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calexbraska

Can a Plan have a more restrictive (narrower) definition of Separation from Service?

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The regulations say a separation from service occurs when a participant's level of service drops to 20% of less of what it had been (I know that's simplified).  It also says you can choose a different percentage so long as it is greater than 20% but no larger than 50%.  This makes sense, because an employer could set it at 1% and then the parties could agree the employee will hardly do anything but still not have a separation as a method to control the payment date.  This also implies that you can have a broader definition of separation from service, but not a narrower definition of separation from service.

So here is my problem:  I have two related companies -- they are related, but they are not related enough to be considered the same employer under the regulations.  The Plan says separation from service is determined according to 409A, but a transfer between the companies is not a separation from service.  This appears to be a narrower definition of separation from service -- is this allowed under the regulations???

NOTE:  I understand that under the separation regulations, companies only have to be 50% related (not 80% like under the normal rule).  I also understand the plan can provide that the companies can be as little as 20% related.  We can't do that here, as the companies are not even 20% related -- and, even if they were, our plan doesn't state this, and any amendment to reduce relations to 20% is only applicable for future elections to defer.

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Sure. 409A limits your separation events. You can always limit them further. You can say that transfer between semi-related companies is not a separation, just like you can not include change in control as a distribution event.

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26 minutes ago, Luke Bailey said:

Sure. 409A limits your separation events. You can always limit them further. You can say that transfer between semi-related companies is not a separation, just like you can not include change in control as a distribution event.

I'm curious how you see this playing out.

If the two employers are not an "Employer" under the 409A regs, when do you have a separation from the first employer if not at the time of transfer? Would you say a separation is when you separate from all employers in the plan, with your entire balance (both from the first and second employer) being tied to the separation from all employers? 

Not saying any of this is right or wrong, just thinking out loud. 

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2 hours ago, Luke Bailey said:

Sure. 409A limits your separation events. You can always limit them further. You can say that transfer between semi-related companies is not a separation, just like you can not include change in control as a distribution event.

Not sure I agree here.  Change of control is optional, true.  But the definition of separation from service is tied to termination from an employer, where the threshold for a controlled group is lowered from 80% to 50% and common control is lowered to 20%.  So, if the two businesses involved don't even get to a 20% common control, how is a transfer not a separation?

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44 minutes ago, XTitan said:

Not sure I agree here.  Change of control is optional, true.  But the definition of separation from service is tied to termination from an employer, where the threshold for a controlled group is lowered from 80% to 50% and common control is lowered to 20%.  So, if the two businesses involved don't even get to a 20% common control, how is a transfer not a separation?

I think I agree with you.  It's clear you can limit Change of Control.  But the IRS specifically has a threshold (20%) of work that you have to keep doing for the employer (which has a specific definition), otherwise there is a separation.  This is a tricky situation, and, in this case, the two entities aren't even both participating in the plan.  After much consideration, I think it is a separation.  And I'm willing to bet there are a lot of plans out there that are doing this wrong.

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Ok, I agree this is much more complicated. I think I was assuming that both companies had adopted the plan, and were saying that you had to separate from both to have a separation from service. Rereading the question, it does not seem that is the case.

Calexbraska has not told us what the plan actually says as to what would trigger a distribution , e.g., separation from both, so we're guessing. But If the companies are not even 20% related, and only one has adopted the plan, I agree you can't require separation from service with both companies as the triggering event.The IRS could analyze that as having a good distribution event (i.e., separation from service with the plan sponsor), but the payment date with respect to the distribution event is not fixed, i.e., the payment date is whenever the individual chooses to separate from the tangentially related employer. Maybe the plan says something different, so I am just guessing, obviously, at what the problem might be.

If the plan can be interpreted as saying that what would otherwise be a separation from service with company 1 (the plan sponsor) is not a separation if the employee "transfers" (however defined) to company 2, and the import is not that separation from company 2 is a distribution event, but that the separation from service distribution event goes away until the employee returns to service with company 1, and otherwise goes away completely so that distribution can only be made upon the attainment of a date certain, death, etc., maybe that would be OK. I would want to comb through the regs to see if anything there can be interpreted for or against such a provision. Again, without knowing the plan terms we're just guessing.

Anyway, for participants who have not yet had a separation, check out Notice 2010-6. It's fairly liberal, Calexbraska,  in permitting corrections for problematic plan provisions. You may want to consider using it here.

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OK, it appears I need to add some information.  We have two companies that are not 20% related, but work together all the time.  They both have adopted the nonqualified plan and the plan says a separation from service means a separation from all participating employers.

I"m fairly certain this violates 409A.  Even though both companies have adopted the plan, they are not considered the same service recipient under the regs.  So long as Separation from Service is a payment trigger, it must be defined consistent with 409A; and here it is not.  

I think the only solution is to correct the plan language.  Unfortunately, I believe several people have transferred between the companies without it triggering payment, so in addition to the plan language issue, we've also had several operational failures.  It's going to be a mess.

 

 

 

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Hmmmh... If they have both adopted the same plan, there may at least be an argument that you can, or maybe have to, define separation as separation from both. You're going to have to work through the definitions carefully. Under 1.409A-1(c), do you really have one plan, or are their two plans housed in the same document, 1 for each employer? That could depend to some extent on how benefit accruals, vesting, etc. are determined. And once you've made that determination, how does it affect your view of who is/are the service recipient(s) under 1.409A -1(g), which could in turn affect how you view "separation from service" under 1.409A-(h). I don't recall that the regs really contemplated this sort of situation, so there may not be a clear answer, but my guess is that if one concludes there is really one plan (as opposed to two different plans in parallel universes just housed in the same document), then you may be OK. You might want to call the IRS off the record. I think this is a tough one. Answer may not be clear.

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I'm hoping that when the plans were set-up that there was at least common control at the 20% threshold.  That's the only way this would make sense. 

1.409A-1(h)(1)(i) begins with An employee separates from service with the employer if the employee dies, retires, or otherwise has a termination of employment with the employer.

How can a participant be employed by two unrelated employers if only working for one at a time? If it's one at a time, there is no transfer; it's a separation and a hire. I've definitely seen related employers adopt the same plans and transfers are not treated as separations, but not unrelated employers.

In the words of the sadly mortal Warren Zevon, "Ain't that pretty at all."

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Given the way the plan has apparently been drafted, I don't know if there is a good answer, or even a conservative one. If the plan segregated the benefits/accounts accrued under each employer and said that you got benefit 1 on separation from employer 1 and benefit 2 on separation from employer 2, you'd really have 2 plans, and so the conventional definition of separation from service would work, serially and separately for separation from each of the two employers, with respect only the benefit with respect to that employer. But if the plan has a single benefit or account that accrues and/or vests in a blended fashion across service for both employers, you'd probably be better off requiring separation from service from both. Maybe not clearly permissible, as pointed out above in several posts, but certainly better than the alternative of saying that you can terminate with employer 1 and immediately go to work for employer 2 and get a distribution of your existing benefit accrued under both employer 1 and employer 2. That is clearly a nonstarter.

XTitan raises tangentially an interesting issue that may or may not have an answer buried in the reg itself. (I took a quick look and didn't see one). Suppose you conscientiously choose the 20 - 50% rule, determine you have a valid reason, write it into your plan, etc., and later the percentage drops to 19%. Do you have to segregate the benefit accrued during the period before the drop to 19% from the benefit accrued after that date, and apply the definition of service recipient differently for the two periods? I think that 1.409A-1(h)(1)(I)'s use of the term, "With respect to a deferral of compensation under the plan," probably implies that it is specific to each deferral, so such a bifurcation would be required.

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