IRS Issues Guidance Addressing Otherwise Excludable Employees:

On April 8, the IRS released Chief Counsel Memorandum 201615013 (the “Memo”). The Memo provides helpful guidance regarding testing certain employees as a separate group for purposes of minimum coverage testing, as well as for purposes of the so-called ADP and ACP nondiscrimination tests.

By way of background, the Internal Revenue Code (the “Code”) provides that tax-qualified plans cannot require employees to be older than twenty-one or to complete more than one year of service to become eligible for their employer’s plan. In addition, once an employee satisfies the plan’s eligibility requirements, he or she must be allowed to enter the plan by the earlier of: (1) the first day of the next plan year after satisfying those requirements; or (2) six months after satisfying such requirements. (The date on which he or she enters the plan is known as the “entry date.”) If a plan provides for eligibility requirements that are less stringent than the maximum permissible requirements (i.e. age twenty-one and one year of service), then the plan sponsor can test employees who have not satisfied those maximum requirements as a separate group for coverage purposes and for ADP and ACP testing. Those employees are referred to as “otherwise excludable employees.”

After summarizing the above-referenced rules, the Memo offers the following hypothetical situation:

  • A plan with a calendar-year plan year allows employees to make elective deferrals immediately upon their hire. A twenty-four year old employee is hired on August 10, 2014. For minimum coverage and ADP testing purposes for the 2014 plan year, this employee is in the “otherwise excludable employee” group. That is because, although the employee is over age twenty-one, he or she will not complete the statutory maximum one-year-of-service requirement during 2014.

The Memo then addresses the question of whether it is permissible to also treat this employee as a member of the “otherwise excludable employee” group for 2015, based on the law’s latest allowable entry date for this employee (i.e. January 1, 2016). The Memo states that such treatment is permissible. Also, a plan sponsor can consider employees as remaining in the “otherwise excludable employee” group until they attain age twenty-one and complete one year of service. As yet another alternative, employees can be treated as remaining in the “otherwise excludable employee” group until they reach their first entry date under the plan.  (The Memo can be accessed here: )

Please note that the Memo cannot properly be cited as legal precedent. Nonetheless, the Memo indicates that the IRS will now apply a very flexible approach to this issue.