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The recently enacted Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) provides that, beginning in 2002, a 401(k) plan may make distributions to employees who have a “severance from employment” as a result of being transferred to another entity in asset acquisitions or other transactions, regardless of whether the employee performs the same job for the acquirer. This law effectively repeals the Internal Revenue Service’s “same desk rule” for 401(k) plans. This rule has often historically prevented employers from distributing 401(k) plan account balances to employees of divested businesses who went to work for the buyer. Under the law as in effect before EGTRRA, 401(k) plan account balances may be distributed to affected employees when (among other times) (1) all or substantially all the assets of a trade or business are transferred or (2) an employee has a “separation from service.” The Internal Revenue Service has long held that a “separation from service” does not occur in the context of an asset sale if an employee is hired by the buyer and continues to perform the same job at the “same desk,” even though the employee has in fact terminated employment with the plan sponsor and its controlled group. The exact scope of this rule has never been entirely clear. Moreover, breaking the rule could lead to plan disqualification. Consequently, many companies have refrained from making distributions in cases when both the buyer and the seller would prefer to do so for good business reasons. Under EGTRRA, plan sponsors may permit separated employees to elect to receive a distribution of their 401(k) plan account balance, regardless of whether they go to work for the buyer. However, if the buyer and seller agree to a mandatory plan-to-plan transfer of 401(k) plan accounts to a buyer plan, the transferred employees will not be permitted to elect distributions. (This prohibition does not apply if the plan-to-plan transfer is elective on the part of the employees.) The new law is effective for distributions that occur from 401(k) plans after December 31, 2001, regardless of when the “severance from employment” occurred. For example, if a transaction is consummated during 2001, 401(k) plan distributions to former employees will be permitted under the new law so long as the distributions occur in 2002 or later, even though the actual date of severance occurred in 2001.

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