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Effen

DB AND DC COMBINED DEDUCTION

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Just an FYI, the following question was raised at the "Dialogue with Treasury and IRS" session:

If an employer contributes to a DB plan for participants who also have an account balance in a DC does the 25% limit come into play or do they actually need to receive an annual addition in the DC plan during the current year.

Harlan Weller answered "that is a fairly messy topic and we have no answer at this time"

I find his none answer very enlightening. I guess I will need to tread a little lighter with my advice to clients.

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Sorry, I did not attend that session. Does this refer to 404(a)(7)?

BTW. Harlan Weller ---> non-answer. I'm shocked, shocked!

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Yes, I believe that was what was being asked. I guess I wasn't expecting a "maybe". I always thought it was fairly clear. Problem was, it was the last question of the session and people were getting restless so there was no ability to follow-up.

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I told the questioner after the session that he should review the threads on this forum for a good discussion of the issues.

A thought: maybe we should put our benefit boards "handle" on our attendance badges at conferences so we can see what those people we have been discussing issues with look like.

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Harlan's non-answer is probably irrelevant.

IRS audits, not Treasury. I care about the line position people, because they supervise the

auditors. Get Holland's answer.

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I told the questioner after the session that he should review the threads on this forum for a good discussion of the issues.

A thought: maybe we should put our benefit boards "handle" on our attendance badges at conferences so we can see what those people we have been discussing issues with look like.

Every time I look, I still fail to see any weirwolf or 3-eyed fish at the conferences. :lol:

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this question was asked at the 2005 ASPPA conference.

It is question #20.

Answer: This will be discussed from the podium.

I was unable to attend the session. but hopefully there is someone out there who did and can provide some insight!

ERISA Outline Book (2006) begining 7.398 gets into a discussion on the issue.

in particluar 7.403 notes PLR 8743096 the IRS ruled that a participant did not cease to be a participant for purposes of 404(a)(7) merely because he longer received allocations of employer contributions under the plan. In that ruling, some DB participants had account balances in the profit sharing plan but were no longer getting contributions.

The same paragraph then goes on to say the IRS has flip flopped on its answer at different conferences, finally suggesting at the 2003 ASPPA conference to transfer the balances of such people to the DB plan to be on the safe side, until the IRS formally rules on the subject.

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Guest FLMaster

PLR 8743096 is old and is not the law. I think everyone is concentrating on 404(a)(7)© and the definition of being a "beneficiary under more than one trust" rather than 404(a)(7)(A) which states" If amounts are deductible...and"the total amount deductible". If a participant is in an existing DC plan and has no employer contributions but no additional corporate deduction is taken, you may make a contribution to the DB plan and take the full deduction without regards to 404(a)(7). The theory of 404(a)(7) is not to allow a double deduction for a DB/DC combination not to create a draconian result.-PLR 8743096 is overruled. :shades:

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What has changed since the 2005 Enrolled Actuary Meeting?

Q15: Deductible Limit: Determining Compensation for Combined Limit on Deductible Contributions

An employer sponsors a defined benefit plan, a profit sharing plan and a §401(k) plan. Employees in groups A and B participate in the defined benefit plan, employees in groups A and C participate in the profit sharing plan and employees in groups A and D participate in the §401(k) plan that provides for employer matching contributions.

a) An active employee in group B has an accrued benefit at the beginning of the year under the defined benefit plan, but accrues no additional benefit during the year. Is compensation for this employee considered for purposes of determining the 25% of compensation limit under §404(a)(7)?

b) An active employee in group C has an account balance at the beginning of the year in the profit sharing plan, but receives no allocation during the year. Is compensation for this employee considered for purposes of determining the 25% of compensation limit under §404(a)(7)?

RESPONSE

a) Yes. This individual is still considered to be a beneficiary under the plan for purposes of §404(a)(7).

b) No. Per Rev. Rul. 65-295, only compensation of individuals who receive an allocation of the employer’s contribution in the year for which such contribution is made is considered.

Copyright © 2005, Enrolled Actuaries Meeting

All rights reserved by Enrolled Actuaries Meeting. Permission is granted to print or otherwise reproduce a limited number of copies of the material on the diskette for personal, internal, classroom, or other instructional use, on the condition that the foregoing copyright notice is used so as to give reasonable notice of the copyright of the Enrolled Actuaries Meeting. This consent for free limited copying without prior consent of the Enrolled Actuaries Meeting does not extend to making copies for general distribution, for advertising or promotional purposes, for inclusion in new collective works, or for sale or resale.

