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Employee termination and rehire for rollover


Guest Steveventure
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Guest Steveventure

I would like to rollover my 403B by terminating employment with the plan of getting rehired by the same agency soon after this. My retirement plan consultant (not connected with my employer) advises that this a a gray area and there is no law against it and no reason why I can't do it. People terminate all the time and then rehire later and there is no law on intent to rehire. I understand that there is also no law about how long one needs to be terminated before they can be rehired.

However my employer is very conservative and claims that if they did this, they would jepoardize their entire 403B plan. However, they cannot sight any law and seems that this is simply a desire to avoid appearance of any impropriety, with nothing to back it up. My question is, is there any law against termination employment, then rolling over the 403B, and then getting rehired at some later date?

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I would like to rollover my 403B by terminating employment with the plan of getting rehired by the same agency soon after this. My retirement plan consultant (not connected with my employer) advises that this a a gray area and there is no law against it and no reason why I can't do it. People terminate all the time and then rehire later and there is no law on intent to rehire. I understand that there is also no law about how long one needs to be terminated before they can be rehired.

However my employer is very conservative and claims that if they did this, they would jepoardize their entire 403B plan. However, they cannot sight any law and seems that this is simply a desire to avoid appearance of any impropriety, with nothing to back it up. My question is, is there any law against termination employment, then rolling over the 403B, and then getting rehired at some later date?

Your employer would place its entire 403b plan in jeopardy. You are plotting the re-hire before the termination. So where's the reality in the termination of employment as a trigger allowing you to withdraw your benefits? If the IRS were to discover the pre-arranged re-hire, the 403b plan could be disqualified from favorable tax treatment.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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In a recent case, some airline pilots got divorced so their wives get money from their retirement accounts as part of the settlement. The IRS came in and the tax courts agreed that the divorces were shams because the pilots got remarried to their wives and had that intention from the very beginning of the process. This is substantially what you propose to do... create an event which allows distribution w/ the full intent of reverting back afterwards.

My retirement plan consultant

Unless you're paying a flat fee for advice, remember that this person has a financial incentive (namely commissions and fees) to push you to take this action. You're consultant won't be the one who's hurt if the 403 gets in trouble w/ the IRS. But be very aware that if the IRS says the rollover was a sham, then the entire amount will be immediately taxable to you (plus penalties and interest).

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Guest Steveventure
In a recent case, some airline pilots got divorced so their wives get money from their retirement accounts as part of the settlement. The IRS came in and the tax courts agreed that the divorces were shams because the pilots got remarried to their wives and had that intention from the very beginning of the process. This is substantially what you propose to do... create an event which allows distribution w/ the full intent of reverting back afterwards.
My retirement plan consultant

Unless you're paying a flat fee for advice, remember that this person has a financial incentive (namely commissions and fees) to push you to take this action. You're consultant won't be the one who's hurt if the 403 gets in trouble w/ the IRS. But be very aware that if the IRS says the rollover was a sham, then the entire amount will be immediately taxable to you (plus penalties and interest).

Actually, there is not distribution with termination of employment....only an IRA rollever, which remains in a tax sheltered situation, unavailable until retirement without penalties. My retirement consultant is simply restating a profit sharing plan I also have. She has no vested interests in this, does not invest and has nothing to gain in to opinion she ventures here.

This morning I consulted directly with the IRS and was routed through to an agent specializing in 403b's. She went through all the regs and advised that there was nothing prohibiting a termination of employment, rollover and then rehiring. This occurs all the time and there in nothing in the regs that relates to intent. She agreed that whether or not there is an intent to rehire, when there is a formal termination and I leave my employment for any peroid of time, this is indeed a triggering event. She agreed that while it may sound like a sham, it is indeed a legal sham. My problem now is getting the powers that be to not try and second guess the IRS, as they still believe that they would be jeopardizing the plan.

It seems that the question about all this has to do with intent. If I really want to quit employment I could to this and rollover my 403b. Then if I decided soon after that I changed my mind and the agency agreed to rehire, all is well. The problem seems to be that others assume illegality if the intent of ending employment is simply to get the rollover. However, the IRS advisd me the the reasons for termination are not relevant or limiting in terms of making a triggering event. I would welcome comments from other who have prehaps gotten a different read for the IRS and had a different experiece on this.

