IRS Proposes Change to ‘One-Bad-Apple’ Rule for MEPs

The IRS has issued a Notice of Proposed Rulemaking (NPRM) relating to the tax qualification of plans maintained by more than one employer. 

These plans, maintained pursuant to section 413(c) of the Internal Revenue Code (IRC), are often referred to as multiple employer plans, or MEPs. The proposed regulations would provide an exception, if certain requirements are met, to the application of what the regulations call the “unified plan rule,” and what the industry refers to as the “one-bad-apple rule” for a defined contribution MEP in the event of a failure by an employer participating in the plan to satisfy a qualification requirement or to provide information needed to determine compliance with a qualification requirement.

The IRS explains that currently, the qualification of a MEP is determined with respect to all employers maintaining the MEP. Consequently, Section 1.413-2(a)(3)(iv) of the IRC provides that “the failure by one employer maintaining the plan (or by the plan itself) to satisfy an applicable qualification requirement will result in the disqualification of the MEP for all employers maintaining the plan.”  Section 1.416-1, Q&A G-2, includes a similar rule relating to the qualification of a MEP, providing that a failure by a MEP to satisfy Section 416 with respect to employees of one participating employer means that all participating employers in the MEP are maintaining a plan that is not a qualified plan.

The agency notes that on August 31, 2018, President Trump issued Executive Order 13847, titled “Strengthening Retirement Security in America.” The Executive Order directs the Secretary of the Treasury to “consider proposing amendments to regulations or other guidance, consistent with applicable law and the policy set forth in … this order, regarding the circumstances under which a MEP may satisfy the tax qualification requirements …, including the consequences if one or more employers that sponsored or adopted the plan fails to take one or more actions necessary to meet those requirements.”

In addition, stakeholders have expressed concerns about the risk that the actions of one or more participating employers might disqualify a MEP, and that some employers are reluctant to join MEPs without an exception to the unified plan rule. In particular, they have said that the cooperation of participating employers is needed for compliance and when a participating employer refuses to take the steps needed to maintain qualification, the entire plan is at risk of being disqualified. Stakeholders assert that without an exception to the unified plan rule, many employers perceive that the benefits of joining a MEP are outweighed by the risk of plan disqualification based on the actions of an uncooperative participating employer.

The IRS’ proposed regulations, which were developed in consultation with the Secretary of Labor, that would provide an exception to the unified plan rule for certain defined contribution MEPs.  Under the proposed regulations, a defined contribution MEP would be eligible for the exception to the unified plan rule on account of certain qualification failures due to actions or inaction by a participating employer, if the conditions set forth in the proposed regulations are satisfied. 

The exception generally would be available if the participating employer in a MEP is responsible for a qualification failure that the employer is unable or unwilling to correct. It would also be available if the participating employer fails to comply with the Section 413(c) plan administrator’s request for information about a qualification failure that the Section 413(c) plan administrator reasonably believes might exist. For the exception to the unified plan rule to apply, certain actions are required to be taken, including, in certain circumstances, a spinoff of the assets and account balances attributable to participants who are employees of such an employer to a separate plan and a termination of that plan.

Legislation currently being considered would open MEPs to employers without a common nexus. Retirement industry stakeholders have urged legislators to also eliminate the one-bad-apple rule.