Employer leaves affiliated service group; Distribution Restrictions?

A dentist was part of an affiliated service group that sponsors a 401k plan (still ongoing). She was paid through her own entity and her staff was paid by a partnership under which she had partial ownership with two other dentists (who were set up in the same vein).

In 2016 she sold her interest in the partnership and pulled the staff that had been working at her location from payroll under the partnership to payroll under her entity (former A-Org). Is there a severance of employment here? Can she and her staff take a distribution of deferrals from the 401k plan that the partnership she sold out of sponsors?

She’s wanting to start her own 401k plan now and we were planning on spinning it off but we found out that distributions had been processed for her and her staff from the plan she formerly participated in as a related employer. I believe the first paragraph of Section III of Notice 2002-4 states that these distributions were okay but I’m getting mixed opinions with some of my colleagues. Some believe that since her entity was formerly a member of the ASG the only options are to leave the funds in the plan of the ASG or create a spin-off plan. So, do you believe that they’ve violated distribution restrictions?

Question for you.  Was her company an adopting employer to the plan that was operated by the affiliated service group?  Or, was she merely a partner in a partnership that sponsored a plan?

Maybe the answer is there, but I'm having an issue following the fact pattern.  This would be my approach to it:

If she was merely a partner in a partnership and sold her interest to the other partners and took some of their employees in order to start a new business, then there would be an argument that a severance of employment took place for her and those departed employees.

However, if her entity was a co-sponsoring adopter to a plan maintained by the partnership, then it would seem that a spinoff would be appropriate since the only change is that she no longer wishes to be a part of that plan (which would become a Multiple Employer Plan since they are no longer part of a related employer group).

My answer would likely change as more information become available, but this would be my first inclination.

Good Luck!

Thank you for your response!

Her company was an adopting employer to the plan sponsored by the affiliated service group. So, a distribution (of at least elective deferrals and safe harbor contributions) from that plan (to her (age 45) and her employees who have yet to reach 59 1/2) should not have occurred once she sold her interest in the partnership even though by selling her interest she was no longer a member of that related group, correct?

Well, maybe.  This would appear to be the case if she sold her interest "in the partnership" while maintaining her ownership in "her own company".  If she actually sold her interest in her company to go and start another one, then you may have the "severance of employment" needed for those distributions.  

The reason that I'm restricted with the answers is that by not knowing the fact pattern, there may be a 'severance of employment' that I'm not seeing. I am tending to agree, because I'm not seeing the severance of employment, "either deemed or actual" to justify a distribution.  That's not saying that it's not there, but the key is to actually identify that event.

There is a rule that says when a company purchases another company and decides not to take over their plan, then this is treated as a severance of employment for distribution purposes.  This situation doesn't even appear to be close to that situation.  

When I was in corporate, I used to tell my employees that 'there is no such thing as a right or wrong answer, there's just a right or wrong approach.  Obviously, this can be challenged as sometimes you just get the wrong answer.  But, my goal was to get them to justify their reasoning and knowing how to think and approach an issue.  In that event, I can see where they got off track and lead them through it.  With that said, I'm not trying to talk in circles, but merely trying to explain how I would approach this.   

Good Luck!

It seems like all these distributions were ok. The key sentences of the section that you point to in Notice 2002-4 are: "Thus, for example, if all employees of a controlled group of corporations (within the meaning of § 414(b)) are covered by a section 401(k) plan and a transaction occurs such that one subsidiary corporation in the group is no longer aggregated with other members in the group under § 414(b), (c), (m), or (o) [emphasis supplied], and in connection with the transaction no assets are transferred from the section 401(k) plan to a plan maintained by the former subsidiary corporation, then, participants in the section 401(k) plan who continue employment with the subsidiary corporation will have a severance from employment with the employer maintaining the section 401(k) plan and may receive a distribution of amounts attributable to elective contributions from that plan." This would seem to directly cover the dentist--she was an employee of a constituent member of the affiliated service group (ASG) that left the ASG, and continues to be such, and she is no longer eligible for or covered by the ASG plan that formerly covered her. Given that distribution to the dentist, who has really not had any change in W-2 employer, is permissible under Notice 2002-4, distributions should be all the more permissible to the staff employees who have actually changed employers in connection with the PC's or PLLC's withdrawal from the ASG.