the day the plan is amended to include the SubCo employees.
- SubCo terminates its plan prior to the acquisition, allowing participants to take distributions. SubCo money is not transfered to the ParentCo plan (although employees could choose to roll it over to the ParentCo plan). ParentCo amends its plan to cover the SubCo employees. SubCo does not cosponsor the plan.
Now we've come to the heart of the matter. For #7, I say ParentCo must count the prior service because of the related employer rules, while others disagree with me. But I think it's important to realize how narrow this disagreement is and how rare it should be.
Situation #7 is a fairly unwise. If SubCo does not cosponsor the plan, ParentCo's deduction limit under Code 404 will not reflect the compensation of the SubCo employees. Code 414(b) says: "With respect to a plan adopted by more than one . . . [controlled group member], the applicable limitations provided by section 404(a) shall be determined as if all such employers were a single employer, and allocated to each employer in accordance with regulations prescribed by the Secretary." It does not provide any additional deduction limit without cosponsorship. Moreover, there are rulings which challenge whether it is an ordinary and necessary business expense under Code 162 for one related employer to deduct contribuitons for another related employer. [Rev. Rul. 69-525; Rev. Rul. 70-316; Rev. Rul. 70-532; PLR 8032079.]
But let's assume ParentCo makes this unwise choice. Can it disregard the SubCo service before the acquisition? We already know SubCo can't disregard the service, and ParentCo can't disregard the service of Parker and its other employees. And Code 414(b) says ParentCo and SubCo are treated as a single employer. If SubCo can't disregard the service, why should ParentCo when they are now a single employer?
We have more than just statutory reasoning here. DOL Reg 2530.210(d) puts the matter plainly:
[I]n determining an employee’s service for eligibility to participate and vesting purposes, all service with any employer which is a member of the controlled group of corporations shall be taken into account. . . . [I]n determining a participant’s service for benefit accrual purposes, all service during periods of participation covered under the plan with any employer which is a member of the controlled group of corporations shall be taken into account.
That really doesn't leave a lot of wiggle room. "All service with any employer" is "all service."
Some professionals believe that Treas. Reg. §1.411(a)-(b)(3)(iv)(B) mandates a different result. This provision states that for vesting purposes:
Service with an employer is treated as service for certain related employers for the period during which the employers are related. These related employers include members of a controlled group of corporations . . . and trades or businesses (whether or not incorporated) which are under common control (see section 414(b) and (c) and 29 CFR Part 2530, Department of Labor regulations relating to minimum standards for employee pension benefits plans).
Some read this regulation to say that the plan must only credit service which is credited during the period the two entities are related. However, the first sentence of the regulation can also be read to say that during the period the two entities are related, each entity must credit all service with the other entity.
That latter reading follows the DOL regulation (above) that the Treasury regulation cites. The DOL says that all service with any controlled group member must be considered.
Under any of these scenarios, Sandy enters the ParentCo plan the day the plan is amended to cover SubCo employees. Sandy has a year of service and passed an entry date long ago. The plan immediately credits Sandy with four years of service for vesting.
I discuss this further, with examples, at Q 19:27 of the 7th edition of Who's the Employer.