1. Employee Categories &
Benefit Plan Design
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Bass, Berry & Sims PLC

2. Benefit Plan Design Decisions
Who will be eligible to participate in the
plan?
When will each category of employees
become eligible to participate in the plan?
What plan benefits will be available to
each category of employees?
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3. Topics
401(k) Plans
► Age and service requirements
► Other eligibility requirements
► Nondiscrimination testing
Health and Welfare Plans
► Eligibility
► ACA’s “play or pay penalties”
► Nondiscrimination testing
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4. 401(k) Plans
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5. Age & Service Requirements
A plan may not, as a condition of eligibility to
participate, require an employee to:
► reach an age older than 21*
► complete more than 1 year of service** measured using
either:
- elapsed time method
- hours count method (i.e., 1 year of service = 12-month eligibility
computation period in which at least 1,000 hours are credited)
A plan may not impose an eligibility condition that is an
age or service requirement “in disguise” and violates
these standards
* An exception may be available for tax-exempt educational institutions
** An exception may be available with respect to employer contributions that vest immediately
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6. Age & Service Requirements
A plan may have different age and service
requirements for different categories of
employees
► Subject to IRC Section 410(b) coverage test
A plan may have different age and service
requirements for different plan features
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7. Service Requirement
“In Disguise”
Exclusion of part-time and seasonal employees
(as defined based on customary work schedule)
by classification is an impermissible service
requirement
► A part-time or seasonal employee may work enough
hours to be credited with 1 year of service
Part-time and seasonal employees may be
excluded on other bases
IRS agents are instructed to closely scrutinize
exclusions to look for service requirements “in
disguise”
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8. Example: Service Requirement
“In Disguise”
Plan X and Plan Y both have a 1 year of
service eligibility requirement
Plan X excludes part-time and seasonal
employees, defined as an employee who is
scheduled to work less than 1,000 hours in a
year - impermissible service requirement
Plan Y excludes part-time and seasonal
employees, defined as an employee who
works less than 1,000 hours of service in the
12-month eligibility computation period -
permissible service requirement
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9. Other Eligibility Requirements
A plan may impose eligibility conditions
unrelated to age and service
► For example, based on job title, location,
exempt/non-exempt, department, division,
union/non-union, internship/regular
► Subject to:
- IRC Section 410(b) coverage test
- May require a “reasonable classification”
- Employment discrimination laws
► Plan terms must be definite as to which
employees are eligible
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10. Exclusion of Leased Employees
Certain rules apply with respect to “leased
employees” as defined by IRC Section 414(n)
An individual is a “leased employee” under
IRC Section 414(n) if:
► the individual has provided services for the
recipient on a substantially full-time basis for at
least 1 year,
► the recipient has primary direction and control
over the individual’s services, and
► the leasing organization, not the recipient, is the
common law employer of the individual
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11. Exclusion of Leased Employees
Common error – employer intends to
exclude all leased employees, but plan
language only excludes IRC Section
414(n) leased employees
Other common errors related to leased
employees:
► Coverage test
► Form 5500 reporting
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12. 401(k) Plan
Nondiscrimination Testing
The 401(k) plan nondiscrimination tests
are generally intended to prevent
discrimination against non-highly
compensated individuals
When determining (or making changes to)
a 401(k) plan design, thought should be
given as to how the plan design will affect
nondiscrimination testing
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13. 401(k) Plan
Nondiscrimination Testing
IRC Section 410(b) Coverage Test
IRC Section 401(a)(4) General
Nondiscrimination Test
Actual Deferral Percentage (ADP) Test
Actual Contribution Percentage (ACP) Test
Top Heavy Test
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14. Notes on 401(k) Plan
Nondiscrimination Testing
Special rules may apply to particular types of
plans
► For example, governmental plans are not subject
to the above-described nondiscrimination testing
Brief description of rules only
► For example, does not cover aggregation rules,
permitted disparity, current year versus prior year
testing, cross testing, or safe harbor plan
requirements
