COVID-19 Questions and Answers

Updated May 4, 2020 at 3:00 pm PT

We will continually update this page as we gather more information and answers. The NCEO is conducting a one-item questionnaire, and you can read a summary and pose your own questions for us on the NCEO COVID-19 Survey Responses post.

NCEO COVID-19 Resource Page

Thus far we have the following topics and questions covered:

How is the government responding and how will it affect me and my business?
What are our options for handling distributions?
How will valuations be affected?
What issues are there surrounding executive compensation?
What can we do to mitigate difficulties in managing repurchase obligation, diversification, and segregation requirements?
How are companies communicating and maintaining their culture through difficult times?

Legislation and employee protections

Q. What is the Families First Coronavirus Response Act?

A. President Trump signed into law the Families First Coronavirus Response Act (FFCRA, H.R. 6201) on March 18, 2020. It makes coronavirus testing free to the public, provides state grants for unemployment insurance, provides nutrition assistance through the Women, Infants, and Children (WIC) program, and, most relevant to ESOP companies, it creates a federal paid sick-leave employee benefit program.

Q. What companies are covered by the paid leave program?

A. NPR describes the program: “It requires employers with fewer than 500 employees to provide two weeks' worth of paid sick leave if employees are unable to work because they're subject to quarantine or isolation, are experiencing symptoms of COVID–19, are caring for someone who is in quarantine or isolation and/or have children in schools that have closed.”

The Department of Labor’s Wage and Hour Division published guidance stating that “[s]mall businesses with fewer than 50 employees may qualify for exemption from the requirement to provide leave due to school closings or child care unavailability if the leave requirements would jeopardize the viability of the business as a going concern.”

Q. With the Paid Emergency Leave provision, are these payments included as “Wages” or “Hours” for retirement plan eligibility in 2020?

A. Compensation is defined in the plan document. Compensation is typically defined as W-2 or 3401(a) wages which would include payments for sick time or FMLA payments sponsored by the employer. Since the Paid Emergency Leave provides that employer’s would pay an employee up to two weeks of leave time if they are unable to work or telework due to COVID-19 related concerns these amounts would be considered payroll and accordingly be included in the determination of retirement plan wages. The fact that the federal government will be reimbursing employer’s for the medical leave pay does not affect the ability for these amounts to be considered wages.

Hours are another defined term in plan document’s and typically include hours for which an employee has performed services and received payment or others for which an employee is entitled to pay. Accordingly paid sick time hours are generally included in the hours determination. Question 36 of the DOL’s FFCRA Question summary addresses multiemployer plans which fund based upon hours worked. The DOL response to this question would support inclusion of the COVID-19 related hours for retirement purposes.

Thank you to board member Barbara Clough of Newport Group for this answer.

Q. How do we calculate paid sick-leave benefits?

A. The Department of Labor’s Wage and Hour Division's guidance has a detailed description of how to calculate the size of the benefit, which depends on which one of six defined reasons applies to a given employee.

Roughly, employees who are unable to work because they are quarantined or experiencing symptoms are eligible for two weeks of sick leave paid at their normal rate, up to a maximum of $511 per day.

Employees who are unable to work because she or he is caring for another person is eligible for two weeks of sick leave at two-thirds of their normal compensation, up to $200 per day, and an additional ten weeks of family leave at two-thirds of their normal compensation.

Q. How do the tax credits work for ESOP companies?

A. In a March 20 press release, the IRS, DOL, and Department of the Treasury described the implementation of the tax credits mandated by the FFCRA as “designed to immediately and fully reimburse them, dollar-for-dollar, for the cost of providing Coronavirus-related leave to their employees.”

The press release notes that companies should be fully reimbursed for the paid sick leave:

“Health insurance costs are also included in the credit.
Employers face no payroll tax liability.
Self-employed individuals receive an equivalent credit.”

The press release notes that “[u]nder guidance that will be released next week, eligible employers who pay qualifying sick or child-care leave will be able to retain an amount of the payroll taxes equal to the amount of qualifying sick and child-care leave that they paid, rather than deposit them with the IRS.”

The credit is not allowed for wages for which a credit is allowed under the existing employer credit for paid family and medical leave (Code section 45S).