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Guest FLMaster

MPreston-Good the EA's all agree and hence it is the law-I disagree-That is not what the law in the code says: Look at 404(a)(7) carefully

404(a)(7)(A) states If amounts are deductible...since no deduction took place in the DB plan for the accured benefit- no 404(a)(7). Forget Paragraph 404(a)(7)© you need not look at this provision as 404(a)(7) would not apply anyway. MPreston please find substantial authority that supports your position rather than quotes from an EA meeting which could not be used in court anyway.

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I enjoy the sparing between FL & Preston.

Do I understand that FL is now advocating that a participant be judged on whether they have

new accruals in the db plan, not on the fact that the plan requires a contribution?

Thus, under this logic, a participant with this accrual pattern could have both deductions:

First year, full 10% of 415 limit. Second year, no accrual, third year full 10% of 415 limit.

DC plan, first year no contribution by employer, second year full allocation, 3rd year allocation of forfeitures.

First year, deduction only for db.

Second year, contribution to dc plan, plus db funding for any underfunded benefits.

Third year, deduction for db only.

The controversy here is in the second year. No increase occurs in the accrued benefit,

so the participant is "not accruing". However, the benefit could be underfunded, maybe because of the big

commissions paid out of first year contributions (I know this is a snide comment).

Thus the employer is permitted and maybe required to contribute to the db plan.

Does FL say this is not going to limit the dc plan deduction?

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Guest FLMaster

There is a guy called Sal Tripdi who wrote a 5 volume tome in this area. He has a theory of multiple plans and avoiding 404(a)(7) by timing the contributions and deductions. See volume 2 page 379 ERISA Outline Book. I think his theory is correct although I cannot find court cases to support his case. I believe it would not violate 404(a)(7) based upon statutory construction as section A precedes section C (under 404(a)(7)). The problem actually occurs in interpreting section B which discusses "contributions"-not deducations. If the language of the statute is interpreted in light most favorable to the reader and aginst the drafter (which normally how contracts are interpreted-but this is the IRS) I would say 404(a)(7) does not apply and Mr. Tripodi's anaylsis is correct. Michael Cannan's Two volume tome "Qualified Retirement Plans" (West publishing) does not take a position on this issue as does Pamela Purdue's "Qualified Pension and Profit Sharing Plans" (Warren Gorham and Lamont). Which means basically you can make contributions to two plans in the same year, but deductions take place in alternative years and 404(a)(7) does not apply as it deals with "deductions" not contributions. (Assuming you are not afraid of potential tax controversy). Hope this is not confusing.

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The greybook is not merely a "quote" from an EA meeting. It is the IRS formal response with respect to an issue, and, although not binding, represents their current position on that issue.

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I am familiar with the theory of double-up by timing the contribution, but that is changing the subject.

Let's analyze what was advocated in FL's previous post. Remember that 404(a)(7) concerns

the deduction. If contributions are made and deducted for the same year, then the DC plan

may become non-deductible when the combined DB & DC plan cost exceeds 25%.

This does not apply if no participant is benefiting under both plans. The problem of "benefiting"

is what we need to clarify. In my example, year one has the participant benefiting only in the DB plan.

In year two, the participant is not benefiting in the DB plan, but contributions are being made to both plans.

In year three, the participant is benefiting in both plans, but contributions are only made to the DB plan.

The IRS has some people who say that the participant in year two is benefiting in the DB plan,

not because of an increase in accrual, but because a contribution is made to improve funding.

Other IRS people say that any participant with account balances in two plans is benefiting in both.

Still others say that the participant benefits only when new benefits are earned.

This also affects the discussion on counting compensation. If a participant is benefiting, then their compensation

is counted for measuring the 25% limit.

Also of issue is the treatment of 401(k) deferrals. If a participant has deferrals, but no forfeiture allocation,

nor match, nor discretionary contribution, are they benefiting in the 401(k) plan?

If there are other participants in the 401(k) plan who do receive these employer additions,

but no rights under a DB plan, do you have a plan with overlapping participation?

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MPreston-Good the EA's all agree and hence it is the law-I disagree-That is not what the law in the code says: Look at 404(a)(7) carefully

404(a)(7)(A) states If amounts are deductible...since no deduction took place in the DB plan for the accured benefit- no 404(a)(7). Forget Paragraph 404(a)(7)© you need not look at this provision as 404(a)(7) would not apply anyway. MPreston please find substantial authority that supports your position rather than quotes from an EA meeting which could not be used in court anyway.