Focus on 401(k) plans
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15. IRC Section 414(q)
HCE Definition
The coverage test, general nondiscrimination test,
ADP test, and ACP test use the IRC Section 414(q)
definition of HCE
An employee is an HCE for the plan year if the
employee:
► was a 5% owner at any time during the plan year or the
preceding year or
► had compensation for the preceding year from the
employer in excess of $115,000 (indexed for inflation) and,
if elected by the employer, was also in the group consisting
of the top 20% of the employees when ranked on the basis
of compensation paid during the preceding year
Attribution rules may apply when determining whether
an employee is a 5% owner
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16. Coverage Test –
Meet One of Three Tests
A plan must meet one of the following three tests:
► Percentage Test – The plan benefits at least 70
percent of NHCEs
► Ratio Percentage Test – The plan benefits a
percentage of NHCEs which is at least 70 percent of
the percentage of HCEs benefitting under the plan
► Average Benefit Test –
- Nondiscriminatory Classification – The plan benefits a
classification of employees that is a reasonable classification
and does not discriminate in favor of HCEs and
- Average Benefit Percentage – The average benefit
percentage of the NHCEs must be at least 70 of the average
benefit percentage of the HCEs
- Only employer-provided contributions and benefits are taken into
account in determining average benefit percentages
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17. Coverage Test – Exclusions
All employees of the employer are taken into account,
except that the following employees may be excluded:
► Employees who do not meet the applicable age and/or
service eligibility conditions of the plan
► Nonresident aliens who receive no U.S. source earned
income from the employer
► Collectively bargained employees
► Employees of qualified separate lines of business
(QSLOB)
► Certain terminating employees
► Employees of certain governmental or tax-exempt entities
► Certain former employees
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18. General ND Test –
Three Subtests
All three of the following subtests must be
satisfied:
► Contributions or Benefits Test
► Benefits, Rights and Features (BRFs) Test
► Nondiscriminatory Plan Amendment
Requirement
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19. General ND Test –
Contributions or Benefits Test
Contributions or benefits provided under a plan must be
nondiscriminatory in amount
Pre-tax, Roth, after-tax and matching contributions are not subject to
contributions or benefits test
► Instead, these contributions are subject to ADP and ACP testing, as
described below
Nonelective contributions are subject to contributions or benefits test
► Nonelective contributions generally include profit-sharing contributions
and other employer contributions that are not matching contributions
Certain formulas are considered “safe harbor” formulas
► For example, a single uniform formula that allocates to each covered
employee:
- the same percentage of plan year compensation,
- the same dollar amount, or
- the same dollar amount for each uniform unit of service
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20. General ND Test – Benefits,
Rights and Features (BRFs) Test
The plan’s BRFs must be made currently and
effectively available on a nondiscriminatory
basis
► A BRF is currently available if it is available to a
group of employees that satisfies either:
- the IRC Section 410(b) 70% ratio percentage test or
- the nondiscriminatory classification requirement of the
IRC Section 410(b) average benefit test
► A BRF is effectively available if the group of
employees to whom it is available does not
substantially favor HCEs, based on facts and
circumstances
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21. General ND Test –
Examples of BRFs
The right to make pre-tax, Roth or after-tax
contributions is considered a BRF
The right to receive matching contributions is
considered a BRF
Other examples of BRFs:
► retirement annuities
► single sum payments
► disability benefits
► plan loans
► the right to direct investments
► investment options
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22. General ND Test –
Nondiscriminatory Amendments
Requires that the effect of plan
amendments be nondiscriminatory
Focuses on whether the timing of an
amendment or series of amendments
discriminates significantly in favor of HCEs
or former HCEs
“Amendment” includes the establishment
or termination of a plan
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23. General ND Test –
Nondiscriminatory Amendments
Example:
► Plan A is a defined benefit plan that covered both
HCEs and NHCEs for most of its existence. The
employer decides to wind up the business. In the
processing of ceasing operations of the business,
but at a time when Plan A covers only HCEs, the
plan is amended to increase benefits and is
thereafter terminated.
► The timing of this plan amendment has the effect
of discriminating significantly in favor of HCEs.
