FUNDING DEFICIENCY QUESTION

[Guest SCUDDESLER]

MY CLIENT IS WORKING WITH A NEW ACTUARY. MY CLIENT SPONSORS A DB PLAN THAT USES THE CALENDAR YEAR AS THE PLAN YEAR. FOR THE PLAN YEAR ENDING 12/31/2000, A MINIMUM REQUIRED CONTRIBUTION OF $110,000 WAS DUE. 09/15/2001 CAME AND WENT AND MY CLIENT FAILED TO MAKE ANY CONTRIBUTION. THIS RESULTED IN AN EXCISE TAX OF $11,000 (OR 10% OF $110,000). ON 10/01/2001 MY CLIENT MADE A DEPOSIT OF $50,000.

FOR THE PLAN YEAR ENDING 12/31/2001, A MINIMUM REQUIRED CONTRIBUTION OF $160,000 WAS DUE. 09/15/2002 CAME AND WENT AND MY CLIENT FAILED TO MAKE ANY ADDITIONAL CONTRIBUTIONS. THIS RESULTED IN AN EXCISE TAX OF $16,000 (OR 10% OF $160,000).

BASED ON THE WAY WE DO OUR TRUST ACCOUNTING, AS OF 09/15/2002, THE CLIENT STILL HAD A RECEIVABLE OF $60,000 FOR THE PYE 12/31/2000 PLUS A RECEIVABLE OF $160,000 FOR THE PYE 12/31/2001. AS ADDITIONAL CONTRIBUTIONS WERE MADE AFTER 09/15/2002 WE CREDITED THOSE CONTRIBUTIONS AGAINST THE RECEIVABLES BEGINNING WITH THE RECEIVABLE FOR THE PYE 12/31/2000 AND THEN THE PYE 12/31/2001.

DOES THE FACT THAT MY CLIENT HAD TO PAY AN EXCISE TAX ON THESE MISSED DEPOSITS RELIEVE HIM FROM HAVING TO MAKE THE MISSED DEPOSITS? IF THE MISSED DEPOSITS MUST STILL BE MADE, IS THE $50,000 DEPOSIT MADE ON 10/01/2001 USED TO SATISFY THE MISSED DEPOSIT FOR 2000 OR IS IT TREATED AS A DEPOSIT FOR THE PYE 12/31/2001 (WHICH WOULD THEN HAVE REDUCED THE FUNDING DEFICIENCY FOR THAT YEAR FROM $160,000 TO $110,000)?

THE NEW ACTUARY CLAIMS THAT THE CLIENT MAY SIMPLY NOT MAKE CONTRIBUTIONS FROM YEAR TO YEAR AND PAY THE 10% EXCISE TAX ON ANY ACCUMULATED FUNDING DEFICIENCY. PUT DIFFERENTLY, THE ACTUARY CLAIMS THAT OUR METHOD OF TRUST ACCOUNTING IS NOT CORRECT. ONCE A FUNDING DEFICIENCY EXISTS FOR A PLAN YEAR, THE ARGUMENT GOES, THE RECEIVABLE FOR THAT YEAR IS ESSENTIALLY REMOVED AND THE FUNDING DEFICIENCY MAY IMPACT (DEPENDING UPON TRUST EARNINGS AND DEPOSITS) THE NEXT YEAR'S FUNDING DEFICIENCY.

WE ARE SORT OF PERPLEXED, BUT NOT AT ALL PREPARED TO ARGUE THAT THE NEW ACTUARY'S VIEW IS WRONG, IT JUST DOES NOT MAKE COMPLETE SENSE TO US YET. CAN ANYONE HELP CLARIFY/EXPLAIN WHETHER THE ACTUARY'S POSITION IS CORRECT? THANKS IN ADVANCE FOR YOUR ASSISTANCE.

[Blinky the 3-eyed Fish]

He is correct.

By the way, your post was difficult to read since everything is in uppercase.

[WDIK]

It also appears that the funding deficiencies were not fully corrected and would be subject to the 100% excise tax as well.

[Guest SCUDDESLER]

Thanks for your responses and I apologize for the all caps post. I just want to clarify something. In my example, the funding deficiency for the PYE 12/31/2000 was $110,000 and a deposit of $50,000 was made on 10/01/2001. Is the 100% excise tax broken down by plan year so that the 100% excise tax for the PYE 12/31/2000 was $110,000 or maybe $60,000 (i.e., $110,000 minus the $50,000 deposit)? What about the funding deficiency for the PYE 12/31/2001? Is the 100% excise tax $160,000?

