Fully invested plans can sometimes run short of cash due to unexpected distributions and other required payments. The DOL has now made it a little easier for an employer to make a short-term, interest-free loan to address those short-term needs without having that loan result in a prohibited transaction.

The new guidance released on April 7, 2006 by the Employee Benefit Security Administration (EBSA) updates a prior prohibited transaction class exemption (PTE 80-26) for interest-free loans from an employer to its plan. The modification removes the previous 3-day loan limit for loans made for purposes incidental to the plan’s ordinary operation.

Such loans may now be subject to a longer limit set by the PTE. For interest-free loans of 60 days or more, these must be in writing.

All of this should make it much easier for plan sponsors to meet short-term cash needs of a plan experiencing a temporary liquidity problem. Typically, these issues arise when distributions or insurance premiums are due for which there is no immediately available cash.

In general, both ERISA and the Internal Revenue Code prohibit most transactions between a “party-in-interest” and an employee benefit plan. Thus, a prohibited transaction arises for the “lending of money or other extension of credit between the plan and a party-in-interest and the … transfer to or use by or for the benefit of a party-in-interest any assets of the plan.” ERISA § 3(14) classifies the plan sponsor, a plan fiduciary, and a service provider as a party-in-interest.

An exemption from this consequence is available for the temporary loaning of cash to a plan under Prohibited Transaction Exemption 80-26. That PTE 80-26 exemption is available when four conditions are met:
	1.	No interest or other fee is charged to the plan in connection with the loan or extension of credit;
	2.	The proceeds of the loan are used only for the payment of ordinary operating expenses of the plan, including the payment of benefits and periodic premiums under an insurance contract or for purposes that are incidental to the ordinary operation of the plan, and provided the loan does not exist for a period of more than three business days;
	3.	The loan or extension of credit is unsecured; and
	4.	The loan is not directly or indirectly made by an employee benefit plan.

The requirement on documenting the temporary loan in writing is effective for transactions entered into on or after April 7, 2006 for loans to pay ordinary operating expenses and for loans that are incidental to the operation of the plan entered into on or after December 15, 2004. Thus, the PTE may be used to correct short-term loans for expenses incidental to the operation of the plan made after the December 15, 2004 date. The updated PTE includes a provision clarifying that the exemption under this PTE is not available for loans enabling an employee stock ownership plan (ESOP) to acquire employer securities.

While the revised PTE permits certain interest-free loans, the plan document must also permit the loan. If the document now contains the 3-day limit on loans incidental to the operation of the plan, that provision must be amended before a longer loan for such purposes would be permitted. In addition, the loan will need to be identified on Form 5500.

Much of the compliance testing associated with 401(k) plans results in calculations that can be carried out to four or more decimal places. One such calculation can involve the determination of whether an employer is in the employer’s top 20 percent highly compensated employee (HCE) calculation. Under that determination only HCEs who constitute the top 20 percent of the employer’s work force are treated as meeting the Code’s compensation definition to be classified as an HCE. Decimal rounding can matter in this calculation.

For instance, is 20 percent of 82 employees 16 or 17 employees? In some plans the decision on how to round 16.4 percent will make the difference between whether a plan passes or fails the ADP testing. As background, an HCE is any employee who performs services during the determination year and falls into one of two categories: (1) During the current or look-back year the employee owns more than five percent of the company, or (2) in the lookback year, the employee’s compensation was in excess of $95,000 (in 2006, one looks back to 2005).

As to this second calculation, the employer may limit the employees included in this determination to only the employees who constitute the top 20 percent of the employer’s work force after omitting certain employees.

In making the 20 percent calculation, Treas. Reg. 1.414(q)-1T, A-3(b) allows the plan administrator to apply any reasonable rounding and tie-breaking rules. These regulations imply that the employer should “adopt” the rules that it applies for its “rounding calculations (e.g., in determining the number of employees in the top-paid group).” The plan administrator may also “adopt a rule breaking ties among two or more employees (e.g., in identifying those particular employees who are in the top-paid group…).” Those rules should be reasonable, nondiscriminatory, and uniformly and consistently applied.

So, in the above case, the employer could adopt a rule to round down to the nearest unit, then only 16 employees would constitute the top 20 percent of the employers for this testing.