Partial Plan Terminations & their Impact on ESOP Companies in a Difficult Economy

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Evelyn Parrish
5 years ago
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1 W W W. S E S A D V I S O R S. C O M Partial Plan Terminations & their Impact on ESOP Companies in a Difficult Economy Written by Brian Wurpts

2 The economic environment over the last eighteen months has had a negative impact on many ESOP companies. Reduced earnings, lower valuations, and tight credit markets have been a challenge. But there is a less obvious complication for ESOP companies in these challenging economic times: partial plan terminations. When we discuss plan terminations, we are usually referring to a unilateral decision made by a company s board of directors. When a plan is terminated, plan participants become fully vested, the assets of the trust are liquidated and benefits are distributed. Partial terminations, by contrast, are more often the result of unrelated business decisions or events, such as the sale of a division, a layoff or early retirement offers. These events are more common during a recession, and often lead to unintended consequences for an ESOP company. Partial terminations cause the accounts of affected participants to vest immediately. This increases the ESOP sponsor s repurchase obligation, typically at a very unfavorable time. Therefore it is important for employers to be aware of the criteria used to evaluate whether a partial termination has occurred.

3 Types and Causes of Partial Terminations Partial termination may be caused by a plan amendment that causes a significant reduction in benefits, discontinuance of contributions, reversion of plan assets to the employer, or significant reduction in the number or percentage of plan participants. This last category of termination is often the result of a layoff, sale, or closing of a division or business location, but may also occur when the employer experiences an unusually high employee turnover rate.

4 Determination Criteria The determination of whether a partial termination has occurred is based on a facts and circumstances analysis. However, the Internal Revenue Service (IRS) provided some guidance through Internal Revenue Procedure : If the turnover rate is at least 20 percent, there is a presumption that a partial termination of the plan has occurred. Whether or not a partial termination occurs on account of participant turnover (and the time of such event) depends on all 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 applicable 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.

5 Determination Criteria (con t.) Turnover rate is evaluated based on the number of participants who had an employerinitiated termination of employment during a particular plan year. In determining whether a partial plan termination has occurred, employers may disregard the termination of participants who left voluntarily. Employers should have good documentation supporting the circumstances of an employee s termination (e.g., a copy of a resignation letter). While certain employees may be excluded in the determination calculation, once a partial termination is determined to have occurred, Rev. Proc states that all participants who terminated during the period are fully vested (regardless of their reasons for leaving). Other facts and circumstances that may affect the evaluation include: documentation describing a reduction in force or layoff; offers of severance pay or early retirement; grouped employment termination dates; sale, relocation, or closure of a business location; and whether terminated participants were replaced by employees with the same function. Examples of mitigating circumstances include a high turnover rate in the employer s industry, an absence of patterns in employer-initiated severance and evidence of participants decisions to terminate voluntarily.

6 Partial Terminations and Distribution Policy Partial terminations affect an ESOP sponsor s repurchase obligation. However, the impact on the timing of the repurchase obligation depends on the plan s distribution policy. Total plan terminations generally require that the plan s assets be distributed within a year of the decision to terminate. Partial plan terminations pay benefits under the plan s normal policy for terminated participants. For example, if the plan s distribution policy calls for five annual installments of benefits beginning after the close of the fifth plan year after an employee terminates, participants affected by the partial termination are paid under the same schedule. When a partial plan termination is imminent, an ESOP sponsor should revisit its distribution policies. It may be possible to lessen the impact of the repurchase obligation by modifying the policy.

7 Summary A determination of whether a partial plan termination has occurred depends on several variables. The employer may unilaterally decide that the plan has incurred a partial termination or may appeal to the IRS to make the determination. If an ESOP sponsor is considering a reduction in work force or is experiencing exceptionally high employee turnover, we strongly encourage employers to consult with their counsel and/or their third party administrator. Avoidance or mitigation of a partial termination can have a significant impact on a sponsor s repurchase obligation. In some cases a smaller or postponed reduction in force may have positive implications for the sponsor.

The author is a member of The ESOP Association s Advisory Committee on Administration. The author reviewed this article with Committee Chair, Nancy K.

8 The author is a member of The ESOP Association s Advisory Committee on Administration. The author reviewed this article with Committee Chair, Nancy K. Dittmer, RSM McGladrey Retirement Resources, Des Moines, IA. Reprinted from ESOP REPORT July 2010 The ESOP Association 1726 M Street, N.W., Suite 501, Washington, DC Phone: (202) Fax: (202) Find out if an ESOP is right for your company. Visit to learn more. SES ADVISORS has one of the nation s largest core groups of ESOP professionals, with offices in Pennsylvania, New Jersey, New York, Massachusetts, Rhode Island, Vermont, Florida, Kentucky, Indiana, Virginia and Texas. HEADQUARTERS: 10 Shurs Lane, Suite 102 Philadelphia, PA Consult your advisors for up-to-date legal and tax information. IRS CIRCULAR 230 DISCLOSURE: Pursuant to Treasury Regulations, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used or relied upon by you or any other person, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or(ii) promoting, marketing or recommending to another party any tax advice addressed herein. Please contact a member of the firm if you require a formal, written tax opinion that satisfies applicable IRS requirements.

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