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Even though there is no tax consequence, the employer should rightly abstain from being a party to the "sham transaction" designed to circumvent the rules. Impermissible distributions even if they are rolled over can jeopardize the whole plan. An IRS auditor or a court may not agree with the IRS agent you talked to on the phone.

PensionPro, CPC, TGPC

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It seems that the question about all this has to do with intent. If I really want to quit employment I could to this and rollover my 403b. Then if I decided soon after that I changed my mind and the agency agreed to rehire, all is well. The problem seems to be that others assume illegality if the intent of ending employment is simply to get the rollover.

The closer in time the re-hire from the date of termination, the more suspicious it will look to an IRS auditor that the re-hire was prearranged before the termination actually occurred. Less suspicion surrounds the situation where a longer period of time has elapsed since termination before the re-hire. You want the termination to be, as tax law Professor Vance Kirby used to say, 'old and cold' before the re-hire takes place.

The same rule against in-service distributions before a certain age generally applies to 401k and profit sharing plans too. There is a state supreme court decision (Sorensen v. Saint Alphonsus Regional Medical Center, Inc., Docket No. 30476 (ID 6/24/2005) (ID, 2005)) that may be of interest. In that situation, the plan improperly began in-service distributions. The IRS discovered this and told the plan it must stop the payouts, or not employ the person for at least 4 months. (The plan in turn informed the employee of her two options. She filed suit to try and prevent the non-ERISA plan from giving her such an ultimatum. She lost. I point this out to show what the IRS had proposed to remedy the improper in-service payouts. Apparently for that IRS auditor, a 4 month gap in employment was old and cold enough.)

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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In a recent case, some airline pilots got divorced so their wives get money from their retirement accounts as part of the settlement. The IRS came in and the tax courts agreed that the divorces were shams because the pilots got remarried to their wives and had that intention from the very beginning of the process. This is substantially what you propose to do... create an event which allows distribution w/ the full intent of reverting back afterwards.
My retirement plan consultant

Unless you're paying a flat fee for advice, remember that this person has a financial incentive (namely commissions and fees) to push you to take this action. You're consultant won't be the one who's hurt if the 403 gets in trouble w/ the IRS. But be very aware that if the IRS says the rollover was a sham, then the entire amount will be immediately taxable to you (plus penalties and interest).

Actually, there is not distribution with termination of employment....only an IRA rollever, which remains in a tax sheltered situation, unavailable until retirement without penalties. My retirement consultant is simply restating a profit sharing plan I also have. She has no vested interests in this, does not invest and has nothing to gain in to opinion she ventures here.

This morning I consulted directly with the IRS and was routed through to an agent specializing in 403b's. She went through all the regs and advised that there was nothing prohibiting a termination of employment, rollover and then rehiring. This occurs all the time and there in nothing in the regs that relates to intent. She agreed that whether or not there is an intent to rehire, when there is a formal termination and I leave my employment for any peroid of time, this is indeed a triggering event. She agreed that while it may sound like a sham, it is indeed a legal sham. My problem now is getting the powers that be to not try and second guess the IRS, as they still believe that they would be jeopardizing the plan.

It seems that the question about all this has to do with intent. If I really want to quit employment I could to this and rollover my 403b. Then if I decided soon after that I changed my mind and the agency agreed to rehire, all is well. The problem seems to be that others assume illegality if the intent of ending employment is simply to get the rollover. However, the IRS advisd me the the reasons for termination are not relevant or limiting in terms of making a triggering event. I would welcome comments from other who have prehaps gotten a different read for the IRS and had a different experiece on this.

Despite what has been posted on this board, as noted by the IRS agent there is no IRS rule that prohibits rehiring an employee who has terminated and received a distribution. In some businesss with high turnover it is a common practice to rehire employees who have terminated to save on the cost of training new employees. In some cases the employer allows rehiring after a specific period has elapsed. In other cases the employee comes back as an independent contractor, or after retirement. There is really no way to distinguish between a sham situation and legitimate case where the employer rehires a employee whose skills cannot be replaced in the market place, i.e., the employee quits in order to be rehired at a higher salary.

