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Furloughs Create Complications for Compensation and Benefits

Posted on May 22, 2020

Employers should be wary of furloughing employees with deferred compensation arrangements if the move is likely to be permanent.

“It would be a problem under [section] 409A to do a one-off arrangement where you’re calling it a furlough, but really it’s a layoff,” Laura McDaniels of Baker Botts LLP said May 21 during a webinar hosted by her firm.

McDaniels said section 409A problems could arise if an employer tries to delay an employee’s termination date and thus delay the required payout under a deferred compensation plan by characterizing the absence as a furlough when there’s really no intention of bringing the employee back.

Equity awards have also been a stumbling block in the wake of furloughs tied to the coronavirus pandemic, McDaniels said.

“Similar to the deferred compensation and severance plan context, equity award plans are generally not going to say: In a furlough situation, this is what happens to your award,” she said. “They may not even say much in the plan document about a leave of absence.”

McDaniels said companies that are dealing with furloughs need to be thinking about how they plan to handle those awards and make sure that they do so consistently. Some companies are electing to have equity awards vest as normal while others are choosing to toll vesting during the furlough, she noted.

Health Plans

Furloughs also pose complicated and unexpected benefit administration issues, and part of the confusion stems from the lack of a clear legal definition of a furlough.

“A furlough is usually considered to be temporary, with the intent that the employee is back to work when the business improves,” McDaniels said. But she added that in the COVID-19 era, the time period for a furlough is often ill-defined.

Some employers want to use furloughs with no fixed end date to keep employees on their health insurance, but this isn’t always possible, according to McDaniels.

“You need to check your health plan documents and your insurance contracts,” McDaniels said. “If someone is on an unpaid leave, usually your plan documents are going to say that they’re ineligible for active coverage after a brief grace period.” Self-insured plans offer more flexibility to treat furloughed employees as active than fully insured plans, she said, but they could still require plan amendments.

“With fully insured plans, it may not be possible to continue treating people as active while they’re on a furlough, especially if it’s a furlough for an indefinite period of time,” McDaniels said.

McDaniels said in making any plan amendments, employers should consider specifying that the amendment is related to the COVID-19 pandemic so it doesn’t end up being broader than intended.

Mark A. Bodron, also with Baker Botts, stressed the importance of contemporaneously documenting any actions taken in case of a future IRS or Department of Labor examination, especially given how quickly practitioners are being forced to act in response to the pandemic.

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