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24. ADP and ACP Tests
ADP test requires that the deferral of income into the 401(k)
plan by eligible HCEs be proportional to that for eligible
NHCEs
ACP test requires that the employee and matching
contributions provided for eligible HCEs be proportional to
those for eligible NHCEs
Contributions generally counted:
ADP Test ACP Test
Pre-tax contributions and
Roth contributions
Matching contributions and
after-tax contributions
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25. ADP Test – Meet One of Two
Requirements
ADP test is met if the plan meets one of
the following requirements:
► The ADP for eligible HCEs does not exceed
125% of the ADP for eligible NHCEs or
► The ADP for eligible HCEs:
- does not exceed 200% of the ADP for eligible
NHCEs and
- does not exceed the ADP for eligible NHCEs plus
2%
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26. ADP Test – Example
ADP for HCEs = 5%; ADP for NHCEs =
3%
► Plan does not meet 125% test, since 5% is
more than 3.75% (3% x 1.25)
► Plan does meet 200%/2% test, since 5% is
less than 6% (3% x 2.00) and 5% is not more
than 5% (3% + 2%)
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27. ACP Test – Meet One of Two
Requirements
ACP test is met if the plan meets one of
the following requirements:
► The ACP for eligible HCEs does not exceed
125% of the ACP for eligible NHCEs or
► The ACP for eligible HCEs:
- does not exceed 200% of the ACP for eligible
NHCEs and
- does not exceed the ACP for eligible NHCEs plus
2%
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28. Top-Heavy Test
Designed to ensure that lower paid
employees receive at least a minimum
benefit when a disproportionate amount of
the plan’s assets are held for the benefit of
highly compensated individuals known as
“key employees”
In general, a plan is top heavy if, as of the
last day of the preceding plan year, 60% of
the aggregate accrued benefits or account
balances under the plan are for the benefit of
key employees
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29. Top-Heavy Test –
Key Employee Definition
Generally, a key employee is an employee
who, at any time during the plan year, is
► an officer of the employer having an annual
compensation greater than $170,000,
► a 5% owner of the employer, or
► a 1% owner of the employer having an annual
compensation from the employer of more than
$150,000
For purposes of the above definition of key
employee, no more than 50 employees (or, if
less, the greater of 3 or 10% of employees)
will be treated as officers
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30. Health & Welfare Plans
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31. Health & Welfare Plan Eligibility
A plan may impose any eligibility conditions
► For example, based on job title, location, exempt/non-
exempt, department, division, union/non-union,
internship/regular
► Subject to:
- IRC Sections 125, 105(h), 129, and 79 testing with respect to
discrimination in favor of highly compensated employees
- Employment discrimination laws
- For “large employers,” Affordable Care Act’s employer shared
responsibility provisions (“play or pay penalties”)
► Plan terms must be definite as to which employees
are eligible
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32. Employers Subject to ACA’s Play or
Pay Provisions
“Applicable large employers” are subject to play or pay
An applicable large employer for a calendar year is an employer that
had an average of at least 50 full-time employees (taking into account
full-time equivalents) on business days during the preceding calendar
year
► Special rule for new employers
► Seasonal worker exception
► Transition relief for 2015 applicable large employer determination
Applies to all common law employers including government entities,
tax-exempt entities and churches
Entities treated as a single employer under the qualified retirement
plan rules are treated as a single employer for determining whether
related entities constitute an applicable large employer
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33. Basic Structure of ACA’s
Play or Pay Penalties
Beginning 1/1/2015, a play or pay penalty may apply if at least one full-time
employee receives subsidized exchange coverage:
No Minimum Essential Coverage Offered
(“No MEC”)
Insufficient Minimum Essential
Coverage Offered
(“Insufficient MEC”)
Employer fails to offer to substantially all
of its full‐time employees (and their
dependents) the opportunity to enroll in
minimum essential coverage
Employer’s offer of minimum essential
coverage to full‐time employees (and
their dependents) is unaffordable or
does not provide minimum value
Penalty (for a month) equals the number
of full‐time employees (reduced by 30)
multiplied by 1/12th of $2,000 (indexed)
Penalty (for a month) equals the
number of full‐time employees who
receive subsidized exchange coverage
multiplied by 1/12th of $3,000
(indexed); or, if less, the penalty that
would have been imposed for No MEC
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34. Substantially All
Full-Time Employees
Offer must be to substantially all full-time
employees:
► Must offer to cover all but 5%* of full-time
employees to avoid No MEC penalty
► If any of the 5%* employees receives subsidized
exchange coverage, the Insufficient MEC
penalty applies
* 2015 transition rule – 30% instead of 5%
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35. What Employees to Consider:
Common Law Employees
“Employee” for purposes of the play or pay mandate means common
law employee
► An individual performing services for you is your common law
employee if you have the right to control and direct not only the result
to be accomplished, but also the details and means by which the
result is accomplished
► Individuals that you may not consider to be “employees,” such as
temporary workers, contractors, and consultants, may be considered
your common law employees
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36. How is Full-Time
Status Determined?
