SoCalActuary

My problem with the non-profit reference is that the employer is a different entity from the recipient of the contract proceeds. The non-profit may not have a deduction, but the employee is being credited with tax-deferred income while participating in the plan. They are getting favorable tax treatment because the cost of the pension is not immediately taxable income. Not so for the sole proprietor's required DB contribution. In the case of the sole proprietor, the person making the required non-deductible excess contribution is also the person receiving the benefits. There is no transfer of value between the employer and the recipient that qualifies as tax deferred income when the required contribution is deposited. If the sole proprietor was only looking for tax deferral on the investment gain, they could put the funds into a deferred annuity contract where the tax basis is clearly defined, and the yield is not currently taxable. And there is no significant limit to the amount so deposited. This is the analogy that fits closest to the facts.

Your argument is interesting. My position comes in part from a discussion that Larry Starr developed some years back, so I'm still inclined to believe that you have IITC, but I'm willing to continue discussing it. Could you also explain the importance of the wording in IRC 172 that moves the excess contribution to the personal tax return? Does this now become a 1040 Schedule A deduction? What other meaning could that section imply?

The non-profit employer and the real estate issues ... what do they have to do with this discussion? My basic point is this: In a DB plan, there are plenty of distribution issues that do not result in taxable income, because they have already been taxed to the individual recipient. In addition to taxed loans and insurance premiums and rollover of after-tax IRAs, this includes non-deductible employee contribution. All of these are investment in the contract (IITC). At issue here is the tax question - if the self-employed individual made a contribution exceeding the allowable deduction, then it is not a business deduction, so does it become IITC? If it is IITC, then under IRC 72 it is not taxable when distributed.

402(a) describes the taxability of benefits under a qualified plan. But I cited several examples where distributions have a tax basis. So it is clear to me that not all distributions are taxable. 172 describes the rules for net operating losses. In this example, a contribution that would otherwise be deductible under 404 would exceed the business income. By reading this more carefully, I note that the excess of contribution over business income is not deductible as a business expense, and the deduction (if any) flows to the individual's tax status. The question then arises, to wit: under 172, if a self-employed individual cannot make a deductible business expense, then the individual can take the deduction elsewhere. But if no such deduction is available, then the contribution is not granted any tax-favored status. Section 72 describes the fact that distributions from annuity contracts, including qualified plans among others, must consider the after-tax investment in the contract. If the funds came into the contract on a tax favored basis, they do not count as investment in the contract, but if they came in without a tax-favored treatment, the owner has a tax basis. Those principles look like they would apply here. Does anyone have a cite showing that the IRS has denied this logic in the Code or Regs?

402(a) does not describe the real tax issues, which are found in IRC 72, where basis in a contract is discussed. There are non-taxable distributions from plans, so 402(a) is not even close to covering the topic. Examples: PS 58 costs, non-deducted IRAs, Roth contributions, previously taxed loan proceeds. IRC 172 (concerned about net operating losses) points out the fact that pension contributions are not deductible as business expenses if they cause a loss. But they might be deductible elsewhere as a non-business deduction. And, if they are not deductible, the payments are attributable to the person. I suspect that meets the classic definition of contributed investment in the contract, discussed extensively in Section 72. I am willing to consider other arguments here, but they need to reflect the provisions of IRC 72.

If the premium is paid from the trust, is the contribution modified to include an expense load of at least the amount of PBGC premium? If not, then you are attempting to amortize the PBGC premium over the average future funding period. Is that your intent? Or maybe you are just managing cash flow for one year by using a plan expense item to meet the FSA and avoid a deficit. I don't like it, but maybe I don't see the reasons for the question.

So, tell me why this is in the DB/CB forum? There are lots of good posts on this in the 401(k) forum. And, by the way, don't forget ASC, another widely-used small to mid-sized plan vendor.

Interest is required in 412 computations. No IRS information has even contradicted this, and all their examples of 412 reflect it. Interest is not reflected in 404 deduction issues, but the maintenance of amortization bases and the "equation of balance" only make sense if you keep both methods consistent in using the pre-contribution interest. However, the interest only helps you, since it lowers the minimum funding requirement and does not hurt the maximum deduction allowed. Maybe you could explain why you would not spend/deposit a $20 bill you found on the sidewalk, since that is a similar analogy.

It may seem unfair, but it appears from your description that all employees are earning the same rate of benefits on new service since the merger, so there is a clear defense against discrimination claims. Further, no one lost any benefits they had already earned. So I doubt you have a case, and I definitely don't see your argument for violation of ERISA.

The participant should not have a 50% excise tax if they did not have effective control of the distribution timing. If the participant is also the plan sponsor or the trustee, they probably will be subject to the penalty. But that is a digression from the topic, and that discussion belongs in the distribution/loans message board.