How long after the minimum funding due date does the 100% excise tax apply and if deposits are eventually made, are the subsequent deposits used to reduce the 100% excise tax? For example, if the 100% excise tax applies 90 days (I just made this time period up for illustration purposes) after the minimum funding due date, but 45 days after the minimum funding due date the client deposits $X, is the 100% excise tax equal to the minimum funding deficiency minus $X?

I am not quite clear how the actuary's position can be correct, i.e., that once the minimum funding due date has come and gone the receivable essentially disappears, if, some period of time after the minimum funding due date, the amount that should have been contributed is automatically subject to a 100% excise tax if not ultimately deposted? Those two ideas seem contradictory to us. Can someone please explain how these two notions (assuming I have stated them correctly) can be reconciled with each other? Thanks.

[david rigby]

Blinky and WDIK are correct.

The receivable does not disappear. Instead, it becomes part of the next year's funding requirement. When the contribution is not made (in this case by 9/15/22001), two things happen: (a) the funding deficiency is created, thereby giving rise to the excise tax (which by the way is paid by the plan sponsor, not by the plan), and (b) the 2000 plan year is closed. No more contributions can be credited to the 2000 plan year no matter when they are contributed.

Now, for 2001 plan year, it starts with a deficiency of the 110K, which is added to any other charges for the year, and becomes part of the amount due on 9/15/2002.

Other possible problems:

1. Quarterly contributions may be due, and could be late or missing. This creates an interest penalty and serves to increase the minimum contribution. If this has been ignored, then the Funding Standard Account will be incorrect (that is, the 2001 and/or the 2002 contribution requirement may be more than you think). The dollar amounts are usually not enormous, but it is part of the funding rules, so do not ignore it. Your actuary will not ignore it.

2. The creation of a funding deficiency as of 12/31/2000 means the 1/1/2001 asset value is not as much as originally expected. This might mean the “deficit reduction contribution” will kick in, or be increased. Details not necessarily important here, but it illustrates that the omission of the 9/15/01 contribution can have more than one impact on the 2001 plan year requirements. (Also, may not be applicable if less than 100 participants.)

3. The existence of a funding deficiency invites an IRS audit.

4. Even if the 10% excise tax was paid timely, the omission of the 9/15/2002 contribution may create a new deficiency, with its 10% excise tax, and the potential for a 100% excise tax on the portion that represents the prior year’s deficiency. As WDIK mentioned, the original deficiency is subject to a second excise tax of 100% if not corrected within a year. However, the timing of that deadline might have some flexibility.

5. Notification to participants.

A possible help: were there any other contributions? Suppose a $20K contribution was made on 04/15/2001, intended for the 2001 plan year. Using it for the 2000 plan year will likely provide some savings by reducing the amount of the funding deficiency. Discuss with your actuary.

Some prior discussion threads on related topics:

http://benefitslink.com/boards/index.php?showtopic=25115

http://benefitslink.com/boards/index.php?showtopic=8576

http://benefitslink.com/boards/index.php?showtopic=10304

[Blinky the 3-eyed Fish]

I am not quite clear how the actuary's position can be correct, i.e., that once the minimum funding due date has come and gone the receivable essentially disappears, if, some period of time after the minimum funding due date, the amount that should have been contributed is automatically subject to a 100% excise tax if not ultimately deposted? Those two ideas seem contradictory to us. Can someone please explain how these two notions (assuming I have stated them correctly) can be reconciled with each other? Thanks.

Because the prior year funding deficiency becomes part of the equation for determining the next year's contribution, the amount of the funding deficiency is not what will necessarily have to be contributed to avoid the 100% excise tax.

There are many components to determining the funding amount, so for example, if the assets in the DB plan were to invest in the next Microsoft and shoot up in value, it is possible that there could be no funding requirement for the year after the funding deficiency even after taking into account the prior year funding deficiency. That would be a situation where the funding deficiency would self-correct itself without any contribution required.

Consider a few examples:

Funding deficiency 2003: 50,000

Required contribution 2004: 40,000

Here 40,000 will alleviate the 100% excise tax.

Funding deficiency 2003: 50,000

Required contribution 2004: 75,000

Here you need to contribute the full 50,000 to alleviate the 100% excise tax

[Guest SCUDDESLER]

Thanks for the excellent explanations. We feel much more comfortable with the actuary's conclusion now.