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Answers are provided by S. Derrin Watson
First Look at Rev. Proc. 2003-86
(Posted November 25, 2003)
Question 260: The IRS is releasing a new revenue procedure on PEO retirement plans. What are your thoughts?
Answer: Personally, I'm delighted to see it and I've been waiting all year for it to come. I'm even more delighted to see that the IRS has done a good job with it.
Rev. Proc. 2003-86 provides welcome amplification to Rev. Proc. 2002-21, particularly with regard to multiple employer retirement plans. The 2002 Rev. Proc. essentially gave Professional Employer Organizations (PEOs) two alternatives with regard to their single employer plans: Terminate them or convert them to multiple employer plans, cosponsored by the Client Organizations (COs). The termination must be effective no later than the last day of the 2003 plan year (the Compliance Date). The conversion must be effective no later than the first day of the 2004 plan year.
Rev. Proc. 2003-86 extends to converting plans some transition relief previously available only to terminating plans. Under the new Rev. Proc., a converted multiple employer retirement plan (to which the Rev. Proc. gives the unlovely acronym of MERP) can choose to treat worksite employees as employees of the PEO up to the end of the 2003 plan year. Alternatively, the MERP can treat the worksite employees as employees of the CO at all times. Most PEOs will take the first choice, because that is the way they have administered the plan.
One of the few deficiencies of the new Rev. Proc. is that it does not spell out that if the MERP treats the worksite employees as PEO employees before the Compliance Date, then the IRS will not challenge for retirement plan purposes the MERP treating the worksite employees as employees of the CO thereafter. I spoke with one of the authors of the Rev. Proc., Pamela Kinard of the Associate Chief Counsel's Office, and appreciate her graciousness in responding so quickly to my questions. She said that it was her interpretation that a MERP could choose to treat worksite employees as PEO employees before the Compliance Date and as CO employees thereafter, without concern (for retirement plan purposes) with the actual common law status of the employees. I believe that is the practical implication of the two Revenue Procedures. While nothing spells out that implication, I think it is clear enough and that a PEO would be well advised to act accordingly.
Additionally, the relief is targeted to the Compliance Date itself, whereas some PEO plans converted early to MERP status, and find themselves in a confusing situation as a result. I doubt the IRS will be overly concerned with this technical nicety, and that a MERP which converted early will still be able to use the transition relief based on the date of conversion.
The new Rev. Proc. answers many of the questions which existed for PEO plans:
- Distributable Events. The PEO can make distributions to worksite employees of employers who don't cosponsor a PEO MERP without concern for whether the successor plan rules prevent a distributable event from taking place. In effect, a distribution mandated by Rev. Proc. 2002-21 is automatically made pursuant to a distributable event except in very unusual circumstances.
- Top heavy. Top heavy status is determined separately for MERP sponsors. In doing so, a CO can either treat preconversion accounts for the worksite employees as coming from the CO (and hence includible in top heavy testing), or as coming from the PEO (and hence not includible in top heavy testing if the PEO is unrelated to the CO).
- First plan year. The first year after conversion into a MERP will be treated as the first year of the plan for CO 401(k) testing purposes. Hence, the CO can freely choose to use prior year testing without regard to what the PEO has done in the past, and, if so, can choose to use the 3% first year rule for the ADP and ACP tests.
- 401(a)(9). The Rev. Proc. clarifies determination of 5% owners for the year of conversion under 401(a)(9).
- HCE Status. For purposes of determining HCE status for the year after conversion, compensation paid by a PEO for services rendered to a CO is treated as though the CO had paid it. For example, suppose I have a salary of $120,000/year and am on the payroll of a PEO, but am performing services for the XYZ CO, a cosponsor of the PEO's MERP. Suppose that, pursuant to the new Rev. Proc., the MERP treats me as a PEO employee prior to 2004 (the date of conversion). Normally, that would mean my CO salary for 2003 would be $0 for retirement plan purposes, and I would not be an HCE of the CO for 2004. However, because of the new Rev. Proc., XYZ must count my 2003 salary and I am an HCE.
Any amendments required under the new Rev. Proc. are due with EGTRRA amendments, in 2005 or later.
All in all, this is a much needed piece of guidance. It provides PEOs with valuable flexibility consistent with the remedial purposes of Rev. Proc. 2002-21. It should be welcomed by practitioners and PEOs alike.
Naturally, this is simply a preliminary look at the Revenue Procedure. I will be posting additional commentary and I welcome questions from my readers.
Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice
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