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Guest Article

(From the March 19, 2007 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Guidance on PPA Changes to Maximum Deductible Contribution Rules

The IRS has issued Notice 2007-28 to provide guidance on some of the changes the Pension Protection Act (PPA) of 2006 (P.L. 109-280) made to the IRC § 404 maximum deductible contribution rules. The notice focuses on those changes that are effective beginning in 2006 plan years (the "2006 changes"), which are as follows:

Increasing the IRC § 404(a)(1) maximum deductible contribution limit to 150 percent of current liability for single-employer plans (applies for 2006 and 2007 plan years only);
Repealing the special rule that permitted plan sponsors to use the long-term corporate bond rate to calculate current liability for purposes of the minimum funding rules and the 30-year Treasury rate to calculate current liability for purposes of the maximum deductible contribution rules; and
Limiting the application of the IRC § 404(a)(7) combined DB/DC plan limit to cases where the employer's contributions to one or more DC plans exceed six percent of compensation.

The PPA also made changes to the maximum deductible contribution rules that will become effective in 2008 plan years, the same time new minimum funding rules will begin to apply. The IRS plans to issue guidance on these changes in the future.

Applying 2006 Changes When Plan Year and Employer's Taxable Year Differ

The 2006 changes apply to employers' taxable years beginning after December 31, 2005. But how do employers determine their maximum deductible contributions for 2006 taxable years if, for example, their 2006 plan years started on July 1, 2005 and their 2006 taxable years started on January 1, 2006? According to Notice 2007-28, Treas. Reg. § 1.401(a)-14(c) gives employers the following alternative deduction limits for these circumstances:

the deductible limit for the plan year beginning in the taxable year;
the deductible limit determined for the plan year ending in the taxable year; or
a weighted average of alternatives (1) and (2).

The plan year used in any of these alternatives is the "associated plan year."

Whatever alternative an employer uses, the deductible limit for a taxable year will be based on calculations for one or more associated plan years. But the deductible limit must reflect the law in effect for the taxable year rather than the associated plan year(s). Notice 2007-28 illustrates these principles as follows:

For example, with respect to the 2006 calendar taxable year, any associated plan year (i.e., a plan year beginning in 2006 or plan year ending in 2006 that is used to determine the deductible limit for the 2006 taxable year) must reflect the 2006 changes. Thus, if the deductible limit is determined with respect to the plan year ending in 2006 (which begins in 2005), the calculation of the limit with respect to that plan year must reflect the use of an interest rate within the permissible corporate range (instead of an interest rate within the permissible 30-year Treasury rate range) ... that was used for purposes of [IRC] § 412, and must reflect the limitation based upon 150 percent of current liability (in place of the limitation based on 100 percent of current liability) under [IRC] § 404(a)(1)(D). The funding method and other actuarial assumptions that were used for purposes of [IRC] § 412 for that plan year must also be used for calculations of the deductible limit.
As another example, in the case of a taxable year that is not the calendar year and that begins in 2005 and ends in 2006, and a plan year that is the calendar year, the deductible limit for any associated plan year must not reflect the 2006 changes. Thus, if the deductible limit for the taxable year beginning July 1, 2005, and ending June 30, 2006, is determined based upon the plan year beginning in the taxable year (the 2006 calendar plan year), the calculations of such limit must not reflect the limitation based on 150 percent of current liability (i.e., must be limited to 100 percent of unfunded current liability) and may use the 30-year Treasury rate in place of the corporate rate.

Also, when determining the deductible limit pursuant to the 2006 changes, the limit is determined as of the plan year valuation date and adjusted for interest to the end of the plan year or the end of the employer's taxable year, whichever is earlier.

Combined Limit

In general, the IRC § 404(a)(7) combined plan limit applies to employers that sponsor both a defined benefit plan and a defined contribution plan that cover at least one of the same employees. Before the PPA, the combined limit for total contributions to all plans for a year was the greater of (1) 25 percent of compensation, or (2) the amount necessary to meet the defined benefit plan's minimum funding requirements for the year, but not less than the plan's unfunded current liability.

As noted, the PPA amended IRC § 404(a)(7), effective for years beginning after December 31, 2005, to:

exclude multiemployer plans from consideration; and
provide the combined limit only applies in the case of employer contributions to one or more defined contribution plans to the extent that such contributions exceed six percent of the compensation otherwise paid or accrued during the taxable year to the beneficiaries under the plan.

According to Notice 2007-28, employer contributions to a 401(k) cash or deferred arrangement are taken into account for purposes of the combined plan limit. However, employee elective deferrals -- which are treated as employer contributions for several purposes -- are not taken into account. Thus, a 401(k) plan funded solely with elective deferrals is not taken into account for applying the combined plan limit.

The combined limit applies only to those employer contributions to defined contribution plans that exceed six percent of compensation of the plans' participants. If employer contributions to defined contribution plans do not exceed six percent of the plan participants' compensation, the combined limit applies only to employer contributions to the defined benefit plan(s).

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, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Laura Morrison 202.879-5653, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

BenefitsLink is an independent national employee benefits information provider, not formally affiliated with the firms and companies who kindly provide much of the content and advertisements published on this Web site, including the article shown above.