In other words, since the credit applies to payroll taxes, S corporation ESOPs that do not pay federal corporate income tax will equally participate.

Q. When does the law go into effect?

A. In a March 24 press release, the Department of Labor announced that the requirements for offering sick leave would go into effect on April 1. Before this announcement, previous guidance had led people to believe the effective was April 2.

A March 20 press release notes that the "Department of Labor will be issuing a temporary non-enforcement policy that provides a period of time for employers to come into compliance with the act. Under this policy, Department of Labor will not bring an enforcement action against any employer for violations of the act so long as the employer has acted reasonably and in good faith to comply with the act. The Department of Labor will instead focus on compliance assistance during the 30-day period.

The refundable credit applies to wages the employer pays between (1) a date that the Secretary of the Treasury must specify within 15 days after the date of enactment and (2) December 31, 2020. The March 20 press release states that the effective date is March 20.

Q. What resources does the DOL have on the sick-leave law?

A. On March 24 the DOL released a Fact Sheet for Employees, a Fact Sheet for Employers, and a Questions and Answers document.

Q. How do I learn more about the sick-leave benefit?

A. There is an excellent analysis and description of the bill that covers the distinction between the sick- and family-leave provisions in the March 19 client alert from the law firm Baker McKenzie.

Q. What does the CARES Act do?

A. The major provisions of the legislation are:

One-time tax rebate checks of $1,200 per individual and $500 per child. Single taxpayers with income over $99,000 in 2018 and married taxpayers with income over $198,000 would not be eligible.
Penalty-free withdrawals for up to $100,000 in coronavirus-related early distributions from defined contribution plans during 2020. This would apply to ESOPs and 401(k)s. These type of measures, while ideologically inconsistent with protecting retirement savings, are commonly enacted in emergency-type situations.
Employers would be able to delay payment of 2020 payroll taxes until 2021 and 2022.

Q. Are hardship withdrawals and loans, such as those allowed for 401(k)s, allowed in ESOPs?

A. Hardship loans against ESOP accounts are legal but carry substantial risks, and we are not aware of any companies that offer such loans. Companies are far more likely to offer hardship loans or withdrawals from 401(k) account balances because those accounts are backed by liquid assets, unlike the ESOP.

Q. In the CARES Act, is a 100% S Corp ESOP considered a “Money Purchase Pension Source”?

A. No, an ESOP is not considered a money purchase plan.

Q. Under the CARES Act, would we need an ESOP amendment to allow for loans and/or hardship distribution, if one is not written in our plan?

A. Probably. The great majority of ESOP plan documents intentionally do not allow for loans or hardship withdrawals since the majority of the assets in the plan is annually valued company stock, which is relatively illiquid. If you do want to allow for loans and withdrawals, you would likely need to amend your plan. However, we recommend that you put the hardship and loan provisions in your 401(k) plan rather than your ESOP due to the complexity associated with valuing the liquidating the stock held by the ESOP to fund such hardship distributions and loans.

Q. Does the new Payroll Protection Act cover contributions to ESOPs?

A. The Payroll Protection Act covers any contribution to a retirement plan during the applicable eight weeks. The statute itself is skeletal and does not outline the many variations on pay that will come up. New guidance continues to be issued. For now, it appears clear that any contributions to an ESOP during the applicable period qualify for the loan (and loan forgiveness). It also seems clear that the $100,000 limit on eligible pay for this purpose does not preclude ESOP contributions made to people making more than that. What is not clear is if contributions made at the end of the year to pay an ESOP loan qualify or not, for instance by pro-rating team over that time period. Note that these answers are not pursuant to any specific SBA guidance, but represent what advisors are telling us as of April 8th, 2020. We will update these questions if we get additional guidance

Q. Are contributions used to handle repurchase covered by the PPL?

A. Again, the answer is not clear. If you put funds into the ESOP and use them to buy back shares, the answer probably is yes; if you use company funds to buy back shares, the answer is not known at this point (April 8th). We will update these questions if we get additional guidance.

