UPDATED – Did COVID-19 Layoffs Trigger a Partial 401(k) Plan Termination? by Melissa Fleitas, CPA
The Consolidations Appropriations Act of 2021, signed into law on Dec. 27, 2020, provides 401(k) sponsors with welcome relief from partial plan terminations that may have otherwise occurred in the wake of COVID-19-related workforce reductions.
Background
Under longstanding IRS rules, businesses that lay off 20 percent or more of employees covered by a defined-contribution plan in a particular plan year can trigger unintended partial plan terminations that would require fully vesting workers whose employment was severed during that period. In other words, plan sponsors that let go of more than 20 percent of their workforce due to downsizing or adverse economic conditions would be required to pay 100 percent of the employer-match and profit-sharing contributions promised to plan participants terminated during the applicable period, regardless of the plan’s vesting schedule or the employees’ actual years of service. Failure to meet this requirement would endanger the 401(k) plan’s tax-exempt status and put the plan sponsor at risk of significant tax penalties and legal claims.
Relief
The recent, $900 billion stimulus package addresses partial plan terminations by providing a temporary exemption for employers whose active participants covered by the plan on March 31, 2021, is at least 80 percent of the number of active participants covered by the plan on March 13, 2020. Essentially, this relief gives employers three months to rehire or replace workers terminated during the pandemic without triggering a partial plan termination. However, it is critical that employers recognize that active participant count is based on the number of employees who are eligible to participate in the defined contribution plan as of March 31, 2021. Employers should review the eligibility provisions of their plans to determine if employees hired during the covered period are, in fact, eligible as of March 31, 2020, and March 31, 2021.
To calculate a plan’s turnover rate, the plan sponsor must divide the total number of employees involuntarily terminated during the applicable period by the sum of 1) all employees who were eligible to contribute to the 401(k) plan since the start of the plan year, plus 2) employees who became eligible to participate in the plan during the applicable period. All employees include every worker who qualifies to contribute to the employer-sponsored plan during an applicable year regardless of the plan’s vesting status or the employees’ history of making prior salary-deferred contributions to that plan.
Generally excluded from the turnover rate calculation are workers who leave a company voluntarily to retire or pursue jobs with other employers as well as workers who are temporarily furloughed and rehired before the end of the plan year or other applicable period.
While the Consolidations Appropriations Act provides welcome relief to businesses struggling to survive the impact of the pandemic, plan sponsors should still make a point to regularly assess their staffing levels and determine if layoffs that occurred earlier in the year caused a partial plan termination and a potential requirement to fully vest those former employees. For example, employers would need to decide 1) if they can rehire workers before the end of the applicable period and avoid a partial plan termination or 2) if they have a duty to fully vest those former employees and immediately pay them any remaining unvested funds plus earnings that may have accumulated since the employees’ termination dates.
About the Author: Melissa Fleitas, CPA, is an associate director of Audit and Attest Services with Berkowitz Pollack Brant Advisors + CPAs, where she provides accounting, auditing and consulting services to a wide range of companies in the healthcare, manufacturing and distribution sectors. She can be reached at the firm’s Miami office at (305) 379-7000 or help@bpbcpa.com.
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