After nearly 19 years and five appearances before the 7th Circuit Court of Appeals, a dispute over retirement benefits has ended where it began and elicited an admission of mistaken interpretation from the court.
The class action, Robert Matz v. Household International Tax Reduction Investment Plan, 14-1683, 14-2507, has provided some answers to questions concerning when employers have to fully vest their workers’ benefits during a layoff.
Federal law requires companies to fully vest the affected workers when the business reduces the workforce. However, the 7th Circuit noted, 26 U.S.C. Sec 411(d)(3), which refers to partial termination, does not clearly state what a partial termination is nor how to calculate a partial termination.
Previously, the rule of thumb used by lawyers and accountants for determining when a partial plan termination had occurred was when 20 percent of the workforce was reduced within a plan year. However, the Internal Revenue Service had never issued a rule formally setting the 20-percent trigger point, and Matz highlighted an ongoing source of confusion by asking who comprises the 20 percent.
The 7th Circuit answered that question differently over the course of the litigation. The appellate court finally settled on the 20 percent threshold and the IRS has established the calculation for identifying a partial plan termination.
In December, the 7th Circuit issued its ruling on the fifth appeal in what the court described as “a seemingly interminable class action suit.” The court dismissed the suit as having no merit and affirmed summary judgment in favor of Household International Tax Reduction Investment Plan plus the award of $64,000 in legal costs.
Indianapolis attorneys Stephanie Smithey of Ogletree Deakins Nash Smoak & Stewart P.C. and Marc Sciscoe of Ice Miller LLP said the combination of decisions from the 7th Circuit and the IRS rule has clarified some of the issues surrounding when employers have to vest retirement accounts.
“The IRS really has followed the approach of the 7th Circuit in Matz,” Sciscoe said, “and (the December 2014 court decision) is really just a further firming up of that by the Circuit Court.”
Back to the beginning
The class action started when Robert Matz lost his job and then sued his employer in 1996 in the U.S. District Court for the Northern District of Illinois, Eastern Division, for the unvested proportion of his retirement plan. He maintained the company had to fully vest his benefits because he was part of a partial plan termination.
Matz worked at Hamilton Investments Inc. from 1989 until 1994 when Hamilton was sold by its corporate parent, Household International Inc. At the time of his involuntary separation, Matz was 60-percent vested in his company’s retirement plan and was paid $27,914.10, which represented 100 percent of his contribution and 60 percent of Hamilton’s matching funds. The remaining 40 percent, or $7,289.92, of Hamilton’s contribution was forfeited.
The 7th Circuit’s first ruling in Matz came in 2000 and tackled the issue of whom to include in the partial-termination equation. Written by Judge William Bauer, the court affirmed the District Court’s method of including in the analysis both fully vested and non-fully vested employees who lost their jobs.
Nevertheless, the court was reluctant to affirm. It described Household’s argument as logical that only non-fully vested terminees should be counted. And the court pointed to In re Gulf Pension Litigation, 764 F.Supp. 1149, 1165 (S.D. Tex 1991), which excluded vested participants from both sides of the equation, as best furthering the purposes of the partial-termination statute.
Still, the panel maintained it had to give deference to the IRS. The agency spelled out its view that both vested and non-vested participants should be counted in an amicus brief it filed in Weil v. Retirement Plan Administrative Committee, 933 F2d 2106, (2nd Cir. 1991).
A year later, the Matz case returned and this time the 7th Circuit was freed from deferring to the IRS. A ruling from the Supreme Court of the United States issued in United States v. Mead Corp., 533 U.S. 218 (2001), noted that courts do not have to give deference to agency interpretations that are not part of a formal rulemaking procedure.
Since the 7th Circuit had based its original decision only on an amicus brief, the court reversed the lower court in 2001. It sided with the defendant’s contention that only non-vested participants should be counted when determining whether a partial plan termination has taken place.
Not addressed by the court was how to calculate percentage of workers affected by the partial termination.
When Matz came before the court again in 2004, the 7th Circuit addressed the calculation by going back to the IRS’s position in the amicus brief. The court set a rebuttal presumption of a 20-percent or greater reduction in plan participants, and it established that fully vested and non-fully vested employees had to be included in the calculation.
“…Having toyed with the alternatives, we think it is the best available and we respect the IRS’s experience in formulating tax rules,” Judge Richard Posner wrote for the court.
In 2007, the IRS issued Revenue Rule 2007-43 which formally adopted the 20-percent margin.
Also, the IRS took the 7th Circuit position that the reduction does not have to occur in a single year if the downsizing was done over a couple of years as part of an overall corporate strategy.
The 2000 Matz decision held the plaintiff could combine terminations from multiple years if he could prove the events were related. Through the subsequent decisions, the 7th Circuit kept that position. But in 2014, the court sidestepped whether all the Household terminations were part of a single act. Instead, the court found that even if all the reductions under Matz were combined, only 17 percent of the plan participants were affected, which is below the 20-percent threshold.
In the 2014 decision, the court made a stunning admission: “We now believe we were mistaken.”
The statement refers to the court’s assumption in the 2004 decision that money from the terminated employees’ unvested retirement accounts returned to the employer and created a tax windfall. Ten years later, the court amended its earlier conclusion and noted any funds the employer removes from the plan would be subject to taxation.
“I think that is one of the most fascinating sentences I’ve ever read in an appellate decision,” Smithey said.
The reasoning in the 2004 opinion left employment attorneys scratching their heads, she said. Employers reduce workforces for economic reasons and changes in business strategies, but no employer has terminated workers to get the money forfeited by the 401(k) match.
Yet, the 7th Circuit concludes, “But whatever the correct rationale for full vesting in the case of a partial termination, it does not affect our decision today….”
However, Smithey questioned the affect of the court’s reasoning in 2004. She wondered if any attorney in the case did not make an argument against the ruling since the court had limited the rebuttals to taxes. Perhaps the case would have had a different outcome if other arguments could have been raised.•