Business Owners: Beware of an Involuntary Partial Plan Termination Due to COVID-19
























Episode 116 – 2020 was undoubtedly a very difficult year for many small-business owners struggling to keep their businesses afloat while their businesses were forced to close or limit operations as a result of government mandates attempting to slow or stop the spread of the coronavirus. That resulted in the layoff of many employees. Many of those layoffs were anticipated to be temporary, but as the pandemic continued into 2021, additional complications for small businesses have arisen.
One of those complications involves businesses that have a defined contribution retirement plan (“plan”), such as a 401(k) plan, in place for the benefit of employees, and the potential for a “partial plan termination” which can cause even greater financial hardship to a business. When a partial plan termination occurs, the law requires that affected plan participants become fully vested in their plan benefits, including employer matching contributions and profit-sharing contributions. That’s true even if there is a vesting schedule that hasn’t yet been fulfilled by the affected employees. The failure to comply with this rule has harsh consequences. The plan can be disqualified, resulting in the loss of all tax benefits to the employer and the plan participants.
Although the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 as amended (better known as ERISA), don’t define what constitutes a partial plan termination, the IRS in guidance1 has interpreted it to mean that there has been a 20 percent or greater reduction in plan participation over an applicable period, which is typically the plan year. Also, a reduction in plan participation must be due to “employer-initiated” terminations, which would be terminations other than from death, disability or retirement. The IRS acknowledges that an employer-initiated termination would include events outside the employer’s control, such as depressed economic conditions. Clearly, if employees were laid off because of the pandemic, those terminations would be employer-initiated, resulting in lower plan participation and potentially causing a partial plan termination.
On July 30, 2020, the IRS issued guidance that employees laid off due to the pandemic, and rehired by the end of 2020, were not to be counted for purposes of partial plan termination requirements.2 Since we’re now into 2021, that guidance is not very helpful. However, the Consolidated Appropriations Act, 2021 (“CAA, 2021”) was signed into law on December 27, 2020. Division EE of the CAA, 2021 is more popularly known as the Taxpayer Certainty and Disaster Relief Act of 2020 (“TCDRA”). Section 209 of the TCDRA contains a temporary rule that provides a plan will not be treated as having had a partial plan termination during a plan year which includes the period beginning March 13, 2020, and ending March 31, 2021, if the number of active participants in the plan covered on March 31, 2021, is at least 80 percent of the number on March 13, 2020. In other words, Section 209 of the TCDRA provides employers until March 31, 2021, to rehire enough employees to avoid partial plan termination status.
While that provision is helpful, the question remains as to whether the TCDRA goes far enough, since the pandemic continues and does not appear that it will abate by March 31. Perhaps the new Presidential Administration and Congress will renew this pandemic-related relief further into 2021 to avoid unintended terminations of retirement plans.