Guest Article

(From the April 9, 2007 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

A Closer Look at IRS Guidance on PPA Changes to Maximum Deductible Contribution Rules for 2006 and 2007

The IRS recently issued Notice 2007-28 ("Notice") 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. One issue the Notice addresses is how and when the combined plan limit -- as amended by the PPA -- applies. The statute could be read to require using the combined plan limit only if the employer's contributions to the defined contribution plan exceed six percent of compensation, but Notice 2007-28 clarifies the combined limit applies to the employer's contributions to the defined benefit plan even if the employer's contributions to the defined contribution plan are six percent of compensation or less. This is a big issue for 2006 and 2007, because employers subject to the combined plan limit may not take advantage of the special 150 percent of current liability deduction limit.

Background

Before the PPA, IRC § 404(a)(1) generally set the maximum deductible contribution employers could make to their defined benefit plans at the amount needed to satisfy their minimum funding obligations under IRC § 412. However, employers that sponsored both a defined benefit and defined contribution plan were subject to a special combined plan limit for contributions to all such plans, equal to the greater of 25 percent of compensation or the amount needed to satisfy the IRC § 412 minimum funding requirements with respect to the defined benefit plan(s). See IRC § 404(a)(7).

Relevant Changes Made by the PPA

The PPA amended IRC § 404(a)(1) to increase the maximum deductible contribution limit to 150 percent of current liability for single-employer plans for 2006 and 2007. The PPA also amended IRC § 404(a)(7) to provide, in part, as follows:

The term "this paragraph" refers to paragraph (7) of IRC § 404(a), i.e., the provision for the combined plan limit. Thus, this language can be interpreted to mean the combined plan limit applies only if the employer's contributions to defined contribution plans exceed six percent of compensation. In other words, if the employer's matching and nonelective contributions to the defined contribution plan total six percent of compensation or less in 2007, the employer would be eligible to use the 150 percent of current liability maximum deductible contribution limit.

However, the IRS interprets the language differently. Their take on this language is explained in Notice 2007-28, Q/A 9, which reads as follows:

In other words, the position of the Treasury Department and IRS is that the combined plan limit still applies to any employer that sponsors both a defined benefit and a defined contribution plan. However, the combined plan limit applies only to the employer's contributions to the defined benefit plan so long as the employer's contributions (other than elective deferrals) to the defined contribution plan do not exceed six percent of compensation.

Effect on Employers

This might sound like an academic debate about statutory interpretation, but it has very real implications for employers. Most employers that sponsor defined benefit plans also sponsor defined contribution plans. The latter interpretation would permit them to deduct defined benefit plan contributions up to 150 percent of current liability for 2006 and 2007 plan years if their defined contribution plan contributions are six percent of compensation or less. However, the Treasury Department and IRS interpretation requires them to apply the combined plan limit to their defined benefit plan contributions in their circumstances.

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. Copyright 2007, Deloitte.