IRS proposes rules for long-term part-time employees

On November 27, 2023, IRS published proposed regulations implementing the long-term part-time employee (LTPTE) rules of SECURE 1.0 (2019) and SECURE 2.0 (2022). The application of these rules is extremely technical and complicated. In what follows, we will discuss some of the issues the proposal presents, but sponsors will want to consult with their recordkeeper and with counsel as to how to comply.

We begin by explaining who is an LTPTE.

Who is an LTPTE

  • Generally, an LTPTE is an employee who is eligible to participate in the plan solely by reason of having completed the applicable number of consecutive 12-month periods (two or, for 2024, three) of 500 or more but less than 1,000 hours of service.

  • Thus, any employee who becomes a participant because they satisfy the “regular” one year of service/1,000 hours rule is not an LTPTE, even if that employee, e.g., subsequently transfers to part-time status.

  • An employee who is an LTPTE and subsequently is (1) transferred out of the unit covered by the plan or (2) completes a “regular” year of service (1,000 hours), is treated as a former LTPTE (see below).

Rules applicable to LTPTEs

Generally, beginning in 2024, LTPTEs may make elective deferrals under a 401(k) plan.

A sponsor may, however, elect to disregard LTPTEs for purposes of applying the Tax Code nondiscrimination rules, including the general nondiscrimination rules, the ADP testing and safe harbor rules, and the ACP testing and safe harbor rules, and for purposes of applying the Tax Code top-heavy rules. If the plan is intended to be a 401(k) safe harbor plan, this election must be set forth in the plan. Non-safe harbor plans must simply include language enabling this election.

LTPTEs and former LTPTEs (see below) get a special vesting rule: they are credited with a year of vesting service for each year in which they have at least 500 hours of service (rather than 1,000 hours of service under the general rule). For this purpose, under SECURE 2.0 (which reversed prior IRS guidance), in determining an LTPTE’s vested benefit, 12-month periods of service beginning prior to 2021 are ignored.

Treatment of former LTPTEs

As noted, a participant who enters the plan as an LTPTE and who subsequently completes a “regular” year of service (1,000 hours) is considered a former LTPTE. After completing the “regular” year of service, the sponsor (generally) must begin making any matching and nonelective contributions provided under the plan for regular employees and may not disregard these former LTPTEs for purposes of the Tax Code nondiscrimination and Top Heavy rules. But – the 500 hour vesting rule will continue to apply to these employees.

The application of the 500 hour rule for vesting for former LTPTEs is controversial and is expected to create some significant administrative complexities. It may result in some very un-intuitive outcomes. Vesting is (practically) irrelevant to a “permanent” LTPTE, who never works 1,000 hours, and who is thus not getting any employer contributions subject to a vesting limitation. But if this employee works one 1,000 hour year of service, she must (generally) begin to get those contributions and will be credited with vesting years for all of her post-2020 part-time service (500 or more but less than 1,000 hours of service per year).

Effective dates

The proposed regulation would be effective for plan years beginning in 2024. There may be (somewhat unusual) circumstances in which the LTPTE rule, under the statute, is applicable in 2023.

The “practical” effective dates for these rules are complicated by two factors. First, 12-month periods of service beginning prior to 2021 are ignored. Thus, the first 12-month period for an employee hired on June 1, 2020 would be June 1, 2020 – May 31, 2021 and would be ignored. Second, the “three consecutive 12-month periods” rule in SECURE 1.0 was shortened to “two consecutive 12-month periods” in SECURE 2.0, effective for plan years beginning in 2025. Thus, for 2024 only, employees who complete three consecutive 12-month periods during each of which they were credited with at least 500 hours of service may become participants in 2024. For all other LTPTEs, the first year in which they may become a participant is 2025.

The rules present a number of administrative challenges, some of which sponsors may be able to address through design, if there is time between now and the 2024 effective date to make those design changes.

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Comments on the proposal are due by January 26, 2024. A public hearing is scheduled for March 15, 2024.

We will continue to follow this issue.