“We are a 501(c)(3) health care organization that recently acquired another 501(c)(3) health care organization, which is not part of our controlled group. We plan on covering the employees of the acquired organization, but how do we treat the pre-acquisition service of these employees? Are we required to credit that past service in our 403(b) plan, or required to exclude it? Or do we have the option to credit or exclude?”

Charles Filips, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

A plan sponsor is NEVER REQUIRED to count past service with any other employer, even if that other employer becomes part of the controlled group. Per the 401(a)(4) regs. (Code Section 403(b)(12)(A)(i) incorporates 401(a)(4) by reference), a legitimate business reason must exist in order for an employer to credit an employee’s pre-participation service with another employer. The regulations supply a non-exhaustive list of the relevant facts and circumstances for determining whether a legitimate business reason exists (see below), including when new employees are part of an acquired group of employees or the new employees become employed as part of a transaction between two employers (such as a stock or asset acquisition, merger or other similar transaction).

(IRS Treas. Reg. Section 1.401(a)(4)-11(d)(3)(iii)(B)(1) and (2), which applies by reason of Code section 403(b)(12)(A)(i)):

(B) Legitimate business reason –

(1) General rule. There must be a legitimate business reason, based on all of the relevant facts and circumstances, for a plan to credit imputed service or for a plan to credit pre-participation service for a period of service with another employer.

(2) Relevant facts and circumstances when crediting service with another employer. The following are examples of relevant facts and circumstances for determining whether a legitimate business reason exists for a plan to credit pre-participation or imputed service for a period of service with another employer as service with the employer: whether one employer has a significant ownership, control, or similar interest in, or relationship with, the other employer (though not enough to cause the two employers to be treated as a single employer under section 414); whether the two employers share interrelated business operations; whether the employers maintain the same multiple-employer plan; whether the employers share similar attributes, such as operation in the same industry or the same geographic area; and whether the employees are an acquired group of employees or the employees became employed by the other employer in a transaction between the two employers that was a stock or asset acquisition, merger, or other similar transaction involving a change in the employer of the employees of a trade or business. Other factors may also be relevant for this purpose, such as the plan’s treatment of service with other employers with which the employer has a similar relationship and the type of service being credited (e.g., vesting service as compared to benefit service or accrual service). A legitimate business reason is deemed to exist for a plan to credit military service as service with the employer.

The boldface text reflects the Experts’ emphasis.

Most preapproved 403(b) plan documents contain a section where the employer can elect whether or not to credit an employee’s pre-participation service with a predecessor employer. Note that the granting of pre-participation service must be nondiscriminatory. For example, if you acquired a physicians practice, you could not just credit prior service for the physicians who are highly compensated employees (HCEs) and not the admin staff who are non-HCEs.

However, the Experts should note that 410(b) coverage and 401(a)(4) general nondiscrimination testing (but not ACP testing) is generally deemed to be satisfied in a merger situation through the year following the year of the merger, so if the transaction took place this in 2021, you have a free pass on such testing until 2023.

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.

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