An employee is considered a full-time employee if he/she
worked an average of at least 30 hours of service per week
(or 130 hours of service per month)
Hours of services that must be included:
► Each hour for which an employee is paid, or entitled to
payment, for the performance of duties for any member of the
controlled group or affiliated service group
► Each hour for which an employee is paid, or entitled to
payment on account of a period of time which no duties are
performed due to vacation, holiday, illness, incapacity
(including disability), layoff, jury duty, military duty, or leave of
absence
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37. Counting Hours
For hourly employees, actual hours must be counted
For non-hourly (i.e., salaried) employees, employers
may count actual hours or use the following
equivalency methods:
► Days-worked equivalency – employee is credited
with 8 hours of service for each day with an hour of
service
► Weeks-worked equivalency – employee is credited
with 40 hours of service for each week with an hour
of service
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38. When Should Full-Time
Status be Determined?
ACA requires an employer to determine whether
each employee is a full-time employee on a month-
by-month basis in real time – this creates
administrative challenges, especially with respect to
variable hour employees
The IRS provided a “look-back safe harbor method”
under which an employee’s full-time or part-time
status can be locked-in for a period of time
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39. Look-Back Safe Harbor:
Ongoing Employees
Standard Measurement Period - employer determines each
ongoing employee’s full-time status by tracking the employee’s
hours during a standard measurement period of between 3 and
12 months
Administrative Period - optional period of no more than 90 days
between measurement and stability periods to count hours and
hold open enrollment
Stability Period - ongoing employees retain their status as full-
time or part-time employees based on hours in standard
measurement period
- Employees determined to be full-time – the stability period must
be the greater of at least 6 consecutive months or the length of
the standard measurement period*
- Employees determined to be part-time – the stability period must
be no longer than the standard measurement period
* Special 2015 transition rule – 6 month measurement period may be used with longer stability period
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40. Look-Back Safe Harbor:
New Full-Time Employees
“New full-time employees” means new hires who are
reasonably expected on their start date to be employed on
average 30 hours or more per week (and who are not
seasonal employees)
An employer that offers coverage to a new full-time
employee at or before the conclusion of the employee’s
initial 3 full calendar months of employment will not be
subject to a penalty
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41. Look-Back Safe Harbor:
New Variable Hour and
Seasonal Employees
“Variable hour employee” means an employee who the employer cannot
determine, at the start date, is reasonably expected to work at least 30
hours per week during the initial measurement period because the
employee’s hours are expected to vary or are otherwise uncertain
► The employer cannot take into account the fact that the employee is likely to
terminate before the end of the initial measurement period in connection with
the analysis (except for seasonal employees)
“Seasonal employee” means an employee in a position for which the
customary annual employment is 6 months or less
► “Customary” means that by the nature of the position the employee typically
works for a period of 6 months or less, and that period begins each calendar
year in approximately the same part of the year
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42. Look-Back Safe Harbor:
New Variable Hour and
Seasonal Employees
Initial Measurement Period - employer determines each variable hour
and seasonal employee’s full-time status by tracking the employee’s
hours during an initial measurement period of between 3 and 12 months
► Begins on the employee’s start date or any date up to and including
the first day of the first calendar month following the employee’s start
date
Administrative Period - optional period of no more than 90 days between
measurement and stability periods to count hours and hold open
enrollment
► Initial measurement period and administrative period together cannot
extend beyond the last day of the first calendar month beginning on
or after the first anniversary of the employee’s start date
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43. Stability Period – new variable hour and seasonal employees retain their