Loans Under the CARES Act

Q. How do CARES Act distributions affect ESOPs?

A. The CARES Act allows “coronavirus-related distributions” (CARES distributions) from retirement plans, including ESOPs. Distributions under this act can be made to employees who are diagnosed with SARS-Cov-2 or Covid-19, whose spouse or dependent is diagnosed with the virus or disease, or any individual who experiences adverse financial consequences resulting from quarantine, furlough, being laid off, a reduction in work hours, or being unable to work because of a lack of child care. Unlike normal early distributions, these are not subject to the 10% early distribution tax. The distributions may be made between Jan. 1, 2020, and Dec. 31, 2020. Distributions are limited to the lesser of $100,000 or 100% of the participant’s account balance. The distributions can be repaid to the plan, without interest, within the three-year period starting the day after the participant receives the CARES distribution. It does not have to be to the ESOP; it can be to another qualified plan. If not repaid, the CARES distributions are subject to income tax.

ESOP companies can choose to implement this plan for their ESOP and/or other retirement plans. If they choose to do it for the ESOP, it could be in shares that can be put back to the company or in cash. It may be difficult to determine at what price the employee would repay the loan if buying back shares as opposed to putting cash in a retirement plan. Some ESOPs may be attracted to this option to help affected employees and/or to manage repurchase by buying shares now rather than later, assuming they have the financial strength to do that.

Q. What are the rules and coverage for the Payroll Protection Act?

A. The Act provides that business who qualify as small businesses (see question below) can obtain a loan equal to the lesser of (i) $10,000,000 or (ii) 2.5 times the average monthly payroll costs during the prior year, plus the amount taken out for an economic injury disaster loan between February 15, 2020 and June 30, 2020 if the applicant wants to refinance that amount into the Payroll Protection loan.

Q. What are the size standards under the Payroll Protection Act?

A. Businesses who either have fewer than 500 employees or, if 500 or more, otherwise qualify as a “small business concern” under rules set out by the Small Business Administration. You can also see a useful table here. Note that many ESOP companies with more than 500 employees will qualify for this program. While the funds for this program are likely to run out, there is a very good chance they will be added to.

Q. What counts as payroll under the Payroll Protection Act?

Wages, commissions, cash tips, payments for vacation, parental, family, medical, or sick leave, insurance premiums, retirement benefits, and state or local payroll taxes. Cash compensation, but not benefit costs, for any employee making over $100,000 per year do not count.

Q. What are the terms of payroll protection loan?

A. The loan carries a 1.0% per year interest rate for a maximum of two years. The first payment is due six months after the loan is taken out.

Q. What is the forgiveness part of the program?

A. The loan will be forgiven up to the amount borrowed to cover payroll costs (as defined above), interest on mortgages and for rent and utilities. Non-payroll costs cannot exceed 25% of the forgiven amount. This amount will be reduced if you do not maintain the same number of full-time equivalent employees after you close on the loan compared to what you were paying between February 15, 2019 until June 30, 2019 or January 1, 2020 until February 29, 2020. The forgiveness amount will also be reduced by the aggregate amount of wage and salary reduction for any employee of 25% or more compared to the previous quarter. Any reductions in the number of employees or wages and salary that occurred between February 15, 2020 and April 26, 2020 will not be included in the reduction in the forgiveness amount if the reductions are reversed by June 30, 2020.

Q. Who has to sign for the loans?

A. Banks generally want the board and the chief executive officer and chief financial officer to sign. The trustee does not have to sign.

Q. Do there need to be personal guarantees?

A. No.

Q. Does the new Payroll Protection Act cover contributions to ESOPs?

Q. Are contributions used to handle repurchase covered by the PPL?

Q. Are expenses that are forgiven under the PPP tax-deductible?

A. In notice 2020-32 issued April 30, the IRS stated that any expenses that are normally deductible but are subject to loan forgiveness under the Payroll Protection Program will not be deductible. 100% S ESOP companies, of course, pay no income tax, so this is not an issue, but it is for all other ESOP companies.

Loans under the Economic Injury Disaster Loan Program

Q. What is the Economic Injury Disaster Loan Program (EIDL)?

A. EIDL loans are also available to ESOPs. They can be made for up to 30 years at 3.75%

Q. Is there loan forgiveness under the EIDL?

A. No, but you can request an emergency $10,000 advance that does not have to be repaid, even if you do not qualify for the loan.

