PLR 200030031: IRS reverses prior ruling on hotel workers' separation from service

Plain-English summary

A hotel management company discharged workers when an unrelated operator took over several hotels, and the new operator rehired most of them. The IRS revoked its earlier ruling that these workers had not separated from service for purposes of distributing their 401(k) elective deferrals. It now ruled that the unconditional discharges counted as separation from service, even though many employees kept working at the same hotels, because there was no merger, asset transfer, common ownership, or promise of rehire. The IRS saw no reason to limit the revocation's retroactive effect because participants had not received distributions in reliance on the earlier ruling. The new ruling assumed the plan remained qualified and its trust tax exempt.

Ruling snapshot

• Question: Could Plan X distribute elective deferrals after workers were discharged during the hotel management takeovers?
• Outcome: Revocation of the earlier ruling; the discharges counted as separation from service on the stated facts.
• Key authorities: IRC §§ 401(k)(2)(B)(i)(I) and 7805(b); Rev. Ruls. 79-336 and 80-129.

Full text (IRS public release)

Internal Revenue Service                Department of the Treasury
200030031

Washington, DC 20224
Uniform Issue List: 401.29-02

Contact Person:

Telephone Number:

In Reference to: T:EP:RA:T4
Date: MAY 1 2000
Attn:
LEGEND:
Company A =
Company B =
Company C =

Partnership M=

Trust N =

Plan X =

Ladies and Gentlemen:

This letter will revoke a private letter ruling which
was issued to Company A on September 17, 1997, in response
to a letter ruling request dated January 3, 1997.

In the prior letter ruling, we concluded that any
distribution from Plan X by reason of Company A's discharge
of certain employees in connection with the sale of various
hotels which had been managed by Company A, which
distributions include amounts attributable to employee
elective deferrals, will not be considered to be made on
account of the employees' separation from service within
the meaning of section 401(k) (2) (B) (i) (I) of the Internal
Revenue Code ("Code").


2 200030031

Upon reconsidering and analyzing the facts and
representations made in your request for a letter ruling
dated January 3, 1997, as supplemented by correspondence
dated April 22, 1997, and August 29, 1997, we believe that
the position taken in the letter ruling issued September
17, 1997, is not in accord with the current views of the
Service and that letter ruling is revoked.

Section 7805(b) of the Code provides that the
Secretary of the Treasury may prescribe the extent, if any,
to which any ruling or regulation relating to the internal
revenue laws may be applied without retroactive effect.

Section 13.04 of Revenue Procedure 2000-4, 2000-1
I.R.B. 115 (January 3, 2000), provides, in part, that if a
letter ruling is revoked or modified, the revocation or
modification applies to all years open under the statute of
limitations unless the Service uses its discretionary
authority under section 7805(b) of the Code to limit the
retroactive effect of the revocation or modification.

Pursuant to section 13.05 of Rev. Proc. 2000-4,
generally, where there is good faith reliance on a letter
ruling by the taxpayer, the revocation or modification of a
letter ruling will not be applied retroactively to the
taxpayer for whom the letter ruling was issued or to a
taxpayer whose tax liability was directly involved in the
letter ruling where revoking or modifying the letter ruling
retroactively would be to the taxpayer’s detriment. The tax
liability of each employee covered by a ruling relating to
a qualified plan of an employer is directly involved in
such ruling.

In this case, however, there is no basis for the
Service to exercise its discretionary authority to limit
the retroactive effect of the revocation of the September
17, 1997 letter ruling because such revocation will not
result in any adverse tax consequences to the affected Plan
X participants. A good faith reliance on that letter ruling
would simply mean that Company A was precluded from
distributing benefits to the affected participants because
the ruling concluded that the affected participants had not
separated from service. These participants have incurred no
tax liability in reliance on the ruling as distributions
from Plan X have not been made to them on account of



200030031

separation from service. Thus, there is no need for
retroactive relief.

In support of your request for a private letter ruling
dated January 3, 1997, your authorized representative
submitted the following facts and representations.

Company A maintains Plan X, a defined contribution
plan. Since July 1, 1991, Plan X has provided for only two
types of contributions: (1) employee elective deferrals
under Code section 401(k) and (2) employer matching
contributions. Plan X received its most recent
determination letter on October 24, 1996.