You are nothing if not entertaining. Do you ever stop to read what you write? (sigh)

since no deduction took place in the DB plan for the accured benefit

Can you elaborate on this? I don't see that statement as being correct, either with respect to the OP or with respect to the example from the Gray Book. Are you saying that you believe the one participant in the example that had no accrual during the year was the only participant in the plan? I don't believe that to be the case. Even if it was, are you saying that if all benefits are frozen that precludes 404(a)(7) from applying? That is certainly a novel interpretation.

What part of 404(a)(7) and Rev. Rul 65-295 does not count as a citation in your mind?

You ask that we read 404(a)(7) carefully. Trust me, it has been read carefully by many. 404(a)(7)(A) merely talks about amounts being deductible. That is it. It doesn't require in any way, shape or form that the amounts deductible be predicated on increases in accrued benefits. Maybe I just missed it though. Maybe you can specify which words therein carry such inference.

The only time that the concept of beneficiary is mentioned is within 404(a)(7)©(i), named, get this, "Beneficiary Test".

As SoCal has pointed out, the controversy revolves around what it means to be a "beneficiary" of either the DB or the DC plan. The IRS believes that anybody in a plan is a beneficiary unless they have been carved out. Rev. Rul. 65-295 does this magical carve out for DC plan participants who do not receive an increase in the employer accounts due to contribution or forfeiture.

Where do you find a similar carve out for a DB plan participant who happens to not have a benefit accrual during the year in question?

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Thanks Mike for the expansion on my comments.

There is still a controversy about what the IRS thinks. In any event, it is not based on what Harlan Weller thinks, unless he can get a Treasury Reg written to clarify the issue. The problem is found in asking what

the IRS will respond on audit in different situations.

I think it is clear that a participant in only one plan is not going to trigger the 25% combined limit.

I think it is clear that a participant who benefits by DC plan additions is going to trigger the 25%

combined deduction limit, where there are DB plan contributions.

I think it is clear that a frozen old Keogh account does not cause the 25% limit (since it is probably irrelevant

for contributions and deductions anyway!)

I don't think it is clear that an employee deferral or a roth 401(k) contribution triggers the 25% combined limit

where there are db plan contributions.

I don't think it is clear that a SEP or SIMPLE plan contribution triggers the combined limit.

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The greybook is not merely a "quote" from an EA meeting. It is the IRS formal response with respect to an issue, and, although not binding, represents their current position on that issue.

I suggest caution here. The Gray Book is not a formal response. For example, at the bottom of every page is this:

The above Response is a summary, prepared by representatives of the Program Committee, of the oral responses to the question posed to certain staff members of the Treasury and IRS, which represent only personal views of the individuals who provided them. Accordingly, the Response does not necessarily represent the positions of the Treasury or the IRS and cannot be relied upon by any taxpayer for any purpose.

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Guest FLMaster

MPreston: Sorry guys, you can flush your Gray or Grey or red book down the toliet in court as well as the IRS informal opinions. (read Lucky stores v. Commissioner (1996) sheding some light on Sal's theory although the issues revolve more around 404(a)(6)).

404(a)(7) discusses DEDUCTIONS in section A not CONTRIBUTIONS nor does it care about who is BENEFITING. Everyone runs to section C and trys to interpret who is benefitting under a plan, if so theory says a7 is triggered. I say look at section A in "pari matera."(very sic).

If you do not take a D-e-d-u-c-t-i-o-n for the plan 404(a)(7) does not apply. I do not care if there is an "accrual" I do not care if you funded for the accrual. If a contribution is made during the year and no deduction is taken, no a7-Why is the IRS having trouble with this? It is because it is drafted with a flesch score of - 6. Time for the beach! :shades:

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FL - if I understand what you are saying, (and perhaps I don't) I think you are missing the point of what most TPA's, accountants, and especially clients are really concerned about. While I believe your theoretical point is valid (again, assuming I'm understanding it) it has little practical application.

I agree that if an employer is contributing to a plan and not taking a deduction, that the deduction limitation under © doesn't come into play. But who the heck contributes to qualified plans and doesn't bother with taking the deductions? If it weren't for the deductions, almost no employer would sponsor qualified plans in the first place.

So I think the question on the IRS interpretation of whether "benefitting" or a "beneficiary" is the governing factor is a valid question. And even if an employer might prevail in a given situation if they go to court, many employers have neither the inclination, time, nor finances to fight in court if the IRS disagrees with whatever position they take.

Everybody "runs to" © BECAUSE they want to take a deduction, and therefore have to attempt to interpret whether said deduction is limited by © or not. And then that's where the confusion about the IRS position sets in.

