In Notice 2018-95, released on December 4, 2018, the Internal Revenue Service (IRS) formally announced a “once-in-always-in” interpretation of the section 403(b) participation exclusion for part-time employees and provided limited transition relief to comply with that interpretation. Under the transition relief, section 403(b) programs may need to operationalize this new guidance as early as January 1, 2019.

By way of background, under the unique “universal availability” requirement of section 403(b), if a program permits elective contributions, all employees must be permitted to make elective contributions subject to very limited exclusions. One of those exclusions is for part-time employees who normally work less than 20 hours per week, which the Treasury explained in 2007 regulations to mean that:

• For the first 12 months of employment, the employer reasonably expects the employee to work fewer than 1,000 hours of service; and
• For each plan year ending after that initial 12-month service period or, alternatively, each subsequent 12-month employment period, if the plan so provides – the “exclusion year” in the language of the Notice – the employer actually worked fewer than 1,000 hours of service in the preceding 12-month period.

These conditions were widely understood to apply sequentially, that is, the status of a part-time employee under the exclusion would be determined by the hours worked in the prior 12-month period on a rolling basis. Under this “in-and-out” interpretation, part-time employees might in some years be eligible to make elective contributions and in other years be excluded, depending on their individual work level in the preceding exclusion year.

• The part-time exclusion of course is not mandatory; it is entirely permissible and administratively sensible (absent matching contributions) to permit all part-time as well as all full-time employees to make elective contributions in all plan years.
• Also, only section 403(b) programs that were not covered by ERISA could follow this interpretation. A separate ERISA rule disallowed the “out” component of the “in-and-out” approach for section 403(b) programs of private sector employers treated as ERISA “pension plans.”

At some point, however, the IRS developed a different interpretation that the conditions under the part-time exclusion applied cumulatively, with the result that a part-time employee permanently became ineligible for the exclusion if in any year he or she exceeded the applicable 1,000 hour requirement. Consider the following example from the Notice involving a part-time employee reasonably expected to work 500 hours in the first 12 months of employment:

Under the “in-and-out” understanding, the employee would have been eligible to make elective contributions in only 2013 and 2018. Under the IRS “once-in-always-in” interpretation, the employee permanently would fall outside the part-time exclusion once he or she worked 1,000 hours in 2012, and must be eligible to make elective contributions in every year starting with 2013.

To say the least, this “once-in-always-in” interpretation is not self-evident from the regulation and previously appeared only in 2015 revisions to the “list of required modifications” (LRM) for section 403(b) pre-approved plan documents. Acknowledging that many employers with section 403(b) programs were unaware of its interpretation, the IRS provided in the Notice the following transition relief:

• Operational relief from the “once-in-always-in” interpretation of the part-time exclusion until the end of the last day of the last exclusion year ending before December 31, 2019, applied on an employee-by-employee basis (referred to in the notice as the “relief period”), with flexibility to deal with “overlap” situations (where the exclusion year switches to the plan year after the initial 12 months of employment) on a reasonable and uniform basis;
• “Failure to follow the plan language” relief for programs using pre-approved section 403(b) plan documents – which incorporate the “once-in-always in” language from the LRM on a retroactive basis to the 2009 effective date of the regulation – until the end of the above relief period;
• Remedial plan amendment relief for individually designed plans – including to reflect that the “once-in-always-in” interpretation was not applied until after the relief period – for plan amendments adopted by March 31, 2020; and 
• A “fresh start opportunity” for exclusion years beginning on or after January 1, 2019, treating the “once-in-always-in” interpretation as first taking effect on January 1, 2018, and disregarding pre-2018 work history that would make a part-time employee permanently eligible for the part-time exclusion.

Eversheds Sutherland Observations

• This appears to be yet another instance where an unrelated retirement plan requirement – in this case, under ERISA – is imported through the section 403(b) tax regulations and generally extended to section 403(b) programs.
  • That said, there are certainly policy arguments in favor of the IRS interpretation – although it affects the cost and potentially the availability of any matching contribution offered by the employer – and it may well be more administrable than the “in-and-out” interpretation.
• In providing transition relief, the IRS is to be commended for being responsive to concerns expressed by the regulated community.
• The plan document relief is highly pragmatic; pre-approved documents are widely in use for section 403(b) programs, and the need to adopt plan amendments is limited to the smaller population of individually designed plans. Among other things, any required plan amendment should state the date on which the “once-in-always-in” interpretation is to be applied.
• The operational relief is less pragmatic, in that the Notice requires all section 403(b) programs potentially to be dealing with its implications in January 2019, less than a month after its release. This follows from the expiration of the relief period on the last day of the exclusion year ending before (not on or before) December 31, 2019.
  • For section 403(b) programs that determine exclusion years from each employee’s employment anniversary, the relief period for part-time employees with employment anniversaries in January 2019 will end with that anniversary.
  • For calendar year plans that use the plan year as the exclusion year, the relief period for part-time employees hired before 2018 will end on December 31, 2018, and for part-time employees hired in 2018 with their 2019 employment anniversary. 
  • For fiscal year plans – e.g., school year plans – that use the plan year as the exclusion year, the relief period will generally expire with the start of the 2019/2020 plan year and, for part-time employees hired during 2018, with their 2019 employment anniversary (which may be during the 2018/2019 plan year). 

That is, there may be part-time employees with new exclusion years commencing, individually or collectively, as early as January 2019 that are outside the relief period and who do not qualify for the fresh start opportunity.

• If such an employee was a pre-2018 hire eligible to make elective contributions in 2018 on the basis of 2017 work history, he or she must continue to be eligible in 2019 regardless of 2018 work levels – potentially a different outcome than under the “in-and-out” interpretation and one that must be operationalized as early as January 1, depending on the expiration of the relief period in the particular circumstances. 
• If the employee was a 2018 hire eligible to make elective contributions in 2018 on an expectation of working at least 1,000 hours, the same result would obtain subject to whatever flexibility is provided by the overlap rule – which is designed for and limited to this fact pattern, and provides no help for the prior fact pattern.

If the part-time employee was not eligible in 2018, eligibility for 2019 is determined by 2018 work levels – as would be the case under the “in-and-out” interpretation – with the result that January 2020 will be the first time that a different outcome might be required under the “once-in-always-in” interpretation.

It may be that a number of section 403(b) programs, and particularly those using preapproved plan documents, are already following the “once-in-always-in” interpretation. For those that are not, however, it is entirely predictable that there will be imperfections in operationalizing this change, particularly to the extent that it requires a 2019 election opportunity to be extended to an additional group (albeit likely a small group, in most cases) of part-time employees on very short notice.

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