Guest Article

(From the December 8, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Rules: Transferred Surplus DB Assets Can Not Fund Matching Contributions

Final Treasury Regulations under IRC §§ 401(k) & (m) impose new stringent timing requirements on the contribution of matching contributions. Amounts cannot be contributed to fund matching contributions before the employee completes the deferral election or performs the underlying service that relates to the deferral. IRS recently ruled that this timing requirement also applies to the transfer of surplus assets from a terminated defined benefit plan. Transferred surplus assets cannot be used to provide matching contributions if the assets are contributed before the employee completes the deferral election or performs the underlying service. IRS Private Letter Rulings 200836034 & 200836035 (dated June 11, 2008).

Timing Restrictions Apply to Matching Contributions

Recently revised Treasury Regulations under IRC §§ 401(k) and (m) -- which became generally effective for plan years beginning on or after January 1, 2006 -- made numerous changes to the rules governing deferrals and matching contributions. Among the changes implemented was a general prohibition against pre-funding deferral and matching contributions. Specifically, employer contributions are not matching contributions if they are contributed:

Previously, employers were permitted to contribute amounts to the plan for allocation as matching contributions during the plan year -- and, in fact, were permitted to contribute the amounts before the end of the employer's tax year to be allocated as matching contributions after the close of the tax year but before the end of the overlapping plan year. Notice 2002-48 provided that such contributions would be deductible for the employer's tax year in which the actual contribution was made.

In implementing the new timing requirement, the Preambles to the Treasury Regulations made clear that amounts contributed under Notice 2002-8 would no longer qualify as matching contributions:

Preambles to Treas. Reg. § 1.401(k) & 1.401(m), Treasury Decision 9169, December 28, 2004. (Emphasis added.)

As a result of the revised Treasury Regulations, employers are no longer permitted to contribute amounts to the plan to be allocated as future matching contributions -- even if the contributions are "guaranteed" to be allocated within the current plan year.

Surplus DB Assets Transferred to a 401(k) Plan Run Afoul of the Timing Rule

IRS recently addressed whether surplus assets could be transferred from a terminated defined benefit plan to fund matching contributions under an ongoing 401(k) plan that was a "qualified replacement plan" under IRC § 4980(d). That section imposes a tax on reversions to the employer from a qualified plan. The employer is generally liable for a tax equal to 50 percent of the reversion, but the tax is reduced to 20 percent if the employer first establishes a qualified replacement plan or increases benefits as provided under IRC § 4980(d).

In May 2007, two very similar ruling requests were submitted to IRS. In the requests, the taxpayer proposed to transfer all of the surplus assets from a terminated defined benefit plan to its 401(k) plan, and to hold the assets in a suspense account within the 401(k) plan until they were allocated as employer matching contributions ratably, on a payroll-by-payroll basis, over the 7-plan year period beginning with the year of the transfer as required under IRC § 4980(d). In the alternative, the taxpayer proposed to allocate amounts from the suspense account as employer nonelective contributions ratably, either on a payroll or annual basis, over the 7-year period.

In June 2008, IRS issued Private Letter Rulings 200836034 & 200836035 in which it concluded that the transferred surplus assets could not be allocated as matching contribution consistent with the timing requirement of Treas. Reg. § 1.401(m)-1(a)(2)(iii) if they were transferred to the 401(k) plan before the time designated under the regulations. However, it ruled that the amounts could be allocated as employer nonelective contributions as the taxpayer had alternatively proposed.

Impact

Employers and plan administrators need to be aware of the timing rule imposed under the new Treasury Regulations, and that it applies to transferred surplus assets as well as to "regular" employer contributions made to fund matching contribution under a qualified plan. Amounts that are contributed to a plan before the time permitted for contributing matching contributions will result in those amounts not constituting a true matching contribution (e.g., the amounts will not be taken into account for ADP or ACP discrimination testing, and will not be deemed to satisfy the plan requirement to provide a matching contribution). In addition to possible testing failures, prefunding matching contributions -- and thereby allocating amounts which are not provided under the plan (i.e., which look like matching contributions but are not) -- would also raise qualification issues with the failure to follow "a definite predetermined formula for allocating the contributions" as required under IRC § 401(a).

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2008, Deloitte.