Reasonable Classification for Discrimination Testing (Posted March 8, 2003) Technical Tip 91: The following question and answer were from the IRS Q&A Session at the 2001 ASPPA Annual Conference: The average benefits test for coverage testing consists of the nondiscriminatory classification test and the average benefits percentage test. To satisfy one part of the nondiscriminatory classification test, it is necessary to determine if the classifications are reasonable based on objective business criteria. Do participants employed at the end of the plan year constitute a "reasonable classification" under Treasury Regulation 1.410(b)-4(b)? IRS Response: Our opinion is that it is not a reasonable classification. Comment by RLR&C ERISA Attorneys: In order to be a qualified plan, a plan must cover a certain percentage of eligible employees. Most plans satisfy this requirement by passing the ratio percentage test. However, if a plan fails the ratio percentage test, it will need to either: (1) expand its coverage to pass the ratio percentage test or (2) pass the average benefits test. The average benefits test consists of: (1) the nondiscriminatory classification test and (2) the average benefits ratio test. A plan will be deemed to satisfy the nondiscriminatory classification test if it passes the safe harbor percentage test. If a plan does not pass the safe harbor percentage test, it must pass the facts and circumstances test. Under this test, a plan's classification of employees must be reasonable and established under objective business criteria that identify the category of employees who benefit under the plan. Reasonable classifications include job categories (e.g. secretaries), nature of compensation (hourly or salaried) or geographic location. The determination as to whether a classification is reasonable is based on all the facts and circumstances. As indicated by the IRS' response, it does not consider "participants employed at the end of the plan year" to be a reasonable classification. View all Tips © 2012 Reish Luftman Reicher & Cohen, a Professional Corporation Important notice: Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner's situation. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of your situation.