Partial Plan Termination Impact on ESOPs

| 3/26/2020
Partial Plan Termination Impact on ESOPs

COVID-19’s potential impact on ESOP plan termination

In this unprecedented and uncertain time, questions abound about the impact of staff reductions on various aspects of employee stock ownership plans (ESOPs).

What triggers a partial plan termination?

The most substantial effect of significant staff reductions can be the triggering of what is known as a partial plan termination. This trigger generally occurs when more than 20% of plan participants are involuntarily terminated during the year. It does not matter that the layoffs are due to adverse economic conditions not within the employer’s control. 

Participants who are furloughed are those who have had a period during which they are not working but who are expected to return to work. They are not treated as involuntarily terminated for plan purposes and are not counted as part of the 20%. 

Participants who voluntarily terminate also are not included in the 20% calculation as long the company can prove on a person-by-person basis that each termination was voluntary. When determining whether a partial plan termination occurred, the IRS will consider whether participants who left voluntarily were constructively discharged and should be included in the 20% calculation. Factors considered for a constructive discharge include the employer's intent, working conditions, and the reasonably foreseeable impact of the employer's conduct on the employees. Participants who leave due to retirement (by the plan’s definition), death, or disability are not included in the 20% calculation.

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What happens when a partial plan termination occurs?

When a partial plan termination occurs, the affected participants’ accounts become 100% vested. An affected participant is anyone who is terminated for any reason during the plan year in which the partial termination occurred and who still has an account balance under the plan. This includes both employees who are laid off and employees who voluntarily terminate, regardless of whether it is proven that the employees left voluntarily as described earlier. 

Other COVID-19 effects

Other than the 100% vesting exception for affected participants in a partial plan termination, all other provisions of the ESOP continue as normal. For furloughed employees who receive payments (to help them financially), hours of service are credited for each hour the employee is compensated, even though no duties are performed. This provision functions similarly to sick leave or vacation pay.

Looking ahead

If a company has significant layoffs, several of the normally run year-end tests might be adversely affected. It might make sense to run projected tests later in the year to avoid issues. It also is possible that companies significantly affected by the economic downturn might need a midyear valuation because the Dec. 31, 2019, valuation generally will not reflect the impact of the downturn on the company.

Want more insights on addressing Coronavirus-related challenges? 
Go to the Crowe COVID-19 resource center for more analysis and updates. 

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Pete Shuler - social
Pete Shuler
Principal, Benefit Plan Tax Services Leader
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Mark Swanson