The difference between your sitution and the situaton cited in the ID case is that in the ID case the payment to the employee violated the IRS rules for inservice distributions whereas payment of your distribution is expressly permitted under the tax law.

However, there is nothing that would require that your employer agree to participate in the scheme you propose.

mjb

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Guest Steveventure
In a recent case, some airline pilots got divorced so their wives get money from their retirement accounts as part of the settlement. The IRS came in and the tax courts agreed that the divorces were shams because the pilots got remarried to their wives and had that intention from the very beginning of the process. This is substantially what you propose to do... create an event which allows distribution w/ the full intent of reverting back afterwards.
My retirement plan consultant

Unless you're paying a flat fee for advice, remember that this person has a financial incentive (namely commissions and fees) to push you to take this action. You're consultant won't be the one who's hurt if the 403 gets in trouble w/ the IRS. But be very aware that if the IRS says the rollover was a sham, then the entire amount will be immediately taxable to you (plus penalties and interest).

Actually, there is not distribution with termination of employment....only an IRA rollever, which remains in a tax sheltered situation, unavailable until retirement without penalties. My retirement consultant is simply restating a profit sharing plan I also have. She has no vested interests in this, does not invest and has nothing to gain in to opinion she ventures here.

This morning I consulted directly with the IRS and was routed through to an agent specializing in 403b's. She went through all the regs and advised that there was nothing prohibiting a termination of employment, rollover and then rehiring. This occurs all the time and there in nothing in the regs that relates to intent. She agreed that whether or not there is an intent to rehire, when there is a formal termination and I leave my employment for any peroid of time, this is indeed a triggering event. She agreed that while it may sound like a sham, it is indeed a legal sham. My problem now is getting the powers that be to not try and second guess the IRS, as they still believe that they would be jeopardizing the plan.

It seems that the question about all this has to do with intent. If I really want to quit employment I could to this and rollover my 403b. Then if I decided soon after that I changed my mind and the agency agreed to rehire, all is well. The problem seems to be that others assume illegality if the intent of ending employment is simply to get the rollover. However, the IRS advisd me the the reasons for termination are not relevant or limiting in terms of making a triggering event. I would welcome comments from other who have prehaps gotten a different read for the IRS and had a different experiece on this.

Despite what has been posted on this board, as noted by the IRS agent there is no IRS rule that prohibits rehiring an employee who has terminated and received a distribution. In some businesss with high turnover it is a common practice to rehire employees who have terminated to save on the cost of training new employees. In some cases the employer allows rehiring after a specific period has elapsed. In other cases the employee comes back as an independent contractor, or after retirement. There is really no way to distinguish between a sham situation and legitimate case where the employer rehires a employee whose skills cannot be replaced in the market place, i.e., the employee quits in order to be rehired at a higher salary.

The difference between your sitution and the situaton cited in the ID case is that in the ID case the payment to the employee violated the IRS rules for inservice distributions whereas payment of your distribution is expressly permitted under the tax law.

However, there is nothing that would require that your employer agree to participate in the scheme you propose.

Yes. This is my contention: that is, even if this is looked on as somewhat a sham, there are no laws against it and whatever the basis of termination, or whatever the future plan of myself or the organization, a formal termination of employment it a triggering event that allows rollover and the the law doesn't negate this no matter when reemployment takes place. My understanding it that the IRS doesn't care so much about this, as even with a rollover the tax sheltered status remains unchanged. However, as my organizatoin pointed out, this is just one IRS agent and for this to fly they understandably want something from the IRS in writing. They are willing to go with this if the IRS puts something in writing that will cover them. That may be a different story and I will post on this when I hear from them on what they are willing to put in writing in terms of an opinion on this.

