Employee Plans Compliance Unit (EPCU) - Completed Projects with Summary Reports - 403(b) Universal Availability K-12 Project and Follow-Up
In June 2006, the Internal Revenue Service (IRS) undertook a project to determine if public kindergarten through 12th grade (K-12) schools understood and complied with the Universal Availability (UA) non-discrimination rules under section 403(b) of the tax code. Anecdotal evidence from IRS audits revealed K-12 schools misunderstood UA and failed to offer all eligible employees the opportunity to deferral salary, putting the 403(b) at risk of losing tax deferred status.
This project began with a census of schools in three States and later expanded to include a sample of schools in the remaining 47 States. The focus was on overlooked employees and how benefits could be restored so all eligible participants could continue to enjoy the benefits of a qualified 403(b). Overlooked employees often play a support role or are not traditional full time (or contracted) employees. These groups include bus drivers, cafeteria workers, janitors, substitute or part-time teachers, and employees regularly scheduled to work at least 20 hours per week. In addition, the project contacts requested information about general participation requirements, mandatory minimum annual deferrals amounts, other salary deferral plans offered, and the method(s) used to communicate deferral opportunities to employees.
The second phase of the project, Project II, began in 2010, focusing on schools who’s Project I responses indicated a possible UA failure. This follow up asked 250 schools to take a closer look at excluded employees, confirm they met UA, and if necessary, provide details about correction. In both phases, responses were voluntary; however schools were cautioned that failing to provide information could result in further action or IRS examination
Results of the Project
A short questionnaire was originally sent to all identified schools in three states (New Jersey, Missouri, and Washington) and was expanded by including a sample of schools from the remaining 47 states regarding UA compliance issues. We discovered during the initial Project I phase that over ninety percent of schools offer employees the opportunity to defer salary to a 403(b) plan. Most appear to make the plan available with little restriction as to minimum deferral amounts required. The vast majority exclude substitute and part-time teachers as a group, usually because they are not considered regular employees or they receive pay on an irregular basis. Some schools allow excludable employees working under 20 hours to participate, effectively losing the option to exclude other part-time employees. Nearly half offered other deferral options like a 401(k) plan in addition to the 403(b). Some offering a 401(k) may not be eligible because it was adopted after the 1986 rules prohibiting most schools from maintaining this type of plan.
Through Project I, 5,901 schools/school districts were contacted regarding UA. Based on the results of the statistically valid sample, 16% of schools/school districts may have violated the UA requirements.
Table 1: Key Result for the Estimated K-12 School Population
|Regional Comparisons (Estimated number in parentheses)*|
|Result Code and Description|
|1: No change: Case closed w/school having 403(b) plan and no errors found||79%||79%||76%||86%||83%||76%|
|4: Error in excluding ANY employee groups.||14%||16%||17%||11%||11%||13%|
|4a: P/T or Substitute Teachers||99%||94%||100%||100%||100%||100%|
|4b: Bus Drivers||6%||7%||3%||3%||6%||9%|
|4c: Cafeteria Workers||3%||0%||1%||1%||5%||3%|
|4e: Miscellaneous Workers||0%||0%||0%||0%||0%||0%|
|4f: Work at least 20 hrs/wk||1%||0%||1%||1%||3%||2%|
|5: Salary deferral plan in addition to 403(b) maintained.||41%||34%||48%||43%||33%||45%|
|5a: 401(k) plan maintained, appears qualified||15%||22%||18%||11%||18%||5%|
|5b: 401(k) plans with effective dates on or after 5/7/1986.||12%||11%||2%||25%||1%||24%|
|Disposal Code and Description|
|6: Correction of operational practice – Future impact.||16%||17%||20%||13%||11%||15%|
|16: No change.||68%||58%||65%||81%||79%||68%|
Other findings predicted nationwide and region-wide include:
- The vast majority (92% to 99%) maintain a 403(b) plan.
- None offer a one-time irrevocable election for 403(b) plan deferrals.
- Very few (4% or less) exceed the required minimum annual deferral of $200.
- Almost none (1% or less) incorrectly impose the ‘additional service requirement’.
- None have referrals to EP classification or exam.
We discovered from Project II that over sixty percent of the schools who initially indicated they excluded certain groups of employees later confirmed those exclusions were either allowable or indicated their first response contained errors. One-fourth of the schools we followed up with failed to demonstrate they adequately corrected Universal Availability or failed to respond to our inquiry and were referred for examination to confirm compliance.
Table 1: Types of Closures
|Referral to EP Exam or R&A
|Correction of Plan
|Correction of Operational Practice – Future Impact
Table 2: Project Results
|No Original Failure||160||64%|
|No Plan Correction||65||26%|
|Correction Made Late||3||1%|
|TP Negative Error Response but Verbiage Differed||0||0%|
|Indicated Error Made, No Correction Made or No Information Provided||2||1%|
It is important for sponsors of 403(b) plans for public K-12 schools to regularly review the IRS.gov web site, fix-it guides, and newsletters to understand and eliminate barriers to participation for employees not part of the regular full time staff or that receive pay on an irregular basis to ensure the requirements of UA are met for all eligible employees.
Internal Revenue Code (IRC) section 403(b) provides the “taxability of beneficiary” under an annuity purchased by a public school. Generally, these annuities are funded by elective deferrals made under salary reduction agreements and nonelective employer contributions. In order to satisfy nondiscrimination, once the opportunity to make salary reduction contributions is made available to an employee, it must be made available to all nonexcludable employees. This requirement is referred to as UA.
IRC section 403(b)(12) provides that all employees may elect to have the employer make contributions of more than $200 pursuant to a salary reduction agreement if any employee of the organization may make this election. However, certain types of employees may be excluded from participating in a public school’s 403(b) plan. Some of these exclusions include employees eligible to participate in sections 457 or 401(k) plans, those expected to normally work less than 20 hours per week, and collectively bargained employees.
This project focused on concerns regarding public schools improperly excluding certain eligible employees such as part-time employees, bus drivers, janitors, and cafeteria employees. The effect of violating nondiscrimination may result in the loss of 403(b) status.
The goals of this project were to determine if the universal availability requirement was being properly applied and executed by public schools. The design of the project was to give public schools with problems related to UA the opportunity to correct them on their own. This entailed educating the schools about UA and providing them with instructions on how to correct a failure of this requirement. The goal of the follow-up to this project began in the EPCU in June of 2010, to ensure a corrective action occurred on those plans that appeared to have violated the UA requirement.