<img alt="" src="https://secure.intelligentdatawisdom.com/782204.png" style="display:none;">

ESOP Technical Alert provides a reminder of a potential side effect of layoffs – a partial plan termination:

In general, under the IRS's current guidelines updated in 2007, when there is a reduction in the number of active participants in your plan as a result of a corporate action (such as a layoff or the closure of a division) which involves more than 20 percent of the participant population in a given year, you will likely have a partial termination of your plan. The primary result is that all affected participants must be treated as fully vested in their accounts. That will result in an unplanned liability for the company, but more importantly, if you have a partial termination and you fail to treat participants appropriately, that could threaten the qualification of your plan.

There are numerous technical articles about this issue out there, so I won't go into the details here, but please take our strong suggestion: When you are laying off any material number of employees, you ought to have this issue investigated by someone who knows enough to advise you as to whether the layoff creates a partial termination and how you should treat the effected participants if it does. Of course, this provision should not change the right business decision, but you should be fully aware of the implications before it is set in stone.

IRS Sets New Standard Regarding "Partial Plan Termination" of Tax-Qualified Retirement Plans discusses the consequences of failing to treat a plan as having a partial plan termination. It also notes that the determination of plan termination is based on "facts and circumstances" and not a set formula:

There is no magical figure at which a partial termination is deemed to occur and, prior to the release of IRS Revenue Ruling 2007-43, the exact level at which it becomes determinative of the issue was somewhat ill defined. Notably, several cases had held that a percentage drop in plan participation standing alone may be sufficiently large (i.e., generally greater than 40 percent) or small (i.e., generally less than ten percent) to determine the partial termination question without the need for any further inquiry into the facts. Between these two extremes, although the surrounding facts and circumstances had been considered in conjunction with the percentage drop in order to decide whether the percentage drop was significant, the primary focus of the determination still had been on the percentage drop in plan participants. In this regard, the IRS, in an amicus curiae brief filed in connection with a court case addressing the partial termination issue, suggested that a tax-qualified retirement plan will generally be deemed partially terminated if at least 20 percent of the plan's participants lose coverage. From this brief and the preceding and subsequent case law, a "semi-bright line" test had developed that a percentage drop of at least 20 percent was sufficient to result in a partial plan termination.

In fact, in a very highly publicized decision in 2004, the Seventh Circuit Court of Appeals, in Matz v. Household International Tax Reduction Investment Plan, held that there is a "rebuttable presumption" that a 20 percent or greater reduction in a plan's participants is a partial termination and that a smaller reduction is not.

In IRS Revenue Ruling 2007-43, the IRS has adopted the Matz 20 percent presumption test. Thus, if the turnover rate is at least 20 percent, there is a "presumption" that a partial termination of the plan has occurred. However, the IRS notes that whether or not a partial termination occurs on account of participant turnover is still ultimately dependent on all of the facts and circumstances in a particular case. Facts and circumstances indicating that the turnover rate for an applicable period is "routine" for the employer, favor a finding that there is no partial termination for that period. For this purpose, information as to the turnover rate in other periods and the extent to which terminated employees were actually replaced, whether the new employees performed the same functions, had the same job classification or title and received comparable compensation, are relevant to determining whether the turnover is routine for the employer.

It also discusses defining the class of affected employees, counting of vested participants, and the relevant determination time period. IRS Revenue Ruling 2007-43 is discussed in IRS Issues Partial Termination Guidance.

Subscribe Now

OTHER ARTICLES FOR YOU