Clients Must Treat Layoffs and Furloughs Carefully

The IRS may determine that a ‘partial termination’ of a plan has occurred if a company undergoes sizable layoffs—but not furloughs—potentially impacting vesting schedules and other aspects of plan operations.  

The true economic fallout of the coronavirus pandemic is slowly coming into view, and one of the unfortunate consequences is that millions of Americans have already lost their jobs or been furloughed.

While neither those people who have been terminated outright nor those who have been furloughed are receiving a paycheck, from the employee benefits perspective, there are actually some very important differences between the two situations. First and foremost, attorneys say, retirement plan sponsors should keep in mind that the Internal Revenue Service (IRS) may determine that a partial termination of a plan has occurred if a company undergoes significant layoffs, but not furloughs.

“Companies tend to use the terms interchangeably, which is why it can be confusing,” says Lorie Maring, a partner at Fisher Phillips. “A furlough is not intended to be a permanent separation of work. A company might ask employees to take a week off, or reduce the work week from five days to four, as a way of avoiding a layoff.”

With a layoff, employers may intend for it to be temporary, hoping that they will rehire the workers at some point in the future, Maring says. But, what actually happens will determine whether a partial plan termination is triggered.

The IRS, broadly speaking, views cases where there is a true separation from employment of 20% or more of the employees participating in the retirement plan in a plan year as a partial plan termination, Maring says.

“In a partial termination of a plan,” says Kevin Brown, a partner with McCarter & English’s Employee Benefits and Executive Compensation Practice, “the benefits to the participants being terminated become fully vested. If the company match and profit sharing contributions in the plan were not otherwise vested, in the case of a termination, they would be.”

Maring says that while there is “no bright line test” that the IRS applies to the number of retirement plan participants being terminated, she has generally found it to be 20% or more. However, Brown says, it can be as little as 10%, depending on the facts and circumstance.

Stephen Ferszt, practice group leader for employee benefits at Olshan Frome Wolosky, says, “In determining whether there could be a partial termination of a qualified retirement plan resulting from some form of an employee’s separation from service, the first thing that you need to examine is how the plan counts an employee’s service. Is it counting actual hours of service performance? Is it using an elapsed time method, or some other method? The IRS’s bottom-line decision is based on an analysis of all facts and circumstances.”