Pension Protection Act Blog

Recognizing when a plan has partially terminated is important and sometimes overlooked. For both participants and plan sponsors, the finding of a partial termination is an important plan event because participants who were partially vested before the partial termination event will become fully vested due to the partial termination.

In Revenue Ruling 2007-43, issued today by the IRS, the Service confirmed that if the turnover rate for an employer is at least 20%, there is a presumption that a partial termination of the plan has occurred. In Rev. Rul. 2007-43, the employer ceased operations at one of its four business locations. Closing that location resulted in 23% of the participants in the employer’s defined contribution plan ceasing active participation in the plan because their employment was terminated. The IRS found that a partial termination occurred and those affected employees became 100% vested in their account balances due to the partial termination.

The IRS has had a long-standing rule on partial termination of a plan resulting in 100% vesting for the affected participants. Treasury regulation 1.411(d)-2(b)(1) provides that it is a facts-and-circumstances test to determine whether a partial termination has occurred. Internal Revenue Code section 411(d)(3) provides that if a partial termination occurs, the affected participants become 100% vested in their account balances.

Not every situation resulting in at least a 20% turnover rate will create a partial termination. The IRS said that it is a facts-and-circumstances test. Factors such as the extent to which terminated employees were replaced, whether the new employees performed the same functions, had the same job classification or title, and received comparable compensation, along with the turnover rate during other periods in the company’s history, are all relevant factors to consider when determining whether a partial termination has occurred.

The IRS also stated that a partial termination can occur for reasons other than the turnover rate, including plan amendments which adversely affect the rights of employees to vest in benefits under the plan, plan amendments that exclude a group of employees who have previously been covered by the plan, or a reduction or cessation of future benefit accruals resulting in a potential reversion to the employer.

How does the IRS learn of the turnover rate? There are at least two ways - Form 5310 and Form 5500. Line 15 of Form 5310, filed with the IRS as part of a determination letter request when a plan terminates, requires identifying the number of plan participants in the year of plan termination, as well as the previous five years before termination. Form 5310 also requires the plan sponsor to identify the number of participants each year who separated without being fully vested. Line 7 of Form 5500 identifies the number of participants who terminated employment during the plan year who were less than 100% vested. On audit, or as part of a determination letter application for a terminated plan, the IRS can request copies of Form 5500 filed by the employer for any year relevant to the determination. Some simple math using the information provided on Form 5500 and Form 5310 will provide the turnover rate to the IRS.

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