Assuming for the moment that the employer DOES contribute to both plans, (DB cost is in excess of 25% of covered payroll, and PS plan contribution is 25%) with no potential overlapping participants except Participant A, and wants to take a full deduction for all contributions, what then is your reading on © if:

1. No contribution on behalf of Participant A in the PS plan, but Participant A is receiving an additional accrual in the DB plan. Is total deduction limited or not? (I would say the logical answer is no limitation as the participant isn't "benefitting" for 410(b) purposes in the PS plan.)

2. Participant A receives a contribution in PS plan, no additional ACCRUAL in DB plan, but there is a required cost to fund the benefits already accrued. (I would say that © would limit the deduction in this case.)

Finally, regardless of what you or I think is the correct interpretation, what do you think the IRS position will be in these two scenarios?

Thanks!

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Guest FLMaster

Belgrath-I agree withyour analysis. When I went over this problem with some of the EAs and CPAs who work in this office we agreed that for the most part practical applications are limited. I agree with your answer to question 1.

In regards to question 2-did they take a deduction for the contribution that year?

What the IRS thinks or says, I do not care. I care what the courts say. When you go to court you try to hammer on the law. If you can't hammer on the law, hammer on the equity. If you can't hammer on the law and equity, hammer on the table.

Then go to the beach! :shades:

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FL, you mean, after all this time, that you have been arguing that the deduction limitation doesn't apply when the combined amount being deducted is less than 25% of pay?

Well, ok. I would think that self-evident. Evidently, you don't.

Going down this silly path, there are two issues that come up.

(1) If the amounts not deducted are attributable to the DB plan, I hope you aren't intending to count them as includible contributions in a future year. I don't think they would enjoy that status.

(2) How does the employer determine which dollars are to be treated as not deducted? Is there a reg somewhere that says if $1 is contributed to a DB plan and $1 is contributed to a DC plan and the deduction limitation is $1 that specifically the DC (or the DB) plan is treated as having its contribution treated as deducted? It matters greatly when determining the amount to deduct in subsequent years.

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FL - thanks for the response. But tell me - when you have a client who comes to you with a combined plan and a deduction question where, depending upon how 404(a)(7) is interpreted, the deduction COULD be limited - do you honestly not care what the IRS "thinks or says?" If your position (and maybe the "correct" position) is that there is no deduction limitation, but you KNOW or have reason to believe that the IRS will fight you on this, isn't it rather cavalier to simply ignore the IRS position? I know that the IRS frequently loses in court, but my non-attorney impression is that the courts are apt to grant a great deal of deference to the IRS opinions. Isn't there always the possibility that your client could lose? I can certainly understand that you might advise a client that in your professional opinion, the deduction is valid, defensible, and likely to be upheld in court, but I find it hard to imagine that you wouldn't at least warn them that the IRS will/might challenge it upon audit.

At any rate, as TPA's, we don't have the luxury of not caring about what the IRS thinks or says, since you attorneys will help your clients to sue us if we are wrong! Hence, all the discussion on this issue which shouldn't be as confusing as it is.

Enjoy the beach! (We got snow here in Red Sox Nation yesterday, so we're boycotting anyone currently enjoying sun and warmth)

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Guest FLMaster

MPreston: To answer question

1. Yes, I am planning to have the DB deducted in a future year-It is a fiscal year DB plan.

2. Yes, there is authority on timing Reg. 1.404(a)-14

3. I also believe Lucky Stores v. Commissioner (T.C. 1996) would not apply-great reading!

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Guest FLMaster

Belgrath: If our firm backed away from tax controversies we would be out of business. They should just see any TPA who will take care of them. Why do they need a tax attorney? Our firm will not take insane positions like my brethern who issued opinions on all insurance 412(i) plans or the "Boss" strategies etc.-have you seen the "Grist Mill Trust" opinion from the largest law firm in New Jersey?-what a piece of insanity! Our firm will argue over the intent and policy issues and legislative history of the code. In any event practicing tax law over 20 years and over 1,000 trusts drafted, many audits no disallowance for any clients. Twenty years ago our firm took a position that a joint trust in a common law state would be allowed a pecuniary marital deduction. A law professor from Emory said this was malpractice as I argue the issue with him in New York City conference. Five years ago, the IRS issued PLRs that sustained our position and the law professor at Emory wrote articles on the PLRs. He is a very knowedgeable professor but not a practitioner. I think these boards are great because they give contrary positions which are better encountered here then later before the service or the court. :shades:

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