410(b) Coverage Testing for Firms With Both 401(k) and 403(b)

“The entity sponsors a 403(b) plan for the vast majority of its employees, but also sponsors a 401(k) for a small wholly-owned for-profit physicians’ practice. Since both are required to be tested as plans of a single employer under the controlled group rules, it would appear that the 401(k) plan, which also provides for a matching contribution, would have failed 410(b) coverage testing for the 401(k) elective deferrals and 401(m) matching contributions each year. However, the plan sponsor had been testing the 401(k) plan separately for these purposes, and had been passing each year. I believe that is not correct, and that the 403(b) plan employees should have been included as eligible employees in the 401(k) and 401(m) coverage tests, but not benefitting, which in this case would have resulted in coverage test failures. What say the Experts?”

Stacey Bradford, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

The Experts say that whomever was performing the past tests was likely correct. The Experts agree with your assertion that the plans are required to be tested as plans of a single employer under the controlled group rules. But Treas. Reg. 1.410(b)-6 allows 401(k) plans to exclude a number of employees that might ordinarily be subject to the coverage testing rules, and this regulation includes this following little-known provision:

(g)Employees of certain governmental or tax-exempt entities –

(1) Plans covered. For purposes of testing either a section 401(k) plan, or a section 401(m) plan that is provided under the same general arrangement as a section 401(k) plan, an employer may treat as excludable those employees described in paragraphs (g)(2) and (3) of this section.

(2)Employees of governmental entities. Employees of governmental entities who are precluded from being eligible employees under a section 401(k) plan by reason of section 401(k)(4)(B)(ii) may be treated as excludable employees if more than 95 percent of the employees of the employer who are not precluded from being eligible employees by reason of section 401(k)(4)(B)(ii) benefit under the plan for the year.

(3)Employees of tax-exempt entities. Employees of an organization described in section 403(b)(1)(A)(i) who are eligible to make salary reduction contributions under section 403(b) may be treated as excludable with respect to a section 401(k) plan, or a section 401(m) plan that is provided under the same general arrangement as a section 401(k) plan, if –

(i) No employee of an organization described in section 403(b)(1)(A)(i) is eligible to participate in such section 401(k) plan or section 401(m) plan; and

(ii) At least 95 percent of the employees who are neither employees of an organization described in section 403(b)(1)(A)(i) nor employees of a governmental entity who are precluded from being eligible employees under a section 401(k) plan by reason of section 401(k)(4)(B)(ii) are eligible to participate in such section 401(k) plan or section 401(m) plan.

Cutting through the legalese, what this provision is saying is, if none of the employees of the 501(c)(3) hospital are eligible to participate in the 401(k), and at least 95% of the employees of the for-profit physicians’ practice are eligible to participate in the 401(k) (and are eligible to receive the match for purposes of the 401(m) coverage testing), then the employees of the 501(c)(3) hospital can indeed be excluded from the 401(k) and 401(m) coverage testing of the physician’s practice.

It should be noted that 501(c)(3) employees may be excluded from coverage testing only for 401(k) and 401(m) purposes. If the 401(k) plan of the physicians’ practice were to offer a non-elective (base) contribution, the 501(c)(3) employees could NOT be excluded from the 410(b) coverage testing for that contribution type.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.