SunGard Relius

The IRS has released Rev. Rul. 2004-11, describing how the “coverage transition rule” of Code § 410(b)(6)(C) applies to the nondiscrimination requirements of 401(a)(4). Under the rule, when there is a change in controlled group or affiliated service group membership, or certain other acquisitions or dispositions affecting the employer, the employer’s plan is deemed to pass coverage during the “transition period.” The transition period begins on the date of the employer transaction and ends on the last day of the plan year that follows the transaction plan year.

The ruling clarifies the following points.

1. The coverage transition rule applies to the Code §401(k)(3)(A)(i) special coverage requirements for 401(k) plans.
   
   
2. The coverage transition rule applies to plan restructuring under Treas. Reg. §1.401(a)(4)-9(c) so long as each component plan separately satisfies the nondiscrimination and coverage rules prior to the acquisition or disposition.
   
   
3. Although not stated directly, it appears that if the plan was a safe harbor plan for nondiscrimination at the time of the acquisition, and the conditions of the transition rule are met, the plan also remains a safe harbor for nondiscrimination during the transition period.
   
   
4. A 401(k) plan which is eligible for the coverage transition rule must still satisfy the ADP and ACP tests (or use an appropriate safe harbor).
   
   
5. Use of the transition rule is optional and elective.
   
   
6. The last day of the transition period is normally the last day of the plan year which begins after the acquisition or disposition. So, for example, suppose Company S sponsors a calendar year plan and Company P acquires all S stock on July 1, 2004. Barring plan or coverage changes, the transition period begins July 1, 2004 and ends December 31, 2005. January 1, 2006 is the first day that the coverage rules again apply to the S plan. Some practitioners had erroneously viewed the transition relief as ending on that last day (December 31, 2005), which would have required the S plan to consider the change in ownership for the 2005 plan year.
   
   
7. A significant change in a plan’s benefit formula during the transition period constitutes a change which terminates the transition period.
   
   
8. If a plan’s coverage or benefits change significantly (other than as a result of the acquisition or disposition itself), the transition period is terminated, but only on a prospective basis. For example, suppose Company S described above amends the benefit formula effective April 1, 2005. The S plan is entitled to the coverage transition rule from July 1, 2004 through March 31, 2005. Beginning April 1, 2005, the plan must again satisfy the requirements of Code §410(b).

Note: The IRS specifically asks for comment on other situations involving the coverage transition rule where guidance is needed. The IRS also identifies three alternative fact patterns and asks for comments specifically relating to 1) the requirement to satisfy coverage before the transaction; 2) the requirement that coverage not change significantly during the transition period; and 3) if there might be non-abusive circumstances where a plan should be regarded as satisfying the general nondiscrimination test during the coverage transition period.

401(k) Plan Workshop
The IRS does not address many common issues confronting practitioners when a plan sponsor undergoes an acquisition or disposition, such as how to determine who are HCEs and how to apply the ADP and ACP tests where there are multiple 401(k) plans maintained by the employers involved in the transaction. We will be addressing many of these issues in the upcoming 401(k) Plan Workshop.