Seyfarth Synopsis: A recently published IRS memorandum provides that employees of a single-member LLC treated as a disregarded entity must be allowed to participate in a section 403(b) plan sponsored by its parent 501(c)(3) tax-exempt organization. The LLC may also be allowed to participate in a 457(b) plan sponsored by such a parent.

New IRS guidance holds that employees of a single-member LLC treated as a disregarded entity of a section 501(c)(3) tax-exempt organization must be allowed to participate in a 403(b) plan sponsored by the 501(c)(3) organization if the plan permits elective deferrals. The IRS reasoned that a disregarded entity is treated as a branch of the member organization. Thus, where the sole member of the disregarded single-member LLC is a 501(c)(3) tax-exempt entity that maintains a 403(b) retirement plan for its own employees, it must also allow employees of the disregarded entity to make elective deferrals under the “universal availability” rule under section 403(b) (unless the LLC employees are covered under another cash or deferred arrangement of the entity).

Similarly, the IRS stated that employees of a single-member LLC treated as a disregarded entity of a tax-exempt organization are permitted to participate in a section 457(b) plan sponsored by the member organization. Because section 457(b) plans are not subject to the same universal availability rules as section 403(b) plans, participation of the LLC employees in a section 457(b) plan is not required.

What does the new memorandum mean for tax-exempt employers who maintain a 403(b) plan providing for elective deferrals and also have employees in a single-member LLC? Memoranda are not formal guidance, but they do provide insight as to the IRS’ perspective. IRS regulations under section 403(b) currently provide that a “subsidiary or affiliate” of an eligible employer must itself qualify as an eligible employer itself (i.e., be a tax-exempt entity) to maintain a 403(b) plan. Based on this regulation, many tax-exempt employers have taken the position that employees of a single-member LLC treated as a disregarded entity could not participate in its parent’s 403(b) plan. In the memorandum, the IRS has “clarified” that a single-member LLC should be viewed as a branch of its parent organization, rather than as a “subsidiary or affiliate” for 403(b) purposes. Under this guidance, most tax-exempt employers will want to review and amend their 403(b) plans to take into account employees of a single-member disregarded entity in order to assure compliance with section 403(b)’s universal availability rule.

The IRS has yet to address whether the memorandum’s interpretation will be enforced retroactively. If the memorandum applies retroactively, it is possible that further corrective action may be required with respect to plans that have violated the universal availability requirement by omitting employees of a single-member LLC treated as a disregarded entity who are not otherwise covered by another cash or deferred arrangement.