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Excise tax on nondeductible contributions


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12 replies to this topic

#1 Belgarath

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Posted 10 September 2003 - 03:22 PM

We have a potential client who received some bad tax advice, in my opinion, and is in a bit of a fix. I wanted to bounce an idea off some of you gurus.

In 2002, client contributed 40,000 to a Money Purchase plan. Client also installed a 412(i) plan in 2002. The contribution to the 412(i) plan is far in excess of the 25% of comp. limitation, so the MP plan has a portion that is nondeductible, (the amount in excess of 6% of comp as per IRC 4972©(6)(B)) and will be nondeductible for many years, as the annual 412(i) cost will exceed the 25% limitation for the forseeable future.

First, the client was told that this excise tax is "one time only." I disagree. I don't reach the same conclusion from the statute. Furthermore, the form 5330 is pretty clear in the instructions that this excise tax is payable EACH YEAR that the MP contribution remains nondeductible.

Here's my bizarre idea. If you look at IRC 4972©(7), as added by EGTRRA 653(a), it appears that you might be able to take an aggressive interpretation to say that this allows you, for purposes of calculating excise tax only, to pay no excise tax whatsoever. I read the EGTRRA conference committee report, which doesn't say anything additional to support this interpretation in the situation I've outlined. I've told the client to seek ERISA counsel with regard to this idea. But in the meantime, I wondered if any of you have considered this issue, and what conclusion(s) you reached?

#2 Blinky the 3-eyed Fish

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Posted 10 September 2003 - 04:03 PM

(7) Defined Benefit Plan Exception.--

In determining the amount of nondeductible contributions for any taxable year, an employer may elect for such year not to take into account any contributions to a defined benefit plan except to the extent that such contributions exceed the full-funding limitation (as defined in section 412©(7), determined without regard to subparagraph (A)(i)(I) thereof). For purposes of this paragraph, the deductible limits under section 404(a)(7) shall first be applied to amounts contributed to defined contribution plans and then to amounts described in this paragraph. If an employer makes an election under this paragraph for a taxable year, paragraph (6) shall not apply to such employer for such taxable year.

I think I agree. To me this is saying that you could lessen the overall deduction to equal the DB contribution and effectively ignore the DC contribution for excise tax purposes. However, being I have never looked into or heard any of this before, I am a bit skeptical.
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#3 MGB

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Posted 11 September 2003 - 08:44 AM

In order to apply this provision you need to answer "What is the full funding limitation under a 412(i) plan?" I don't know the answer to this (I have never seen or know anyone with a 412(i) plan and hope I never do).

#4 pax

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Posted 11 September 2003 - 08:53 AM

The first order of business might be to re-examine the 412(i) plan. Looks pretty expensive.

#5 Belgarath

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Posted 11 September 2003 - 09:07 AM

Our actuary is on vacation, and I don't know either. It would seem reasonable, however, that if this "full funding" limitation even applies to 412(i) plans, that it would be the required premiums, plus or minus whatever adjustments are necessary for interest. I would assume that for the first year contribution, there would be no interest adjustment, so the "full funding limitation" might simply be the cost? In other words, in a 412(i), there's no range of acceptable costs as there is (at least sometimes) in a regular DB plan. But again, I'm only speculating since I don't KNOW anything about this. Thanks for the responses. As I said, I told them to seek counsel anyway. There are advantages to being able to have the buck stop somewhere else...

#6 Blinky the 3-eyed Fish

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Posted 11 September 2003 - 09:52 AM

There is no FFL in a 412(i) plan.
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#7 MGB

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Posted 11 September 2003 - 10:37 AM

If the the full funding limitation does not apply, then, in my opinion, the EGTRRA provision is not available.

#8 Blinky the 3-eyed Fish

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Posted 11 September 2003 - 10:46 AM

I don't agree. The way I read the first line of 4972©(7) is that an employer may disregard contributions up to the FFL, but not contributions that go over the FFL. Example:

DB Contribution - 100,000
DC Contributon - 25,000
FFL - 120,000

The employer could disregard 25,000 of the DB contribution, deduct 100,000 and pay no excise tax. Again though, this is new to me and I could be way off.

Also, I presume there would be a 25,000 nondeductible in the DB plan.

Edited by Blinky the 3-eyed Fish, 11 September 2003 - 10:49 AM.

"What's in the big salad?"
"Big lettuce, big carrots, tomatoes like volleyballs."

#9 Effen

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Posted 11 September 2003 - 11:43 AM

Was the MP plan doc submitted to the IRS for approval?
Has the MP 5500 been filed?
Would it be easier to amend the corp. return and forget the MP ever happened, especially if the chances of ever using it again in the future are nil? (Not that I would ever recommend such a thing)

He will have admin charges for recordkeeping, 5500's and document work into the foreseeable future for a plan that will provide very little benefit in return. It seems like it may be better for him to cut his losses before he incurs many more.

P.S. It's also good to know that the 412(i) salesmen are asking the proper questions and giving good advise to their clients. Maybe "dom firmani" can jump into this discussion an explain why it's ok.
The material provided and the opinions expressed in this post are for general informational purposes only and should not be used or relied upon as the basis for any action or inaction. You should obtain appropriate tax, legal, or other professional advice.

#10 mwyatt

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Posted 11 September 2003 - 12:44 PM

Uh oh, Effen, might be waking up the sleeping bear...


#11 Belgarath

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Posted 11 September 2003 - 02:30 PM

Thank you all for the responses. It seems likely that this provision cannot be used in this situation, which is what I thought in the first place, but I'll let their attorney figure it out! Thanks again.

#12 Blinky the 3-eyed Fish

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Posted 11 September 2003 - 02:48 PM

Huh?
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#13 Belgarath

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Posted 12 September 2003 - 07:55 AM

Blinky - as I thought about it some more, it seemed to me that since the exception refers specifically to the FFL under 412©(7), and since 412©(7) does not apply to a 412(i) plan, that it would be even more aggressive than I originally thought to attempt to apply this to a 412(i). I think it would work fine in a regular DB, but I can't produce an argument that convinces me that it is "safe" to use it with a 412(i). But maybe their attorney can.