Employees of a ‘Disregarded Entity’ May Participate in a 501(c)(3)’s 403(b), IRS Says

The IRS in a recently released chief counsel memorandum (CCM) says that employees of a “disregarded entity” are eligible to participate in a 501(c)(3)’s 403(b) plan — and as such they also are subject to the universal availability rule.

In CCM 201634021, which is dated July 11, 2016 (but was released by the IRS on Aug. 19), Deputy Associate Chief Counsel Stephen Tackney of the IRS Tax-Exempt and Government Entities Office of Associate Chief Counsel addresses the following questions:

• whether the employees of a single-member LLC that is a disregarded entity and is not eligible to sponsor a 403(b) plan may participate in the 403(b) of the LLC’s member, a 501(c)(3) organization tax-exempt organization;

• whether the universal availability rule described in Treas. Reg. §1.403(b)-5(b)(1) applies to the employees of the single-member LLC disregarded entity; and

• whether the employees of the single-member LLC disregarded entity may participate in the 457(b) plan of its tax-exempt organization member.

In the CCM, the IRS concludes that:

• the employees of a single-member LLC disregarded entity may participate in the 403(b) plan of the 501(c)(3) organization member;

• the employees of the single-member LLC disregarded entity must be allowed to participate to the extent necessary to comply with the universal availability requirement; and

• because no universal availability requirement exists under Internal Revenue Code Section 457, the employees of the single-member LLC disregarded entity are not required to participate in the 457(b) plan, but may be permitted to do so.

The IRS explains that an LLC with a single owner may elect to be classified as an association (and thus a corporation) or to be disregarded as an entity separate from its owner in accordance with the default classification rules. And it adds that a disregarded entity’s activities are treated in the same manner as a sole proprietorship, branch or division of the owner.

Also, says the IRS in the CCM, a disregarded entity is treated as a branch or division of the 501(c)(3) organization that is the plan sponsor and not as a subsidiary or affiliate — and, therefore, the employees of a disregarded entity are treated as employees of the 501(c)(3) organization member for purposes of Code Section 403(b).

As employees of a branch or division of the 501(c)(3), the IRS says, not only are such
individuals eligible to participate in the organization member’s 403(b), they also are covered by the universal availability requirement under Treas. Reg. §1.403(b)-5(b). This means, the IRS says, that the 501(c)(3) organization must permit all employees — including those of the disregarded entity — to make elective deferrals if any employee of the 501(c)(3) is allowed to do so unless the employee falls under a specific exception from the universal availability requirement.

A similar analysis applies to a single-member LLC disregarded entity whose member
sponsors a 457(b) plan, the IRS notes, except that a 457(b) plan may be sponsored by a governmental entity or any entity exempt from tax under Code Section 501(a).

Note that CCMs are expressions of the IRS’ view on specific matters and are not formal IRS guidance, nor are they regulations and are not broadly applicable and do not require compliance. Nonetheless, CCMs do provide an indication of the IRS’ thinking on the issues they address and therefore merit the attention of parties involved in such activities.