The Internal Revenue Service (IRS) recently released General Counsel Memorandum 201634021 (“Memorandum”) concluding that the employees of a disregarded single member limited liability company (SMLLC) (1) must be allowed to participate in the member’s Internal Revenue Code (“Code”) Section 403(b) plan, and (2) may participate in the member’s Code Section 457(b) plan. Until now, the necessity of having such employees participate in the member’s 403(b) plan, and the ability of such employees to participate in the member’s 457(b) plan, was unclear. The open question with respect to 457(b) plans was whether the employees of a SMLLC with a member that is an “eligible employer” for purposes of Code Section 457 could participate in the employer’s plan, even though the SMLLC itself could not be an eligible employer.

Background

The employees of almost any tax-exempt Code Section 501(c)(3) entity may participate in 403(b) plans or tax-sheltered annuities. The regulations under 403(b) further specify that a subsidiary or affiliate of an “eligible employer” for such plans (which includes, inter alia, tax-exempt entities) does not qualify as an eligible employer merely because of such affiliation. Treas. Reg. § 1.403(b)-2(b)(8)(ii).

To sponsor a 457(b) plan, an entity must be a tax-exempt “eligible employer,” as defined in Code Section 457(e)(1). That definition, while similar but not identical to the rules in Code Section 403(b), also includes tax-exempt entities.

As a general rule, unless a SMLLC affirmatively elects to be taxed as a corporation, the SMMLC is disregarded and treated as a branch or division of its member for all purposes under the Code. Treas. Reg. § 301.7701-2(a), 3(c). However, for some employment-related purposes, including employment taxes and certain excise taxes such as the assessable payments under the Affordable Care Act, a SMLLC is not treated as a disregarded entity. Treas. Reg. § 301.7701-2(c)(2)(iv), (v). This disparity, along with the regulation cited above regarding the status of the subsidiaries and affiliates of entities that are eligible employers for 403(b) plan purposes, has left the advisors of many non-profit entities that are the members of one or more SMLLCs questioning whether such SMLLCs are to be treated as disregarded entities for purposes of the eligible employer definitions applicable to such non-profit entities’ 403(b) and 457(b) plans.

New Guidance

The Memorandum answers this question and provides the following clarifications:

• A SMLLC that does not elect to be taxed as a corporation is disregarded with respect to its member for purposes of the 403(b) and 457(b) eligible employer requirements. Therefore, if the SMLLC’s member is an eligible employer, then the SMLLC is also an eligible employer for both 403(b) and 457(b) plans.

• Employees of a SMLLC generally must be allowed to participate in a 403(b) plan sponsored by the member in order to avoid violating the “universal availability” rule applicable to such a plan under Code Section 403(b)(12)(A)(ii).

• Employees of a SMLLC may be allowed participate in a 457(b) plan sponsored by the member.

In light of this guidance, tax-exempt employers which are the member in one or more SMLLCs should review any situations in which the employees of any such SMLLCs have not been treated as the employees of the member. In certain cases, such employees must be allowed to participate in the member’s 403(b) plan and may be permitted to participate in the member’s 457(b) plan.