Q. What does an EIDL cover?

A. Fixed debts, payroll, accounts payable and other debts that would have been paid but for the disaster occurring.

Q. What are the size standards?

A. The same as for the Payroll Protection Act (see above).

Q. Are personal guarantees required?

A. Yes, for loans above $200,000.

The Mid-Sized Business Loans

Q. Do ESOP companies qualify for the new mid-sized business loans?

A. Yes, if they meet the other criteria.

Q. What does the program provide?

A. Loans will be provided at a maximum of 2% annual interest, and first payments can be deferred for six months. The loan is not forgivable. The application deadline is the end of 2020. The company must show it “intends to restore not less than 90 percent of the workforce of the Recipient that existed as of February 1, 2020, and to restore all compensation and benefits to the workers of the Recipient no later than 4 months after the termination” of the declaration of a public health emergency.

Q. What are the requirements for the loans?

A. The company cannot “pay dividends with respect to the common stock of the eligible business, or repurchase an equity security that is listed on a national securities exchange of the recipient or any parent company for the recipient while the direct loan is outstanding, except to the extent required under a contractual obligation that is in effect as the date of enforcement of this Act.” This appears to allow closely held ESOP companies to continue to make repurchases of shares, but not pay dividends or distributions. No officer who received more than $425,000 in 2019 can receive compensation that exceeds that.

IRS Deadlines

Q. Has the IRS issued any guidance or amendments to deadlines in 2020?

Yes. IRS Notice 2020-23 automatically postpones a number of benefit plan deadlines, including several ESOP deadlines. Any deadline that would ordinarily fall on or after April 1, 2020, through July 14, 2020, is now automatically extended to July 15, 2020. These include:

Sixty-Day Rollover Requirement: Distributions that are eligible for rolling over into another retirement plan or IRA must be rolled over within 60 days to that other plan to avoid taxation. If the end of the 60-day period would fall within the delay period, the 60-day period is automatically extended to July 15, 2020.

ESOP Put Options: ESOP participants have two 60-day put periods after receiving a distribution in shares to sell the stock back to the company. In employee stock ownership plans (ESOPs) maintained by many private employers, participants are entitled to receive distributions of their ESOP accounts in the 60-days following the distribution then another 60 days one year later. If the end of the 60-day period would fall within the delay period, the end of the 60-day period is automatically extended to July 15, 2020.

Identifying Qualified Replacement Property in a Section 1042 Transaction: Sellers to an ESOP who use Section 1042 to defer taxation on the gain must identify Qualified Replacement Property investments not later than 12 months after the sale. If that 12-month period falls in the delay period, the deadline is extended to July 15, 2020.

Distributions

Q. Like many companies, we are facing a very difficult financial situation. Can we defer making distributions?

A. The issue here is whether this violated the anti-cutback rule. In past recessions, many companies have amended their plans to delay distributions. Arguments can be made on both sides of this issue, and having a conversation between you, your trustee, and your attorney is essential. It may be easier to do this if your current policy calls for earlier than the required maximum time to start distributions. Some plans, for instance, provide for earlier distributions of some amount (such as under x dollars) or of all accounts provided doing so does not put the company at substantial financial risk. If you are currently paying out only under the default ERISA rules (starting one year after the end of the plan year for employees who die, retire, or are disabled; five years after the end of the plan year for everyone else), this may be more difficult.

If your current plan calls for distributions in shares, employees have a put right. If the company cannot redeem them because it would potentially create insolvency, state law may actually prevent you from purchasing them. You would need a solvency opinion from a CPA, which may be reluctant to do that.
As we will repeat in many of these answers, it is critical to communicate with employees in these situations about what to expect and why. Many will be understanding. Many may also not want to put back shares in 2020 or 2021 and prefer to wait until the economy improves.

Q. Our rules provide that employees have two 60-day periods to put back shares they receive in distributions. We expect some will want to wait until the economy improves. Can we allow that?

A. Yes, as long as you make this offer on a non-discriminatory basis.

Q. We now pay our distributions in cash. Can we change that to making them in stock?

A. The form of the distribution is not a protected benefit, so yes, you can do that. That may make it easier to delay actual payment for the shares, as explained in the answer on deferring distributions. Make sure to explain to employees how and why you are doing this.

Q. We have an account rebalancing provision in our plan that allows us to buy and sell shares within the plan so everyone has the same percentage. Can we not do that this year?