It is important to remember that the cb participant has a claim against all assets of the trust fund, regardless of the investments purchased. If the presumably sane trustee minimized investment risk by purchasing the assets to mirror the election, but the assets were all owned by the same trust account, then 401(a)(26) does not get violated. If the funds are not adequate to meet the benefit, then the sponsor must make further funding and/or the participant is stuck with annuitized payment streams, but they don't get to transfer the trust assets that match their interest credit option in the cb plan. On the other hand, if each participant is given a separate trust to administer, and the benefits were solely derived from that separate trust, you would meet the plan design idea but completely violate a26. So the setup and the expectations of the participants must match the rules of DB plans to avoid dis-qualification, both of which are communication and consulting issues. On a related note, PriceWaterhouseCoopers has been marketing these plans to very large lawfirms, where the market rate of return is essentially the same as the trust results. For a few thousand dollars, maybe you could get Ira Cohen to explain it to you.

You should worry about 415 limits here. We had such a plan, where the back payments were affected by the maximum 100% of pay limit, and the client elected with ERISA counsel to get approval from the IRS. Subsequently, the IRS added new reg's to address that back payments should not exceed 100% of pay, unless it was an optional lump sum that reduced future payment limits.

My read on a26 is different. If there is a single trust that is used to provide the benefits for 40%/50 people, that complies, but it is not the same as the benefit level of each person. a26 is the "don't neglect me" provision, it is not the "don't discriminate" provision.

The employer only guarantees the contribution credit and that the prior balance would receive the properly indexed amount. This is less risk than a traditional db. The challenge is to keep it from looking like a profit sharing plan, but that's the job for the ERISA counsel & the actuary.

I ask again, are you relying on the accrued to date method for non-discrimination compliance? Is that your only successful testing method? Because a safe-harbor design doesn't need the test, and an annual accrual method ignores any benefits accrued prior to the current year, i.e., all the past service credits for the db plan.

$100,000 is the magic number. If the combined assets exceeded that amount, then you should recommend a final 5500 for each plan, showing the distribution on the 1099R and a 945 if any taxable withholding applied. When you add the DB plan, you should certainly take account of the other plans to check for your $100k minimum assets.

If you are testing on annual accrual method, the past service grants have already been earned before the testing period. Do you have a safe-harbor design on the db plan accruals? If so, you don't even have to test it.

Standard wisdom is that you ask for a ruling if you are uncertain. Your facts probably do not result in a PPT, but the IRS has the authority to second-guess you. At the very least, you will be dealing with PBGC notification.

to what end would you consider this? It simply means all the headaches of continued accrual. Why not put the employee money into their deductible salary deferral accounts? If the corporate finance people hope to get some arbitrage off the use of employee money, is it worth it?

You are doing a beginning of year valuation with your best estimate of future compensation. Do so with peace of mind, because this is highly logical. At least two widely used small plan valuation systems accommodate this. It is commonly used.

Purchase of additional credits is a feature of the CALPERS and CALSTRS plans, among other governmental programs. A formula is provided that allows conversion of hard dollars into DB benefits, as a permanent change in the nature of the funds. This is similar to an annuity purchase, but not exactly the same. This approach has been used by allowing transfer of pre-tax funds from an existing DC or 457 plan, or from a rollover account. If after-tax funds are allowed, the tracking of tax basis must be considered as well. The formula may also be different during a time window, such as initial conversion into the system, than the rates that would apply for an ad-hoc change requested by the participant. A warning: this can be used to unfairly enrich HCEs, who are more likely to have the funds available for the purchase of credits. The conversion rates can also be highly optimistic, based on interest and mortality factors that do not fairly price the added benefit. This may have an effect on the funding ratio of assets to liabilities, which will probably be measured on a different set of assumptions.

A 412(i) plan is a defined benefit plan under IRC 401. That makes it subject to all 401 rules, unless specifically exempted. So, you need 40% coverage in the 412(i) plan.

If you are only working with a DC plan, the limit of contribution to earned income after deductions might apply. Then the 100% of pay 415 limit would apply giving a result of 50% of net SE income after SE taxes. However, this presumes that 401(k) deferrals are a substantial part of the total earned income. Otherwise, the 25% of pay deduction would limit the contribution to effectively 20% of net SE income after SE taxes. You should look at the deduction worksheet in the appendix of IRS Pub 560, which sets out the deductions for a DC plan of a self-employed person.

Start with IRC 401©.

Assuming you have not "tainted" the plan with one penny of DC money, I believe you now get the greater of the existing limits under 404 and the new limits on 150% CL - assets.