3769 / What is the ‘one bad apple rule’ and why do business owners interested in the MEP structure need to be aware of it?

Prior to 2019, under the “one bad apple rule,” (or “unified plan rule”) the entire MEP could be disqualified based upon the actions of only one employer that participated in the plan—based upon the assumption that the MEP is to be treated a single unified plan.

In 2019, the IRS and Treasury proposed rules that would mitigate the potential impact of the rule.¹ The SECURE Act finalized those rules by eliminating the one bad apple rule in certain situations.²

The SECURE Act provides that if one employer’s actions would disqualify the plan, only that employer’s portion of the MEP will be disqualified. Under the new rules, in the case of one participating employer’s failure to act in accordance with the qualification rules:

(1)  the assets of the plan attributable to employees of the employer will be transferred to a plan maintained only by that employer (or successor), to an eligible retirement plan under Section 402(c)(8)(B) for each person whose account is transferred (unless the Treasury determines that it is in the best interests of the participant for the assets to remain in the plan), and

(2)  the employer (and not the plan in which the failure occurred) will be held liable for any liabilities with respect to such plan attributable to the employees of the employer.³

Under the IRS proposal, to continue as a qualified MEP after a single member-employer has taken action that would otherwise disqualify the entire plan, the plan must have established practices and procedures in place that are designed to ensure compliance with the qualification rules by all MEP participants.

In 2022, the IRS released proposed guidance on the SECURE Act’s elimination of the one bad apple rule.

Essentially, under these rules, the MEP would continue as a qualified plan so long as the qualification failure is isolated to a single employer, rather than a reflection of a widespread issue across the employers participating in the MEP. The plan administrator must have a process in place that will provide notice to the employer responsible for the failure, and such notice, as proposed, would include a description of the failure, actions necessary to remedy the failure, and notice that the relevant employer has only 60 days from the notice date to take remedial action.

The proposed rules provide that the plan may be required to provide up to three notices to a participating employer that does not respond to the initial notice. The final notice must be provided to the DOL and all impacted participants. The non-qualifying employer has two options upon receipt of a notice: (1) take remedial action or (2) initiate a spinoff within 60 days of the final notice. If the employer does neither, the MEP administrator must stop accepting contributions from the non-compliant employer and participants. The MEP must also provide notice to the impacted participants and give them an election with respect to the treatment of their accounts. Participants could elect to remain in the plan or transfer their funds to another retirement plan. The IRS notes that it intends to publish guidance that contains model language for MEP plan administrators.

In addition, the plan must provide a description of the consequences if the noncompliant employer fails to take the remedial action necessary and notice of the plan’s right to spin off the non-compliant employer’s portion of the plan and assets.