We posed this question in our May Newsletter. Since then the IRS has issued coronavirus-related guidance on partial terminations and provided some relief for plan sponsors but many questions remain. While it still depends on the facts and circumstances for each plan, the new IRS guidance makes it clear that it is likely too early to conclude one way or the other.
Background
As we indicated in May, the Internal Revenue Code (Code) requires all unvested benefits to immediately vest when a (tax-qualified) plan is either terminated or the plan experiences a “partial termination.” Whether or not a partial termination occurs, and the exact point in time the partial termination occurs, is determined based on all the facts and circumstances involved. Under both IRS guidance and applicable case law, a rebuttable presumption that a partial termination occurred is triggered if the number of participating employees in a plan is reduced by 20% or more in an applicable period. Once the turnover rate reaches the 20% threshold, the burden to rebut the presumption of plan termination falls squarely on the plan administrator. If the turnover rate is below 20%, no presumption applies.
Likewise, it is the obligation of the plan administrator to make sure the vesting requirements of the Code are met. On termination or partial termination, the rights of all “affected employees” to benefits accrued to the date of such partial termination, to the extent funded on that date, or the amounts credited to their accounts, must become vested. Failing to comply with the vesting requirements would expose the retirement plan to potential disqualification and loss of tax-exempt status by the IRS. And the plan sponsor could also be subject to participant benefit claims and/or class action litigation.
IRS Update on Partial Terminations
On August 3, 2020, the IRS released its Coronavirus-related relief for retirement plans and IRAs questions and answers (“IRS Release”).¹ It specifically addressed a question on partial termination in Q&A #15.
The IRS provides the question:
"Are employees who participated in a business's qualified retirement plan, then laid off because of COVID-19 and rehired by the end of 2020, treated as having an employer-initiated severance from employment for purposes of determining whether a partial termination of the plan occurred?"
And the IRS answers:
"Generally, no. Subject to the facts and circumstances of each case, participating employees generally are not treated as having an employer-initiated severance from employment for purposes of calculating the turnover rate (defined in Rev. Rul. 2007-43, 2007-28 IRB) used to help determine whether a partial termination has occurred during an applicable period, if they're rehired by the end of that period. That means participating employees terminated due to the COVID-19 pandemic and rehired by the end of 2020 generally would not be treated as having an employer-initiated severance from employment for purposes of determining whether a partial termination of the retirement plan occurred during the 2020 plan year."
Under this guidance, the IRS will not deem a partial termination to have occurred if a plan sponsor is able to rehire terminated employees before the end of 2020. However, the unprecedented circumstances created by the pandemic are much more complicated for plan administrators than simply hiring employees back before the end of 2020. We hope the IRS provides additional clarification on COVID-19 with respect to partial terminations because there are many questions left to be answered.
As we explained in Part I, an applicable period is not necessarily one plan year—it can span across multiple plan years. The IRS Release does mention rehiring before the end of an “applicable period” but in its example the IRS only refers to rehiring “by the end of” 2020. There is uncertainty as to what happens if there hiring takes place in 2021, assuming a vaccine does not allow businesses to ramp up to full capacity until then. The issue of involuntary terminations and how are they to be determined is left to plan administrator to interpret for themselves. For example, it is not clear what happens if employees are extended an offer to return to work before December 31, 2020 but “voluntarily” decide not to accept that offer. Plan sponsors and administrators will need partial termination guidance for COVID-19 situations to help them properly determine whether a termination is involuntary. Otherwise, these decisions should be made with careful consideration and with advice from ERISA counsel.
More Thoughts on Rebutting the Presumption
The plan administrator must show evidence that the turnover rate was not caused by an employer-initiated severance from employment (i.e., severance was voluntary and should not be included in the turnover rate) in order to rebut the presumption of partial termination. The more facts a plan administrator can detail and record within its personnel files to rebut this presumption, the better. Consequently, it is critical for plan administrators to diligently describe and document the underlying reasons for each employee termination that occurs and the circumstances surrounding each termination. This should include notes in personnel files, obtaining employee statements, or documenting the cause of each severance through other corporate records. If applicable, the plan administrator may also provide evidence that the turnover rate is routine, in order to rebut the presumption.
Since a voluntary termination would not be included when calculating the numerator (for the turnover rate) when determining a partial termination, the plan administrator should work to establish a record of facts that supports each voluntary termination. The more facts that a plan administrator can provide when under audit, the less likely the IRS would recast the voluntary termination as an involuntary termination under a constructive discharge theory. The IRS has indicated that an “employer's intent, working conditions and the reasonably foreseeable impact of the employer's conduct on the employees are factors in evaluating a constructive discharge.”²
For example, plan sponsors may have furloughed a significant number of employees and have since tried to reopen by offering these employees their original jobs back. It seems reasonable for a plan sponsor to argue that if an employee has found other employment and rejects a valid offer to return to work, that this instance could—under the right facts and circumstances—be deemed to be a voluntary termination. Given the financial impact of COVID-19, certain plan sponsors have implemented a variety of cost cutting measures that have led to employees leaving, measures that come short of termination.
There are employers that have altruistically tried to lessen the hardship on their employees by offering a salary reduction or reducing the number of hours of work, rather than simply terminating their employment outright. Certainly, there is some possibility that these situations have ultimately resulted in turnover, either because employees may find the circumstances to be unacceptable, or simply found other opportunities to make more money. Whether an employee left his or her employment voluntarily because of fear or an unwillingness to accept lower pay or reduced hours, during a pandemic, will be up to the plan administrator to determine. Depending on the size of the plan, the amount involved, and other circumstances such as a pending sale of the business, the plan administrator may want to seek confirmation from the IRS by filing a Form 5300 and making a partial termination ruling request.
Conclusion
While the IRS has provided some new helpful guidance for employers that rehire employees by the end of 2020, it remains critical for employers to review their plans to determine if a partial termination has occurred and to clearly document and/or record the underlying facts that explain why each employee terminated their employment to accurately determine their turnover rate within the applicable period. Plan sponsors and administrators are encouraged to carefully consider all of the relevant facts and circumstances, with the advice of their ERISA counsel, before deciding whether or not a partial termination has occurred.
¹ https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-answers.
© Boutwell Fay LLP 2020, All Rights Reserved. This handout is for information purposes only and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us. The information contained in this article is effective as of September 2020.