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On a slightly different vein... how does your employer treat the termination for things like seniority, vacation eligiblity, service awards, sick leave, etc? My current (non-union) employer starts employees over just like a new hire, so you'd drop back to zero days of service, meaning have to wait a full year to restart vacation, no seniority, no service awards, no sick leave, etc. Make sure you understand what happens to all perks and benefits before you do something that can't be undone.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Guest Steveventure
On a slightly different vein... how does your employer treat the termination for things like seniority, vacation eligiblity, service awards, sick leave, etc? My current (non-union) employer starts employees over just like a new hire, so you'd drop back to zero days of service, meaning have to wait a full year to restart vacation, no seniority, no service awards, no sick leave, etc. Make sure you understand what happens to all perks and benefits before you do something that can't be undone.

That is not relevant in my case. I work 38 hours weekly and am not benefited at all. I guess this boils done to the definition of termination. I thought if I turned in a resignation, and stopped working, that would be considered termination. The agency is free to choose not to rehire me and I am free not to return. According to some of the input here, it is all about intent, and when someone quits and job while considering return to the job, that would then not be considered termination. It's just that no one and been able show me a law that would support this notion. But then, in a nation where Czars and judges increasingly determine things, maybe laws aren't all that relevant.

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I guess this boils done to the definition of termination.

No, what matters is what the IRS and the Tax Courts determine to be a "sham transaction". To get a better idea of what we're talking about, try a Google search on the three words: tax sham transaction

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Guest Steveventure
I guess this boils done to the definition of termination.

No, what matters is what the IRS and the Tax Courts determine to be a "sham transaction". To get a better idea of what we're talking about, try a Google search on the three words: tax sham transaction

I just did that and this is what I came up with: a transaction that is made to mislead or deceive others : a transaction having no economic effect that is made to create tax benefits. So where is the tax benefit to what I am proposing??

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To take what is essentially an in-service distribution before age 59 1/2 that is not permitted--in the absence of a real, substantive termination of employment.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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And to continue deferral of otherwise taxable income. You may see it as simply moving the money from one tax deferred pot to another, but the reality of it is that one part of the IRS Code says when you can take a distribution from your 403, another part of the IRS Code says when that distribution is "rollover eligible" and a third part of the IRS Code says that when you do the rollover properly then you can continue to defer the income and tax.

It's not a "certainty" that the IRS will declare your rollover to be a sham; but it is a legitimate and documented "risk". As such, we can't give you anything concrete to show your employer to make them okay w/ your proposal. However, J Simmons' cited case does show what the IRS considers to be a sufficient break; it could likely be a shorter time and still be okay but we can point to that 4 months w/ some level of comfort. A quick glance at the calendar shows if you took a break from working this Fall, at least you'd get the Holidays off!

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Guest Steveventure
And to continue deferral of otherwise taxable income. You may see it as simply moving the money from one tax deferred pot to another, but the reality of it is that one part of the IRS Code says when you can take a distribution from your 403, another part of the IRS Code says when that distribution is "rollover eligible" and a third part of the IRS Code says that when you do the rollover properly then you can continue to defer the income and tax.

It's not a "certainty" that the IRS will declare your rollover to be a sham; but it is a legitimate and documented "risk". As such, we can't give you anything concrete to show your employer to make them okay w/ your proposal. However, J Simmons' cited case does show what the IRS considers to be a sufficient break; it could likely be a shorter time and still be okay but we can point to that 4 months w/ some level of comfort. A quick glance at the calendar shows if you took a break from working this Fall, at least you'd get the Holidays off!

Yeah....I could use the break...LOL! Bottom line is what the IRS is willing to put in writing. While this doesn't have tax implications, they may be loath to sanction something appearing to be a sham that may set a precedence for other terminations that would indeed have tax implications.

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I guess this boils done to the definition of termination.

