This issue snapshot will focus on the impact of Revenue Ruling 2007-43 in determining if a partial termination occurred. It will also address vesting requirements and affected employees. IRC Section and Treas. Regulation IRC section 411(d)(3) Treas. Reg. section 1.411(d)-2 Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources) Rev. Rul. 2007-43, 2007-2 C.B. 45 Rev. Rul. 2002-42, 2002-2 C.B. 76; GCM 39310 Weil v. Terson Co. Retirement Plan Administrative Committee, 933 F. 2nd 106 (2d Cir. 1991) Matz v. Household International Tax Reduction Investment Plan, 388 F.3d 570 (7th Cir. 2004); Borda v. Hardy, 138 F. 3d 1062 Analysis IRC section 411(d)(3) specifies that a plan will not be qualified unless it provides that, upon its partial termination, the rights of all “affected employees” to benefits accrued to the date of such partial termination, to the extent funded on that date, or the amounts credited to their accounts, are nonforfeitable. The facts and circumstances determine whether or not a partial termination occurred under IRC section 411(d)(3). If a partial termination occurs, all participating employees who had a severance from employment during the applicable period must be fully vested in their account balance or their accrued benefit, to the extent funded. Under Rev. Rul. 2007-43, the IRS established that a 20% or greater turnover rate in the applicable period creates a rebuttable presumption that a partial termination occurred. Turnover Rate To calculate the turnover rate, take all participating employees, both vested and nonvested, into account. The turnover rate (TR) is determined by dividing the number of participating employees who had an employer-initiated severance from employment during the applicable period (A) by the sum of all of the participating employees at the start of the applicable period (X) and the employees who became participants during the applicable period (Y). Rev. Rul. 2007-43. For an applicable period, the formula for the turnover rate would be calculated as follows: 𝑇R = 𝐴𝐴 / 𝑋 + 𝑌 For example, in a determination application submitted on Form 5310 (rev. 12-2013), line 16a provides information on terminated participants. See the chart below. 16a Enter the total number of participants employed at any time during the plan year of termination and each of the 5 prior plan years on the schedule below. If all such participants were fully vested at all times during such years, do not complete lines 16(a)1 through 16(a)5, and instead enter “0” in line 6 of columns (i), (ii), (iii), (iv), (v) and (vi). (i) (ii) (iii) (iv) (v) (vi) Enter Plan Year End 12/31/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015 12/31/2016 a(1) -Number at end of prior plan year 55 48 31 23 22 24 a(2) -Number added during the plan year 6 5 2 1 2 2 a(3) - Total. Add lines (1) and (2) 61 53 33 24 24 26 a(4) -Number dropped during the plan year 13 22 10 2 0 1 a(5) -Number at end of plan year. Subtract line (4) from line (3) 48 31 23 22 24 25 a(6) - Total number of participants in this plan from vesting service during the plan year without full vesting 10 15 6 0 0 0 In the 2011 plan year in the above example, there were 13 employed participants (this is “A” in the formula) dropped and 61 total participants (this is “X + Y” in the formula). The turnover rate (“TR” in the above formula) is 21% (13/61 = 21). The applicant may claim that only participants who were dropped without full vesting during the period under consideration should be used in calculating the turnover rate. In the above example, when taking into account only those 10 participants who were dropped without full vesting in 2011, the turnover rate drops to 16% (10/61 = 16). However, Rev. Rul. 2007-43 and prior court rulings indicate that both vested and non- vested participants who were dropped during the period under review must be considered when determining the turnover rate. Applicable Period Typically the period is one plan year, but can be longer if there are a series of related severances from employment. If there is a short plan year, the period includes the short plan year and the immediately preceding plan year. In the above example, the applicable period may include plan year 2012, since the form indicates that 22 were dropped. Affected Employee IRC section 411(d)(3) and Treas. Reg. section 1.411(d)-2(a) require that upon a plan’s termination or partial termination the benefits accrued to the date of such termination or partial termination, to the extent funded, are fully vested for each affected employee. “Affected employee” is not defined in the Code or Regulations. The court in Borda v. Hardy, 138 F. 3d 1062, 1067, reasoned that an “affected employee” should be an employee who had separated from service and was one who still stood to be “affected” by the termination of the plan. The court also relied on the finding of GCM 39310 that concluded “an employee who separates from service but will not suffer a forfeiture until he incurs a break-in-service will become vested in his accrued benefit, to the extent funded, if the plan terminates prior to his incurring a break-in-service.” Mere termination of employment does not operate to automatically result in a forfeiture of an accrued benefit. There are plan provisions, such as “deemed cash-out” for 0 % vested participants, which can result in forfeiture or cause non-vested accrued benefits to be ignored. You should carefully examine the plan document to ensure that any forfeitures were in compliance with the Code, Regulations and the plan document itself. Employer-Initiated Severance This generally includes any severance from employment other than a severance that is on account of death, disability or retirement on or after normal retirement age. It also includes events outside of the employer’s control, such as depressed economic conditions. Facts, Circumstances and Presumption of Partial Termination The presumption of a partial termination happens when the turnover rate is 20% or greater. If the plan sponsor can provide evidence that the turnover rate was not the result of employer-initiated severance from employment and the severance was purely voluntary, the IRS may find that there was no partial termination. This type of evidence may include information from personnel files, employee statements or other corporate records. The employer may also provide evidence that the turnover rate is routine. To determine if a turnover rate is routine, the employer must show the turnover rate in other periods and the extent to which terminated employees were actually replaced. The IRS will also consider whether or not the new employees did the same types of work, had the same job classification or title, and received comparable compensation. Rev. Rul. 2002-42 provided that the merger or conversion of a money purchase pension plan, without other indications of a partial termination, does not result in a partial termination. If the employer cannot provide sufficient evidence to show that the turnover rate was routine or was not the result of employer-initiated severance from employment, the presumption of a partial termination will stand and the affected participants, including those who voluntarily terminated during the applicable period, must be fully vested. Not Just Turnover A partial termination can occur for other reasons, not just turnover. If a sponsor adopts amendments that adversely affect the rights of employees to vest in benefits under the plan, excludes a group of employees that previously had been included, or reduces or ceases future benefit accruals that can result in a reversion to the employer in a defined benefit plan, the IRS may find that a partial termination occurred, even if the turnover rate is under 20%. Issue Indicators or Audit Tips The Employee Plans Compliance Unit (EPCU) found the following where plans Form 5500s reported decreases in participants who were not fully vested: Over half of the taxpayers made errors in participant counts A significant number had fully vested all participants as a result of the partial termination, but reported that the participants were not fully vested on Form 5500 In 30% of the cases, EPCU concluded there was no partial termination In 10% of the cases, there was a partial termination and affected participants were not fully vested It appears that there still remains confusion in the taxpayer and practitioner community on what constitutes a partial termination and the vesting requirements resulting from a partial termination.