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IRS Lets Nonprofits Cut Some Workers From 401(k) Testing

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The Internal Revenue Service is loosening antidiscrimination requirements for organizations that offer 401(k) retirement plans to some employees and 403(b) plans to others.

The new regulations, published today in the Federal Register, could affect a medical center, university or other organization that includes a government entity along with a for-profit entity, or a nonprofit arm along with a for-profit arm.

Because of current and past regulatory limitations on use of 401(k) plans, some employers have offered 401(k) retirement savings plans for employees of the for-profit arms along with 403(b) retirement savings plans for employees of governmental or nonprofit arms.

Section 410(b) of the Internal Revenue Code sets minimum coverage requirements for employers with 401(k) plans. To meet the requirements, employers must test to see whether rank-and-file employees are getting roughly as much value from the plans as the high-paid employees are getting.

The IRS wrote the new rule, Exclusion of Employees of 501(c)(3) Organizations in 401(k) and 401(m) Plans, to implement a section of the Economic Growth and Tax Relief Reconciliation Act of 2001.

The EGTRRA section lets employers that meet certain conditions exclude 403(b) plan members from 401(k) plan minimum coverage testing.

The new final rule, based on a proposed rule published in March 2004, will let government entities and entities with government and for-profit components leave 403(b) participants out of minimum coverage testing if more than 95% of the employees who are legally eligible to benefit from the 401(k) plan benefit from the 401(k) plan in a given year.

An organization with a unit that qualifies as a Section 501(c)(3) nonprofit organization can leave the 403(b) participants out of minimum coverage testing if:

- The 403(b) participants are not eligible to join the 401(k) plan.

- 95% of the employees of the for-profit arm (employees who are not employees of a nonprofit organization or a government entity) are eligible to join the 401(k) plan.

The same rules that apply to 401(k) plans apply to 401(m) plans, according to the regulation text.

A copy of the final rule is on the Web at Document Link