A. Yes, this is an optional plan design feature and can be changed.

Q. We have an account segregation policy in which we buy shares from terminated employees and pay the money in cash investments but don’t pay that out till later. Can we not do that this year or any year we are facing significant financial issues?

A. Yes, this is an optional plan design feature and can be changed.

Q. Can we delay satisfying the diversification requirement?

A. No, this is a statutory requirement.

Valuation

Q. What impact are current economic conditions and COVID-19 having on December 31, 2019 valuations?

A. The simple answer is that current world events have no impact on December 31, 2019 valuations. Appraisal standards require that opinions of fair market value only incorporate what was known or knowable as of the Valuation Date. As such, December 31, 2019 valuations will not include the impacts the COVID-19 pandemic are currently having on the economy, a company’s industry, the capital and equity markets, and the specific company being appraised. While this valuation position is not in question, it will likely create a challenge in the execution of many December 31, 2019 valuations that have not yet been completed or even initiated. Management will be asked to discuss the state of the company’s business at year-end 2019 and generate projections without being influenced by what they now know to be the initial impact of COVID-19.

Q. My business has been materially impacted by COVID-19 and I believe that the value of my company is significantly different than it was as of December 31, 2019. How do I address this situation before paying terminated participants?

A. Assuming that a company’s value has been significantly impaired by the pandemic, an interim valuation may be considered. But a careful review of other options and an understanding of the actual magnitude of the potential difference in value and impact on repurchase obligation is critical. The ultimate decision on whether an interim valuation is considered prudent will ultimately depend on ESOP plan document provisions and analysis by the ESOP plan administrator, and ESOP trustee, and legal counsel.

Q. I think I want an interim valuation. What is involved?

A. An interim valuation is not much different than the customary year-end valuation. The valuation must include current financial statements, a new forecast that considers near and long-term impacts of COVID-19 (and any other specific factors that influence the company’s expected performance, positive or negative), current industry research, an update of guideline public company and merger and acquisition analysis, and a discussion regarding the current state of the company allowing an appraiser to accurately assess all of a company’s individual risks. In addition, most trustees require a full appraisal report for an event this significant versus any type of summary or limited valuation document.

Q. When should I get the interim valuation done?

A. Unfortunately, no one knows right now. The only definitive answer is that it should be done before any 2020 distributions are processed. While the near-term impacts of COVID-19 may be clear, the lack of clarity on the long-term impacts of COVID-19 on the economy, various industries, the capital and equity markets, and the specific company being appraised result in challenging forecasts and ultimately challenging valuations. To the extent possible, ESOP companies may choose to delay conducting an interim valuation which could result in better clarity on future performance.

Thanks to Matt Schubring at Chartwell for these responses.

Executive Compensation

Q. If the 12/31/2019 valuation of our company’s stock does not reflect the downturn associated with the pandemic, can we do an interim valuation or delay distributions under our stock appreciation rights (“SARs”) plan or other nonqualified deferred compensation plan (“NQDCP”)?

A. As always, it depends. There are two issues to consider: value and timing.

Value: As to the value, this is a matter of contract law and will turn on the language in the plan document for the NQDCP, which can broadly be categorized into three main approaches:

If the NQDCP provides that fair market value (“FMV”) equals FMV as determined for the ESOP for the last day of the preceding ESOP plan year, then the NQDCP value is fixed at the 12/31/2019 ESOP value and an interim valuation would not help.
If, however, the NQDCP has fairly common language that ties FMV to the most recent ESOP value, the value in the NQDCP would automatically adjust to an interim ESOP valuation obtained prior to the NQDCP distribution. If this is the case, it is important that the updated ESOP value is also used for the NQDCP value. To do otherwise would likely mean the NQDCP was being paid at a value higher than FMV, in violation of the NQDCP document and potentially creating issues under Section 409A (more below).
Finally, the NQDCP language might provide the board with discretion to adjust the value or obtain an interim valuation.

This is a tricky area so be sure to consult with your legal counsel when interpreting these provisions.