Section 6.4(a) of Plan X provides for the distribution
of a participant’s vested account balance to an electing
participant upon his or her termination of employment.
Section 10.4 of Plan X provides, however, that termination
of employment for purposes of eligibility to receive a
distribution shall not be deemed to occur until the
earliest date therefor permitted by law.

Company A is a hotel management company. The bulk of
its operations consist of managing hotel properties on
behalf of, and as agent for, hotel owners. Under a typical
hotel management arrangement, the owner of the hotel
property enters into an agreement with Company A or one of
its controlled group members, which acts as the hotel
manager. As compensation for its services, Company A
receives a management fee, usually a percentage of hotel
gross revenues. The management agreement specifies a term
at the end of which either party has the right to terminate
the relationship. The agreement generally also provides a
right in favor of the hotel owner to terminate the
agreement prior to the end of the stated period for reasons
such as the sale of the hotel facility by the owner to a
third party. Upon termination of the agreement before the
end of its stated term, the hotel owner is typically
obligated to make a termination payment to the manager.

Under its standard form of management agreement,
Company A does not generally own, acquire or create any
tangible or intangible assets in connection with its
management activities. Virtually all of the assets Company
A needs in order to perform its duties are either leased or
made available to it as part of the management arrangement.



4 200030031

Generally, Company A or one of its affiliates acts as the
employer of the workers employed at the hotels.

June 1996 Takeovers

Pursuant to three separate management agreements,
Company B, an indirect wholly-owned subsidiary of Company
A, was the manager of three hotel properties owned by
Partnership M. On November 27, 1995, Partnership M entered
into an agreement to sell these three hotel properties to
an affiliate of Trust N. Trust N is a large real estate
investment trust that owns a substantial number of hotel
properties. Prior to the transaction, Company B was the
employer of the employees at one hotel location, and
Company C, a sister entity of Company A, was the employer
of the employees at the other two locations. No operating
assets of any kind were transferred by Company A to either
Partnership M or Trust N as part of the sale transaction.
All of the affiliates of Trust N are collectively referred
to herein as Trust N.

Trust N originally intended to terminate the
management arrangements with Company A and its related
entities after the acquisition, but because a substantial
termination payment was due to Company A upon termination
of the agreements and Trust N was not ready to manage the
hotels itself, Trust N agreed to permit Company A to
continue to manage the hotels for a brief period of time.
In accordance with new agreements between Company A and
Trust N entered into on April 26, 1996, Company A continued
to manage the three hotels until June 19, 1996.

As of June 19, 1996, an affiliate of Trust N took over
the management of the three hotels but, effective June 20,
1996, Trust N entered into a licensing agreement with
Company A which allowed Trust N to continue to operate the
hotels under the Company A trade name. It was anticipated
that the licensing agreements would all end by March, 1997,
and Trust N would enter into a licensing agreement with
another unrelated entity.

As a result of the takeovers, substantially all of the
employees working at the three hotels were unconditionally
discharged from their employment by Company A. A few on-
site managers (such as the hotel general managers, sales

managers, and food and beverage managers) were not fired



5 200030031

but were transferred by Company A to other Company A
locations. Trust N replaced this personnel with its own
managers. Trust N did not undertake an enforceable
obligation to rehire any of the discharged employees but,
as anticipated by the parties, Trust N rehired
substantially all of these employees.

Following the takeovers Trust N installed its own
accounting and payroll systems at the hotels, as well as
its own computer systems, training manuals and procedures,
personnel policies, promotion practices, pay levels, and
employee benefits. There is no indication, however, that
the nature of the work of the terminated employees has
changed by their termination and subsequent rehiring.
Further, it also appears that the employees will continue
to work at the same hotel facility as before.

October 1996 Takeovers

A second series of related transactions occurred later
in 1996. On or about August 12, 1996, Trust N acquired
certain hotels from various owners. Of the hotels
purchased, four were being managed by Company A. At the
time of acquisition by Trust N, Company A held no equity
interest in three of the four hotels so acquired and it
indirectly held a less than 5% interest in the fourth.
Prior to the transaction, Company B was the employer of the
employees at two of the hotels and Company C was the
employer at the other two.

Also, on August 12, 1996, the former owners of the
hotels, Company A, and Trust N entered into an amendment to
the management agreement for each of the hotels. Company A
continued to manage the four hotels pursuant to the new
agreements until October 1, 1996. At that time Trust N took
over as the new manager of the four hotels.