status as full-time or part-time employees based on hours in initial
measurement period
► Must be the same length as the stability period for ongoing employees
► If a new variable hour employee or seasonal employee is determined to be
full-time during the employee’s initial measurement period, then the stability
period must be a period of at least 6 months and no shorter than the initial
measurement period
► If the new variable hour employee or seasonal employee is determined to be
part-time during the initial measurement period, then the stability period must
not exceed more than one month longer than the initial measurement period
and may not exceed the remainder of the standard measurement period
(plus associated administrative period) in which the initial measurement
period ends
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Look-Back Safe Harbor:
New Variable Hour and
Seasonal Employees

44. Look-Back Safe Harbor Periods
Measurement periods, administrative periods, and stability
periods may differ in length or in their starting and ending dates
for the following categories of employees:
► Collectively-bargained employees and noncollectively-
bargained employees
► Each group of collectively-bargained employees covered by a
separate collective bargaining agreement
► Salaried employees and hourly employees
► Employees whose primary places of employment are in
different states
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45. H&W Nondiscrimination Testing
Like the 401(k) plan nondiscrimination tests, H&W
nondiscrimination tests are intended to prevent
discrimination against non-highly compensated
individuals
When determining (or making changes to) H&W plan
design, thought should be given as to how the plan
design will affect nondiscrimination testing
Unlike the 401(k) plan nondiscrimination tests, no special
exclusions for governmental or church plans
The standards for determining who is “highly
compensated” vary based on which test is being applied
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46. Rules Governing
H&W Nondiscrimination Testing
IRC Section 125
► Applies to cafeteria plans
IRC Section 105(h)
► Applies to “self-insured medical
reimbursement plans,” including:
- Self-insured medical, dental and vision plans
- Health reimbursement arrangements
- Health care flexible spending accounts
► Traditionally, has not applied to fully-insured
plans
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47. Rules Governing
H&W Nondiscrimination Testing
IRC Section 129
► Applies to dependent care benefits, including
dependent care flexible spending accounts
IRC Section 79
► Applies to group term life insurance
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48. ACA Rules Regarding
Fully-Insured Plans
Traditionally, fully-insured plans were not
subject to nondiscrimination testing, other
than indirectly when such benefits were
provided pursuant to a cafeteria plan
The ACA provides that fully-insured “group
health plans” must satisfy rules similar to
those described in IRC Section 105(h)
Enforcement postponed until after regulations
or other administrative guidance has been
issued
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49. Current State of
H&W Nondiscrimination Testing
H&W nondiscrimination testing is generally
considered difficult to administer:
► Regulations under IRC Section 125 proposed in
2007, but never finalized
► Cross referencing of tests designed for other
purposes
► General ambiguity as to how tests should be
applied
Practitioners expect that the ACA regulations
for fully-insured plans will clarify the existing
H&W nondiscrimination rules
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50. General Focus of
H&W Nondiscrimination Testing
Tests generally focus on:
► Which employees are eligible to participate in the
plan
► What conditions employees must meet in order to
participate in the plan
► What type of benefits are made available to
employees under the plan
► Which employees actually receive benefits under
the plan
► What amount of benefits employees receive
under the plan
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51. Plan Designs Warranting
Additional Caution
Separate cafeteria plans for different groups of
employees
Disparate eligibility requirements for different groups of
employees
Disparate waiting periods or entry dates for different
groups of employees
Disparate contributions or rates for different groups of
employees
Exclusion of part-time, seasonal or temporary
employees
Exclusion of employees based on division or company
within the controlled group
Benefits based on years of service or compensation
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