Timing: Setting aside qualified plans (e.g., 401(k) plans, ESOPs), Section 409A generally applies to all arrangements that defer the receipt of compensation for more than 2 ½ months after the end of the year (“NQDCP”) in which the compensation was no longer subject to forfeiture (i.e., vested). Section 409A applies to such deferred cash compensation plans, phantom stock plans and some SARs plans. If Section 409A applies, distribution timing must be objectively determinable on the date the award is granted, and must be tied to permissible distribution events, such as death, disability, separation from service, or a specific date (e.g., age 55). Once distribution timing is set at the time the award is granted, it cannot be altered or delayed to a later year unless making the distribution would create such a financial hardship as to jeopardize the company’s ability to continue as a going concern. Note that the distribution cannot be delayed merely because the distribution would cause the company to violate a loan covenant. Further analysis is needed to determine whether violating the loan covenant would cause going concern status to be jeopardized. If making the distribution would jeopardize going concern potential, the distribution can be delayed until the first taxable year of the employee that making the distribution would not jeopardize going concern potential. Note also that even if the distribution can be delayed due to the going concern rules, the value paid in the subsequent year might still be the 12/31/2019 value based on the contractual arrangement, as discussed earlier.

Finally, some arrangements are not subject to Section 409A, such as SARs or stock options where recipients can choose when to exercise the award, the awards are granted at fair market value (i.e., non-discounted) and payment occurs at the same time the award is exercised. Recipients holding such 409A-exempt SARs and stock options might prefer to exercise now to avail the 12/31/2019 price. Or, if it is clear the NQDCP value would follow an interim valuation as discussed above, such recipients might decide to delay the exercise-- as provided by the exercise window afforded by the plan document-- until company stock price has recovered to their liking. As always, check with your legal counsel regarding the applicability of Section 409A and the specific provisions of your plan.

Thanks to Matt Keene of Chartwell for this response.

Repurchase obligation, diversification, segregation, plan operations

Q. We expect to have a cash flow problem meeting our repurchase obligation. Can we delay it? If so, how should we do it?

A. You may be able to alter your distribution provisions to lower the amount you are required to pay out. For example, if your plan states distributions will be paid in a lump sum, amending the plan to change to installment distributions could reduce the amount required to be paid by up to 80%. In addition, you can amend the plan to not force out distributions less than $5,000 or less than $1,000. What is a bit more of a grey issue. is whether or not you can change the timing of when a distribution is to begin. For example, if your plan document states distributions will be offered beginning the year after the year in which the participant terminates employment, it is unclear whether you can amend the plan to institute a delay (say, five years). Most practitioners say this is not allowed because it is an anti-cutback issue. It’s uncertain how the current economic crisis will impact share prices for 12/31/2019, if at all, because the fallout from COVID-19 was largely unforeseen at that time. However, it will surely impact share prices if a valuation was performed for these companies as of 3/31/2020 or later. Therefore, trustees may want to prevent the ESOP from making payments to terminees and/or those who are eligible to diversify based on the 12/31/19 valuation. Rather, they may want to call for an updated valuation (to the extent the Plan allows for such) if they feel the 12/31/19 valuation is no longer a good representation of the company’s value and that using that valuation would have a significant negative impact all the other participants in the plan. Also, keep in mind that while the plan may be required to offer the distribution to the former employee, unless the vested account balance is $5,000 or less, the participant will need to positively elect to receive the distribution. So, there is also a chance participants will knowingly choose to defer receipt of the distribution until the economic conditions rebound and their account balance rebounds.

Thanks to John Prodoehl of Principal Financial for this response.

Q. We expect to have a cash flow problem meeting our account segregation policy. Can we delay it? If so, how should we do it?

A. A segregation policy is a provision that can be amended out without anti-cutback issues. So, you can simply amend the Plan to remove segregation. The segregation language in most plans reference "available cash", which means the plan will segregate terminees out of company stock to the extent the ESOP has available cash to do so. If the active ESOP participants don’t have cash in their accounts, no segregation happens. Thus, the company has control over whether segregation occurs because it determines whether cash goes into the ESOP (via contributions and/or dividends or S-distributions).

Thanks to John Prodoehl of Principal Financial for this response.

Q. We expect to have a cash flow problem meeting our diversification requirements. Can we delay it? If so, how should we do it?

