On May 5, 2000, the IRS issued Rev. Rul. 2000-27 which dramatically diminishes the impact of the "same desk" rule, that prohibited 401(k) plan distributions under certain circumstances. This ruling specifically permits 401(k) plan participants to receive a distribution of their 401(k) plan account balances upon a sale by their employer of less than "substantially all" of the employer's assets used in that trade or business, treating the sale as resulting in a separation from service.
Prior to this ruling, the "same desk" rule would have precluded a distribution, thus requiring that the participants' 401(k) plan account balances remain in the selling employer's 401(k) plan even though the participants commenced employment with a new, unrelated employer.
Under the Internal Revenue Code ("IRC"), 401(k) plans may only make distributions to participants under certain circumstances, e.g., upon (i) an employee's separation from service or (ii) the date of the sale or other disposition by a corporation of substantially all the assets used by the corporation in a trade or business of the corporation to an unrelated corporation under IRC Section 401(k)(10).
However, for years the IRS has taken the interpretive position that if a participant is performing the same services before and after the transaction at the same desk, then the participant has not actually been separated from service, even though the participant has a new employer.
The "same desk" rule has caused employers, particularly those that are part of a large ERISA controlled group, significant problems in 401(k) benefit plan administration. For example, if a transaction does not result in an employee's separation from service, the participant may not receive a distribution from the seller's 401(k) plan (and roll over such amount to an IRA or to another employer's tax-qualified benefit plan) and the seller could be forced to maintain a 401(k) plan for participants, most of whom are no longer employed by the employer.
Similarly, a purchaser may have employees who now must track their 401(k) plan benefits under two separate plans, or participants with outstanding 401(k) plan loans at the time of the transaction may be placed in a difficult position of having to repay a loan where they might otherwise have been able to roll over the loan into the new employer's 401(k) plan.
401(k)(10) Distribution Exception
401(k) plan distributions are allowed to participants who are impacted by a transaction that falls within IRC Section 401(k)(10) - that is, the sale of all or substantially all of the assets used in a trade or business. Such a transaction must also satisfy certain requirements as described in Treas. Reg. Section 1.401(k)-1(d)(4), i.e., the seller must continue to maintain the plan after the sale and the employee must continue employment with the purchaser of the assets. The regulations define "substantially all" the assets used in a trade or business to mean the sale of at least 85% of the assets.
To avoid the types of problems discussed above and for overall 401(k) plan administrative ease, employers involved in a transaction have often tried, where possible, to classify a transaction as the sale of all or substantially all of the assets used in the trade or business.
Rev. Rul. 2000-27
Under Rev. Rul. 2000-27, an employer ("Employer X") sold certain assets constituting less than 85% of the assets used in a trade or business to an unrelated employer ("Employer Y"), and most of the employees associated with the transferred assets were hired by Employer Y upon the close of the transaction in the same capacity, performing the same function -- they were essentially at the "same desk." Employer X then allowed the transferred employees to receive distributions from the Employer X's 401(k) plan.
The IRS ruled that the transaction was not a sale of substantially all of the assets used in a trade or business under IRC Section 401(k)(10) and the distribution would only be allowed if the change in their employment status constituted a "separation from service".
The IRS ruled: "The change in the status of transferred employees following the sale of less than substantially all of the assets of a trade or business of Employer X to Employer Y constitutes a 'separation from service' . . . as of the date of the sale of assets (when their employment with Employer X terminated)." Although the employees continued to perform the same tasks at the same location following the transfer (thus ostensibly falling within the ambit of the "same desk" rule), Rev. Rul. 2000-27 treats the participants eligible in a distribution based on a separation of service to them.
Impact of Rev. Rul. 2000-27 on Prospective Transactions
Rev. Rul. 2000-27 will, on its face, likely cause unintended results absent additional guidance or action by Congress, Treasury or the IRS.
- Structure Sales of Less than 85% of the Assets. The requirements for a distribution under the 401(k)(10) exception are more restrictive than those under Rev. Rule 2000-27. Whereas Rev. Rul. 2000-27 looks only to whether a separation from service has occurred, 401(k)(10) requires (i) the sale of at least 85% of the assets, (ii) that the seller maintain the plan after the sale, and (iii) that the employees commence employment with the purchaser. Accordingly, it could be beneficial to structure a transaction to fall below the 85% threshold so plan sponsors could take advantage of the new ruling and its more permissive distribution rules.
- Sales to Partnerships Permitted Under Rev. Rul. 2000-27. The 401(k)(10) distribution exception applies only to corporations (note that IRS PLR 9848008 strictly interpreted 401(k)(10) to preclude a distribution if the sale is to a partnership). In contrast, Rev. Rul. 2000-27 does not appear to be so limited. Thus, structuring a sale of less than 85% of the assets used in the trade or business to a partnership would allow a distribution based on the separation from service theory where it would not have been a distributable event under 401(k)(10).
For 401(k) plan sponsors, Rev. Rul. 2000-27 is a welcome sign. It clearly provides at least partial relief from the "same desk" rule and should make it easier for plan sponsors to reduce 401(k) plan administration and concerns in the context of corporate transactions. For 401(k) plan participants, Rev. Rul. 2000-27 is also welcome in that it eases pension portability and further enables participants to receive 401(k) plan distributions by an expanded definition of a separation from service.
Further, since the enactment of IRC Section 401(k)(10) was a response to the "same desk" rule, it is reasonable to believe that Congress will revise Section 401(k)(10) or that Treasury and/or the IRS will take some future action to conform Section 401(k)(10) accordingly in light of Rev. Rul. 2000-27 and expand the view of what constitutes a separation from service.