Is This a Sham Termination?

Termination of employment is a valid reason for a participant to receive a distribution from their retirement plan. However, what if that employee is terminated, receives a distribution and is then hired back? Is this a sham termination or is it still a valid distribution?

According to the NAPA Case of the Week: Sham Termination of Employment, “The IRS could view the firing and rehiring of an employee who has taken a distribution of plan assets due to a separation of service or severance of employment as either a “sham” or a “bona fide” termination depending on the facts and circumstances.”

The following facts and circumstances could be considered by the IRS:

  • Was the participant a highly compensated employee?
  • Did the termination of employment and distribution follow the established administrative procedures?
  • Is there documentation to support the termination and distribution?
  • How much time passed from the date of termination to the date of rehire?
  • Were the terms of the plan document followed?

If the IRS deems there was a conspiracy between the plan sponsor and the participant to stage a fake termination of employment to allow the participant access to their retirement funds, the plan status would be in jeopardy and, under investigation, the IRS could impose tax consequences on the employer and the participant.

If you have questions regarding a termination of employment, please contact us.

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