A. I am not aware of any way to delay offering or honoring the statutory diversification elections made by qualified participants. It’s uncertain how the current economic crisis will impact share prices for 12/31/2019, if at all, because the fallout from COVID-19 was largely unforeseen at that time. However, it will surely impact share prices if a valuation was performed for these companies as of 3/31/2020 or later. Therefore, trustees may want to prevent the ESOP from making payments to terminees and/or those who are eligible to diversify based on the 12/31/19 valuation. Rather, they may want to call for an updated valuation (to the extent the Plan allows for such) if they feel the 12/31/19 valuation is no longer a good representation of the company’s value and that using that valuation would have a significant negative impact all the other participants in the plan. Many participants may positively elect to diversify if they think that the 12/31/2019 stock price is overstated vs. what the next price might be. Again, getting an updated valuation to use in processing these diversification elections might be a good way to address this. Then again, there is a chance that participants will opt to not diversify if the value has gone down significantly during these times and they may want to hold onto the company stock in anticipation of the company value coming back.

Thanks to John Prodoehl of Principal Financial for this response

Q. We may need to lay people off because of the coronavirus impact on our business. We have been told this may lead to a partial termination. What does that mean?

A. A partial termination of an ESOP or other qualified plan occurs when a significant portion of the workforce is terminated or otherwise loses its rights to benefits under the plan, such as the cessation of contributions or the tightening of vesting requirements. With Revenue Ruling 2007-43 (July 9, 2007), the IRS issued clarifying regulations on what constitutes a partial plan termination. The ruling says that an employer-created termination (such as a layoff) of coverage for 20% or more of plan participants in any one plan year is a partial termination. Voluntary employee turnover does not count, but layoffs or changes in plan coverage rules, for instance, would (so people may still be working for the company, but a partial termination would nonetheless be deemed to have occurred). Employees no longer covered must be made to be 100% vested under existing partial termination requirements. Some employers voluntarily declare a partial termination for a smaller percentage of their workforces to make sure the affected employees become fully vested.

Q. Are any of the new government programs for loans a potential source for handling repurchase obligations? What about other costs?

A. At this time (March 23), legislation related to corporate loans is still pending at the Federal level. It is unclear the terms/stipulations for any loan programs the Federal government approves.

However, the Federal government offers a Small Business Association (“SBA”) Disaster Relief Loan for businesses, private nonprofits, homeowners, and renters. These are low interest loans that can be used to repair or replace the following items damaged or destroyed in a declared disaster: real estate, personal property, machinery and equipment, and inventory and business assets. Businesses can also apply for Economic Injury Disaster Loans (EIDL). Substantial economic injury means the business is unable to meet its obligations and to pay its ordinary and necessary operating expenses. EIDLs provide the necessary working capital to help small businesses survive until normal operations resume after a disaster. While not perfectly clear, ESOP repurchase obligations may be considered ordinary and necessary operating expenses that are incurred on a regular basis. (Note: this is one interpretation and subject to confirmation with government authorities through the application process). These loans may not exceed $2 million. The interest rate for the EIDL will not exceed 4% and the term will not exceed 30 years.

In addition, states and municipalities are adding programs by the day to support local businesses. Check your governor’s website for up-to-date information about relief available in your area.

Thanks to Dan Kaczmarek of Chartwell Financial Advisory for this response.

Q. My company has a safe harbor contribution, can we stop this due to COVID-19?

A. Safe harbor non-elective (3%) or safe harbor matching contributions may be reduced or suspended if one of the following criteria are met:

The plan sponsor is operating at an economic loss as defined in Internal Revenue Code 412(c)(2)(A) OR
The plan sponsor’s annual safe harbor notice specifies the right to suspend or reduce contributions midyear

In the event these contributions are suspended mid-year it may not be possible to “re-start” later in the year. The majority of plans which utilize these provisions do so in order to avoid Average Deferral and Average Contribution Percentage testing under §401(k) and §401(m). One solution may be to revise the notice to exclude Highly Compensated Employees (HCE) during the affected period. By doing so the plan would continue to provide these contributions to non-highly compensated rank and file employees and avoid the necessity to test under the 401(k) rules which could potentially result in taxable refunds to HCE’s.

HCE’s are those employees who earned over $120,000 in 2018 plan years or over $125,000 in 2019 plan years. The determination of HCE is a look-back period to the compensation in the prior plan year. In addition, employees who have direct ownership of greater than 5% and certain family members are HCE as well.

