The COVID-19 pandemic has brought operational challenges and financial strain to businesses in every sector. While some organizations have terminated employees, other businesses have been able to furlough some of, or all, their workforce instead. How the employer handles the furlough is important for many reasons, including how the guidelines of Internal Revenue Code Section 409A (IRC 409A) impact decisions made by both employer and employee.
A furlough implies an intent by the organization to bring the employee back to fulltime work, presumably as soon as is economically feasible for the employer. Per this March 26, 2020, article published by Bass Berry Sims, titled “COVID-19: Deferred Compensation Plans and Executive Agreements FAQs,” if it is in fact the intent of the employer to bring back an employee once business conditions stabilize, then the furlough should not be treated as a “separation from service” for purposes of Section 409A.
Under 409A, a “separation from service” does not include a “bona fide” leave of absence, which is a leave of absence in which there is reasonable expectation that the employee will return to perform services for the employers and in which either of the following apply:
- The leave of absence will not exceed six months.
- The leave of absence exceeds six months and the employee has either a contractual or statutory right to re-employment.
There are, however, circumstances that can arise after placing employees on furlough or on a reduced work schedule that can then trigger a separation from service. And of course, if during the time of furlough, the employer chooses to terminate the employee, the furlough then does become a separation from service.
Trigger circumstances are fact specific, such as the following example of reduction in work load resulting in the furlough becoming a separation from service.
- A 409A separation from service occurs effective on the date the employer and employee reasonably anticipate that the employee’s bona fide services (after a certain date) will permanently decrease to no more than 20 percent of his/her average level of bona fide services performed in the immediately previous 36-month work period. In other words, if an employee’s hours drop below the 20 percent threshold for an extended period, the IRS may deem that employee to have separated from service.
If new legislation is enacted or new guidance becomes available, we’ll continue to share our insights with you. As we have all come to realize, the COVID-19 pandemic has brought challenges along with the need to navigate what can feel like uncharted waters. The Fulcrum Partners team is available to assist you.
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This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Any tax advice contained herein is of a general nature. You should seek specific advice from your tax professional before pursuing any idea contemplated herein.
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