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Treasury, IRS Seek to Peel Back 'One Bad Apple' Rule

Regulatory Compliance

The Treasury and IRS have proposed regulations designed to encourage adoption of multiple employer plans (MEPs)  – though they’re not final yet.

Specifically, the proposed regulations would provide an exception to the “one bad apple” rule for certain MEPs. A MEP is a plan adopted by two or more employers that are not part of a controlled group or an affiliate service group.

A MEP is generally treated as a single plan – referred to in the proposed regulations as the unified plan rule (there are some limited exceptions, such as coverage and nondiscrimination tests, where individual plan conditions still apply). This unified plan rule is the basis for existing regulations (Treas. Reg. §1.413-2(a)(3)(iv)) which state that the failure of one employer to satisfy a qualification requirement will result in the disqualification of the entire plan – a result that many have come to call the “one bad apple” rule.

The proposed regulations were issued in response to President Trump’s Aug. 31, 2018, Executive Order 13847, which directed the Secretary of the Treasury to, among other initiatives, consider proposing guidance regarding the one bad apple rule. The rule is often cited as a reason why some employers are reluctant to join a MEP.

In general, the proposed regulations require a MEP satisfy the following conditions to be eligible for relief from the consequences of a “bad apple”:

  • The MEP/plan administrator must have established practices and procedures to promote compliance and to implement the other requirements of the proposed regulations (and the plan document must contain relevant language, which the IRS will provide).
  • The MEP/plan administrator must notify the participating employer, within prescribed time frames, about the failure or potential failure and provide an opportunity for the participating employer to take remedial action.
  • If the participating employer responsible for the shortcoming fails to take appropriate action (which could include an employer initiated spinoff from the MEP), then the MEP/plan administrator must spin off and terminate the portion of the MEP attributable to the participating employer.
  • The MEP/plan administrator must report the spinoff or spinoff-termination to the IRS and cooperate with any IRS requests for additional information (one might well expect the mandatory reporting of the bad act to the IRS to serve as a deterrent to an otherwise unresponsive participating employer).

As it turns out, the proposed regulations are consistent with the MEP provisions of both the SECURE Act and the Retirement Enhancement and Savings Act (RESA). Those bills also provide an exception to the “one bad apple” rule for MEPs where employers have commonality of interest, certain “open” MEPs (where there is no commonality of interest), and any other MEPs as prescribed by the Secretary of the Treasury.   

While there will doubtless be enthusiasm (and promotion of the MEP concept), it’s important to note that the regulations cannot be relied upon until they are finalized. Note also that under the proposal, only defined contribution MEPs would be exempt from the “one bad apple” rule. Furthermore, the qualification failure, or potential qualification failure, must be solely due to the action of a participating employer (i.e., the relief is not available if the qualification failure is due to actions or lack of appropriate action by the MEP sponsor or administrator).

As a matter of policy, the proposed regulations will receive support from the practitioner community. As the saying goes, however, the devil is in the details. The American Retirement Association expects to submit comments on the proposed regulations, which are due by Oct. 1, 2019.

Look for updates in upcoming NAPA webcasts.