Also, as of October 1, 1996, Trust N and Company A
entered into a licensing agreement for each of the four
hotels. The licensing agreements as to three of the hotels
terminated in November, 1996, and the termination payments
became due. The licensing agreement as to the fourth hotel
is expected to be terminated in October 1997 and the
termination payment will become payable.

As a result of the October 1996 takeovers,
approximately 1160 employees at the four hotels were


200030031

unconditionally discharged by Company A. The remaining
facts relating to the discharged employees are
substantially the same as for those recited with respect to
the June 1996 takeovers.

With respect to the June 1996 and October 1996
takeovers, it has been represented that: (1)there was not,
and is not, any overlap in the ownership of Company A and
Trust N; (2) Company A has not liquidated or terminated its
business-- that business will continue to be carried on at
numerous other locations; (3) no assets or property of any
kind have been transferred by or to Company A in connection
with these takeovers; and (4) there was no pre-existing
contractual or other relationship between Company A and
Trust N prior to these takeovers.

Based upon the foregoing facts and representations,
your authorized representative has requested the following
ruling:

That distributions from Plan X by reason of Company
A’s discharge of certain employees in connection with the
1996 takeovers by Trust N, which distributions include
amounts attributable to employee elective deferrals, will
be considered to be made on account of the employees’
separation from service within the meaning of Code section
401 (k) (2) (B) (i) (I).

Section 401(k) (2) (B) (i) of the Code provides, in
relevant part, that distributions of employee elective
deferrals under a qualified cash or deferred arrangement
may not be made earlier than the occurrence of certain
stated events. Section 401(k) (2) (B) (i) (I) further provides
that one of these distributable events is "separation from
service."

Revenue Ruling 79-336, 1979-2 C.B. 187, provides that
an employee will be considered separated from service
within the meaning of section 402(e) (4) (A) of the Code only
upon the employee’s death, retirement, resignation, or
discharge, and not when the employee continues on the same
job for a different employer as a result of the
liquidation, merger or consolidation, etc. of the former
employer (i.e. the same desk rule). Revenue Ruling 80-129,
1980-1 C.B. 86, extended this rationale to situations where
an employee of a partnership or corporation, the business



7 200030031

of which is terminated, continues on the same job for a
successor employer formed to continue the business.

In the instant case, the issue is whether the
terminated employees incurred a separation from service on
account of their discharge by Company A, notwithstanding
the fact that they were subsequently rehired by Trust N to
perform substantially the same job at the same location. In
this case, unlike in Revenue Ruling 79-336, there is no
liquidation, merger, consolidation, transfer of corporate
assets or similar corporate event associated with the
discharge of these employees. There is no overlap in the
ownership of Company A and Trust N. Also, Trust N is not a
"successor employer" to Company A within the meaning of
Revenue Ruling 80-129. Moreover, prior to the 1996
takeovers, the terminated employees had no legal or working
relationship with Trust N. Further, after the 1996
takeovers and the end of the related transition agreements,
Company A had no legal or working relationship with any of
the terminated employees. Also, there was no agreement that
Trust N would hire the terminated employees after they were
unconditionally discharged by Company A. Lastly, Trust N
instituted its own payroll and training systems and its own
compensation and benefits packages.

Accordingly, we conclude that distributions from Plan
X by reason of Company A’s discharge of the terminated
employees in connection with the Trust N takeovers, which
distributions include amounts attributable to employee
elective deferrals, will be considered to be made on
account of the employees’ separation from service within
the meaning of Code section 401(k) (2) (B) (i) (I).

«

The above ruling is based on the assumption that Plan
X is qualified under sections 401(a) and 401(k) of the
Code, and the related trust is tax exempt under section
501(a) at all times.

This ruling is directed only to the taxpayer that
requested it and applies only with respect to Plan X as
submitted with this request. Section 6110(k) (3) of the Code
provides that this private letter ruling may not be used or
cited as precedent.


In accordance with a power of attorney on file with
this office, a copy of this ruling is being sent to your
authorized representative.

Sincerely yours,

[illegible]

John G. Riddle, Jr., Manager
Employee Plans Technical Group 4

Enclosures:

Notice of Intention to Disclose
Deleted copy of the letter