IRS Proposes Rule to Ease Liability Under 401(k) Multiple Employer Plans

New proposal complements a Department of Labor proposed rule on open MEPs

Stephen Miller, CEBS By Stephen Miller, CEBS July 15, 2019

The IRS has proposed a rule that would make 401(k) multiple employer plans (MEPs) more attractive, especially for small employers, by addressing the risk posed to a MEP by one member's bad actions.

All employers in a MEP could face penalties under the unified plan rule if one employer violates its fiduciary responsibilities—for example, by failing to funnel employee contributions to the plan on schedule. The "one bad apple" liability risk that a negligent member can pose to an entire plan has been a major stumbling block for employers considering whether to participate in a MEP. 

Currently, "MEPs are hard to do," commented Robert Toth, principal at Toth Law and Toth Consulting in Fort Wayne, Ind. "It is also quite a task to remove an uncooperative MEP member," he noted.

The U.S. Department of Labor (DOL) lacked the authority to address this issue when it released its own proposed rule on MEPs last October. That rule, which would let unrelated businesses in different industries join in an "open" MEP offered through association retirement plans, has not yet been finalized.

The new proposal, which the IRS published July 3 in the Federal Register, would apply to "closed" MEPs, which must share common relationships such as being in the same industry, and would apply to open MEPs when the earlier DOL rule becomes final.

"The 'one bad apple rule' is presumably of lesser concern for plans that cover employers with some sort of commonality because the required nexus of the participating employers is likely to provide a greater degree of cooperation than in the case of an 'open MEP,' ” noted an analysis by HR consultancy Buck.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

A Unified Plan Rule Exception

Under the unified plan rule, a MEP is qualified based on all employers in the plan. Consequently, the failure by one employer to satisfy a qualification requirement would disqualify the plan for all participating employers.

Another example of this sort of qualification violation in a 401(k) MEP would be an individual employer's failure to pass the ADP (actual deferral percentage) test for a given year, noted Michael Barry, a senior consultant with October Three, a retirement plan advisory firm. "Under IRS rules, in a MEP the ADP test is applied separately to each employer, on an employer-by-employer basis," he wrote recently. "But if one employer failed the ADP test (with respect to its employee-participant population), under the one bad apple rule, the entire MEP would be subject to disqualification."

The new proposal would provide an exception to this disqualification risk if certain other requirements are met. For instance, the MEP's other employers could spin off the noncompliant member's assets and account balances into a separate plan.

The IRS proposal offers a solution that would be "clear, effective and easy to follow and would remove one of the most significant barriers to establishing a MEP," said Rob Neis, a partner with law firm Eversheds Sutherland in Washington, D.C., and former benefits tax counsel at the Treasury Department. "The Treasury Department and IRS should be commended on taking this important step toward making MEPs more widely available to the employers that need them, particularly smaller employers," Neis said.

Conditions to Be Met

Under the IRS proposal, five conditions must be met to avoid plan disqualification due to "one bad apple," Barry explained:

  • The MEP must meet certain eligibility requirements (e.g., maintain practices and procedures promoting compliance and adopt certain plan language).
  • The MEP administrator must comply with detailed notice provisions and provide the "failing" employer an opportunity to remedy the failure.
  • At the time of the first required notice, the MEP may not be under examination.
  • Where the "failing" employer does not remedy the failure, the MEP administrator must implement a spin-off of the failing employer's share of the plan. This spin-off may be initiated by the failing employer; where it is not, the MEP administrator must both spin-off and terminate the plan.
  • The MEP administrator must comply with information requests from the IRS and the representative of the spun-off plan.

Rule Mirrors SECURE Act Provision

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed by the U.S. House of Representatives May 23 and awaiting a vote in the Senate, addressed the same liability issue by providing a safe harbor for employers in a MEP.

"The proposed regulations closely follow provisions of the SECURE Act," Neis said. The SECURE Act provides that if an employer participating in a MEP fails to comply with the qualification requirements, "the unified plan rule is not violated if the plan assets attributable to that employer are transferred to a single-employer plan maintained solely for the employees of that employer, and that employer is solely responsible for any liabilities associated with the plan qualification failures. The proposed regulations would do the same thing," Neis explained.

The proposed regulations provide more details than the SECURE Act on spinning off the assets of "bad actors," he added. The additional details address notices, timing and similar matters. "It's fair to say that the proposed regulations would cure most of the problems caused by the unified plan rule and that the SECURE Act provisions addressing the unified plan rule would no longer be necessary," he said.

Gray Areas Remain

The proposed regulations still leave unresolved issues regarding "the forced spinoff of a recalcitrant participating employer," Toth pointed out. "The IRS proposal only really addresses a small part of what actually happens under these circumstances—all of which will eventually need to be addressed," he noted.

This may take a significant regulatory effort, he added, especially if the SECURE Act becomes law.

"The legislation would give the Treasury and the IRS the authority to issue these types of regulations," Neis said.



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