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In this update we briefly review two issues presented by the layoff or furlough of employees in the current Coronavirus crisis – treatment of outstanding plan loans and possible partial termination – and IRS’s extension to July 15, 2020 of certain filing deadlines.
Layoffs/furloughs – plan loans and partial termination rules
Generally, we use “layoff” to mean the termination of an employee not-for-cause and “furlough” to mean the temporary suspension of work and pay for an employee. Either action with respect to an employee-participant may present issues under applicable Internal Revenue Code plan loan and partial termination rules.
Plan loans
The Internal Revenue Code provides that a plan must require “substantially level amortization” of a plan loan over 5 years. For active employees, for whom repayments may be implemented via payroll deduction, administration of these regular loan repayments may be relatively simple.
Administration is more complicated where the employee terminates employment, and 401(k) plans will often provide that the balance of a participant’s loan is due upon termination. If the terminated participant does not thereupon “repay” the loan, then it is typically defaulted and treated as a distribution of the participant’s account balance, subject to current taxation.
In normal times, this treatment is both (relatively) straightforward and reasonable. In the current situation, it may be more problematic. First, because employees terminated in connection with the Coronavirus pandemic and related economic downturn may be experiencing significant current financial distress. And, second, because non-terminated, “furloughed” employees may not be receiving a paycheck from which loan repayments may be deducted.
The CARES Act includes a provision effectively waiving the 5-year repayment/level amortization rule for the remainder of 2020 for individuals who (or whose spouse or dependent) are diagnosed with the disease or who experience adverse financial consequences as a result of, among other things, being furloughed or laid off or having work hours reduced due to the Coronavirus.
Under this rule, sponsors may defer loan repayments for non-terminated, furloughed employees, and postpone defaulting the loans of terminated employees, for the rest of 2020. Indeed, they may defer repayments for any employee who meets the applicable criteria.
As with Coronavirus-related distributions, this loan treatment is not mandatory – nothing in CARES requires it.
Partial terminations
There has also been some concern that a layoff or furlough of a significant group of employees will trigger a partial termination.
Generally, whether a partial termination occurs depends on the facts and circumstances of a particular case. Facts/events that may trigger a PT include: “the exclusion, by reason of a plan amendment or severance by the employer, of a group of employees who have previously been covered by the plan; and plan amendments which adversely affect the rights of employees to vest in benefits under the plan.” (Quoting applicable IRS regulations.) A general rule of thumb is that “there is a rebuttable presumption that a 20 percent or greater reduction in plan participants is a partial termination.”
Thus, a separation from service of a large group of employees may raise the possibility of a PT. A temporary furlough that does not result in a separation from service is less likely to raise that possibility.
The consequences of a PT are relatively mild: (1) the benefits under the plan of affected participants must be fully vested to the extent funded; and (2) a “reportable event” under Pension Benefit Guaranty Corporation regulations occurs, for which notice is generally waived.
Extension of time for IRS filings
Finally, we note that on April 9, 2020, IRS published Notice 2020-23, extending to July 15, 2020, the deadline for a number of required filings otherwise due on or after April 1, 2020 (notably absent was an extension for Annual Funding Notices in defined benefit plans which still need to be postmarked by April 29 (it’s a Leap Year)). Those that affect retirement plans include:
The requirement that plan loans be repaid over a substantially level amortization period. As noted above, this requirement is waived for Coronavirus affected individuals under the CARES Act for the remainder of 2020. IRS’s extension would apply to any repayment (that is, including repayments to be made by individuals who are not affected by the Coronavirus), but only through July 15.
The requirement that required minimum distributions begin as of an April 1 “required beginning date.” We note that, generally, DC plan RMDs for 2020 are waived.
The requirement that certain excess 401(k) contributions be distributed by April 15.
The 60-day rollover deadline.
The Form 5500 filing deadline.
The PBGC “4010 filing,” applicable to certain underfunded plans.
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We will continue to follow these issues.