Q. We have layoffs of employees due to COVID-19. Will this affect our Minimum Coverage Test?

A. Provided the plan document indicates that employees who are on temporary or approved layoff as of the end of the plan year are considered employees it may not have an impact. The minimum coverage test compares the number of Non-Highly Compensated Employees (NHCE) to the number of Highly Compensated Employees (HCE) who are eligible for the plan and receive the employer contribution. At least 70% of the NHCE’s must receive a benefit (aka contribution or forfeiture reallocation) under the plan.

If layoffs extend for a long period of time it may be possible that employees do not meet the minimum required hours to qualify for a contribution (typically 1,000). In addition, in the event there is a significant reduction in the workforce due to termination of employment the test may fall below the required threshold. Should this occur plan sponsors may amend the plan up to 8 ½ months following the end of the plan year to add employees in a fashion which allows the minimum coverage test to pass.

Q. We have layoffs due to COVID-19. Will this affect the contributions we can make to our ESOP?

A. Potentially. The Maximum Deductible Contribution is calculated by first determining the eligible compensation for a plan year. For 2020 plan years the maximum compensation which can be counted for qualified plan purposes is $285,000. A layoff or key executives reducing or even ceasing to receive compensation will reduce this figure. In addition, if employees are on layoff for an extended period of time their compensation for the plan year will be reduced.

In the event a plan sponsor exceeds their maximum contribution limit the excess is taxed at 10% and regulatory filings are required. This may be problematic for plans that have large cash out lay to pay participant distributions or plans which have leveraged ESOP loans with higher benefit levels. When determining the payments which count towards this limit the following are included: employer matching contributions, safe harbor contributions, discretionary contributions to the ESOP or other employer sponsored defined contribution plans as well as Principal payments on a C-Corporation ESOP or Principal PLUS Interest payments on a S-Corporation ESOP loan.

Q. Will COVID-19 cause my §409(p) test to fail and impose penalties on my company/plan?

A. It depends. The effects of COVID-19 on items such as the fair market value of the stock at plan year end, the employee population after terminations or layoffs and the manner as well as amount of distributions paid out to participants may have an effect on the test

The important things to keep in mind are that cash-based synthetic equity such as funded deferred compensation plans, annuity plans which rely on actuarial conversion to a future date, and stock appreciation rights (SARs) all require a conversion to applicable shares for testing purposes based upon Fair Market Value (FMV). If your FMV on the testing date has decreased these items will result in a higher number of shares being considered for testing purposes.

In addition, leveraged ESOPs are required to do a mock allocation of shares awaiting release from leveraged loans on the testing date. Significant changes to the employee population or compensation could result in significant changes to the projections. Careful monitoring and review of the company’s situation prior to year-end may be prudent.

Culture and communications

Q. With our staff working remotely now, we are concerned about losing connection with people, but also concerned about burdening people with too many virtual meetings.

A. This is a major concern. In an interview with the radio show Freakonomics, Stanford economist Michael Bloom, who has studied this issue said “One narrow piece of advice around working from home would be to try and regularly check in with your employees. So, it’s an unusual thing to do, but we’re in unusual times. You could easily set up every day, beginning of the day, end of the day, 10, 15 minutes, face-to-face, one-on-one Skype call and just chew the fat. It’s going to be really important for employees to feel like somebody is there that cares about them and notices they’re there.” That might also take the form of a 10-minute check in for employee teams or even larger groups every day to review any new ideas, projects, or problems.

One of our members noted that they have also placed a great focus on checking in with staff members multiple times per day, specifically on their physical and mental health, even tasking certain extroverts on their team to reach out to specific individuals at least daily via video chat or phone call. Employees have given great feedback on their appreciation for the communications and are grateful for the open and caring interaction.

NCEO COVID-19 Resource Page

COVID-19 Questions and Answers

Updated May 4, 2020 at 3:00 pm PT

How is the government responding and how will it affect me and my business?

What are our options for handling distributions?

How will valuations be affected?

What issues are there surrounding executive compensation?

What can we do to mitigate difficulties in managing repurchase obligation, diversification, and segregation requirements?

How are companies communicating and maintaining their culture through difficult times?