Tax Article - Nonprofits' Employee Contribution Plans

The failure to afford salary-reduction opportunities to eligible employees when employers are required to do so under the tax code is the top issue facing IRS agents when dealing with public schools and nonprofit organizations, an IRS official told a group of practitioners on September 7, 2006. The concept of "universal availability" under Code Sec. 403(b) requires that, if institutions make salary-reduction contributions available to some employees, they must be made available to all employees who work at least 20 hours a week.

IRS Senior Tax Law Specialist, Employee Plans Division, Tax Exempt and Government Entities, Robert Architect told a group of practitioners that IRS exams have found that failure to adhere to the universal availability rule is generally inadvertent and due to "poor plan design." Architect's made his remarks during a panel discussion on retirement, deferred compensation, and welfare plans of tax-exempt and governmental employers, held in Washington, D.C., and sponsored by the American Law Institute and the American Bar Association (ALI-ABA).

Architect discussed a list of current and future examination concerns associated with Code Sec. 403(b). Final regulations for that provision are not anticipated before the end of 2007, he added.

Universal Availability "What happens is we see plans designed that accord individuals the right to make salary-reduction contributions if they are full-time employees," Architect said, noting that the plan will then incorrectly define a full-time worker as anyone who works at least 2,000 hours. "Right away, we have a problem," Architect said. Architect observed that a part of the widespread failure to provide universal availability stems from some organizations' failure to tell their employees that they have the right to make a salary-reduction contribution.
Institution officials (for example, those at public schools, universities, and tax-exempt organizations) have told examining IRS agents that they have plans in place allowing the contributions, Architect said, but employees are made aware of the plans only upon inquiry. "That is not sufficient," Architect noted. "We look for some form of notice to participants to complete the universal availability requirement for the salary-reduction opportunity."

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Garbled Contribution Rules Architect also reported that agents continue to see an excess of elective deferral contributions. He noted that the problem centers on the misunderstanding of the use of a 15-year catch-up provision provided under Code Sec. 403(b). Under the code, for elective deferral there is a $15,000 limit for the year 2006. If an individual happens to be 50 or older in the current year, he or she is allowed another $5,000.

Proposed Reg. §1.403(b)-4(c)(3)(i) provides that, in the case of a qualified employee of a qualified organization for whom the basic tax sheltered annuity (TSA) elective deferrals for any year are not less than the elective deferral limit for that year, the TSA elective deferral limitation for the tax year of the qualified employee is increased by the lesser of (a) $3,000; (b) the excess of $15,000 over the total special TSA catch-up elective deferrals made for the qualified employee by the qualified organization for prior years; or (c) the excess of $5,000 multiplied by the number of years of service of the employee with the qualified organization over the total elective deferrals made for the qualified employee by the qualified organization for prior years.

"But, in that mix somewhere is the idea that, if an individual for most types of exempt organizations --public schools, churches, health care organizations --has worked for that specific organization for 15 or more years, he or she may be entitled to another catch-up contribution of up to $3,000," Architect said. "What is happening is that people don't realize, at the grass-root, that this is a type of a catch-up that is a subject of a special formula; therefore, you cannot say that an individual, because they've worked 15 or more years with the organization, is absolutely entitled to an additional $3,000."

Improper Hardship Distributions Another key concern of agents is that of improper hardship distributions. "Serial hardship" individuals, as Architect referred to them, regularly go to multi-vendors and say they have a hardship. "The only thing they have to do to certify the hardship to the vendor is check a box." Architect also noted that agents have found situations of people using multiple vendors to get loans in violation of Code Sec. 72(p)'s limits on loan amounts.

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