No, what matters is what the IRS and the Tax Courts determine to be a "sham transaction". To get a better idea of what we're talking about, try a Google search on the three words: tax sham transaction

How about giving us a example where the IRS held a termination, distribution and rehire to be a sham transaction where there is no avoidance of taxation that would otherwise occur. If a distribution permitted under the IRC such as 401(k)(2)(B) is rolled over as permitted under IRC 402©(4) then the deferral continues as it would if the benefits had remained in the plan. If the distribution is not rolled over then the employee is incurring tax rather than avoiding the taxation that would occur in a sham transaction. Thousands of employees terminate and are rehired each year by their employer for varying reasons. Is it ok for a laid off employee who has taken a distribution to be rehired because of an increase in work without there being a sham? What about an employee who quits, takes a distribution and then returns to work for an increase in pay? What about rehiring an employee who elected to retire and take a lump sum as permitted under the plan? There is problem in defining what constitutes a sham transaction for rehiring an emplmlyee who receives a distribution upon an event permitted under the IRC when employment is legally in the US as at will where either the employer or employee can terminate employment and both subsequently agree to reemployment.

mjb

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The sham transaction doctrine is typically applied in situations where the transaction is designed basically for the purpose to generate a tax deduction.

Similar concepts are applied in situations where something other than a tax deduction is the objective. For example, in Powell v Strategic Outsourcing Inc, S.D. Texas (March 18, 2009), a COBRA continuation opportunity was the objective of a termination and quick re-hire--a 'sham termination':

In this case, Plaintiffs have failed to present evidence that a "qualifying event" occurred that would trigger any obligation for Strategic to provide COBRA notice of the option to elect continuation coverage. Mr. Powell states in his affidavit that ESOR engaged in a sham termination in June 2005 in which ESOR terminated his employment and then immediately rehired him.
See
Affidavit of Dennis Powell, Exh. C to Plaintiffs' Response [Doc. # 28], ¶3. A "sham termination" is not a "qualifying event" for purposes of COBRA notification and coverage continuation requirements. It is undisputed that Mr. Powell's employment with ESOR was not terminated and that he remained employed by ESOR without a break in service and with no reduction in hours until April 1, 2006. Consequently, there was no termination of Mr. Powell's employment that would operate as a "qualifying event" for purposes of the COBRA requirements.

Plaintiffs have failed to present evidence of a "qualifying event" required to trigger COBRA requirements for notice and continuation coverage. As a result, Strategic is entitled to summary judgment on Plaintiff's COBRA claim.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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One of the facts that jumps out at me here is the fact that the employee feels they have enough control in this situation to be rehired. In the normal termination situation, the employee does not have sufficient control to know that they will be re-employed, especially to arrange the number of months within which they will be rehired. Sham transactions are a facts-and-circumstances test, and I think the amount of control is an important fact.

The other part of this transaction that I'm curious about is what the plan says about leaves of absence and breaks in service. Does the plan provide for a leave of absence because this sounds more like a leave of absence than a severance of service.

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Guest Steveventure
One of the facts that jumps out at me here is the fact that the employee feels they have enough control in this situation to be rehired. In the normal termination situation, the employee does not have sufficient control to know that they will be re-employed, especially to arrange the number of months within which they will be rehired. Sham transactions are a facts-and-circumstances test, and I think the amount of control is an important fact.

The other part of this transaction that I'm curious about is what the plan says about leaves of absence and breaks in service. Does the plan provide for a leave of absence because this sounds more like a leave of absence than a severance of service.

I do have some confidence that my employer would be glad to rehire me. But that is certainly not guarentee. And if that were a criteria, then anytime anyone quit employment, had some confidence that they might be welcomed back and had thoughts of returning, then their choice to end employment would not be considered termination. If motivations and reasons for termination play a role in terms of what is considered to be legitimate termination of employment, then I would think there would be an exit questionaire on this to decide whether the reasons someone left employment were legitimate. But I don't think such questions are an issue when employment ends.

The difference between my choice to terminate employment and an LOA is that there is no assurance on the part of the employee or the employer that I would be returning. If such guarentees were given by either party, then I think the legitimacy of the termination would be called into question. I may be one of the first to ask about this. But obviously many have already left employment, done a rollovers and then based on whatever personal reasons, chosen to return to work and are welcomed back to employment.

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If all the facts and circumstances lead to the conclusion that the re-hire was not prearranged at the time of the termination, then the fact that an application was later made for and re-hire does occur does not mean that a distribution before the re-hire was improper or a sham termination. The factual merits of each situation come into play and must be examined.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Guest Rollover-IRA-401k-403b-457

This is generally a very poor practice and could be viewed as improper reason termination. However, in all likelihood, no one would most likely be the wiser.

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