FIS Relius
Rehired Employees: When Do They Enter the Plan? 3/24/2014
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Practitioners find the eligibility rules difficult to understand while the employers find them completely counterintuitive. The rehired employee rules are even more challenging for practitioners and employers.  

As a general rule, if an employee satisfied the plan’s eligibility requirements during his/her initial period of employment, the employee would enter on the date of rehire unless the break-in-service rules came into play. Accordingly, the plan may not treat the rehired employee as a new employee that must re-satisfy the eligibility conditions. The plan also may not delay the employee’s entry to the plan until the next plan entry date because such a delay would violate the time of participation requirements (entry into the plan after satisfying the eligibility conditions on the earlier of (1) the first day of the plan year, or (2) 6 months after satisfying the eligibility conditions). Of course, if an employee is rehired before his/her initial plan entry date, the plan can wait until the plan entry date to make the employee a participant.  

Example. A calendar year plan imposes eligibility conditions of one year of service and age 21. The plan has semi-annual entry dates (January 1 and July 1). Ann (age 30) commenced employment on April 1, 2013 and terminates employment on December 1, 2013, after completing 1200 hours of service. The plan would credit Ann with a year of service as of March 31, 2014.  She does not need to be employed for the full 12 months to earn a year of service. She need only complete 1,000 hours during the computation period. However, she does not enter July 1, 2014 because she is not employed on that date. If she is never rehired, the fact that she completed a year of service is academic. However, assume Ann is rehired on October 15, 2014. Many employers might misapply the year of service rules and treat Ann as a new employee who must satisfy the one year of service rule again. However, not only may the plan not treat Ann as a new employee, the plan must recognize that she completed one year of service. Accordingly, Ann should enter the plan immediately upon reemployment (October 15, 2014). If she were rehired on June 15, 2014, the plan would not place her into the plan until her initial entry date (July 1, 2014).  

For a plan with a one year of service (or less) eligibility condition, the Code provides only two possible break-in-service rules, each of which rarely applies. A complete explanation of the break-in-service rules is beyond the scope of this technical update but a brief description will assist the reader in understanding the rehired employee rules.   

The one-year holdout rule permits a plan to hold the participant out of the plan (i.e., disregard previous service) until he/she completes a year of service after the break-in-service (generally after being rehired).  If the employee completes the year of service, the plan must credit the prior service. The crediting of the prior service generally means the rehired employee will need to enter the plan retroactively to his/her date of rehire. For a full-time employee, the rule generally serves only to keep the rehired employee out of the plan temporarily. The IRS takes the position that a 401(k) plan may not use the rule for the elective deferral portion because a participant cannot make retroactive elective deferrals.   

The other break-in-service rule is the “rule of parity.” For this rule to apply, the employee must have (1) been a participant in the plan, (2) been 0% vested, and (3) incurred 5 or more consecutive breaks-in-service. For a 401(k) plan, if the participant had made any deferrals, the rule would not apply because the participant would have been vested in the deferrals. The same would be true if the participant had received an allocation of QNECS or safe harbor nonelective contributions.  

What if an employee did not complete the eligibility conditions during his/her first term of employment? Do the rehired employee rules have any application? The correct response is that the rehired employee rules continue to have application. The plan, of course, does not need to make the employee a participant immediately but it cannot treat the employee as a new employee with a new employment commencement date from which to count eligibility service. Unless the prior service is disregarded under a break-in-service rule (rare), the plan must count service based on the anniversary of the original employment commencement date or on the basis of the plan year if the plan shifts to the plan year. Since most plans shift, the measuring period likely will be the plan year. 

Example. A calendar year plan imposes eligibility conditions of one year of service and age 21. The plan has semi-annual entry dates (January 1 and July 1). Dan commenced employment on April 1, 2013. He terminates employment on October 1, 2013 after completing 800 hours of service. Dan is rehired on May 1, 2014 (working 160 hours/month). If the plan treats him as a new employee (which would be improper), he would not enter the plan until July 1, 2015. However, if the plan recognized his prior service (proper treatment), he would complete 1,000 hours during the computation period (plan year) and enter the plan on January 1, 2015. It is important to note that under the year of service rules, Dan neither has to be employed at the beginning of the computation period nor be employed for the full 12 months. Completion of 1,000 hours of service during the computation period is all that is necessary. 

The examples illustrate the difficulty and importance of properly applying the rehired employee rules. A misapplication of the rules can result in the employer needing to make corrective contributions and resolving the error under the IRS correction programs. Unfortunately, IRS agents are trained to look for such issues. Accordingly, practitioners must carefully inquire about prior employment and then properly apply the rules. 

In the Southern Retirement Plan Conference, April 24-25 in Atlanta, GA, we will discuss both the part-time employee exclusion and rehired employees. The conference will include many other important topics. See more information below.

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