David MacLennan

Several years ago I spoke with one (prominent) actuary who speaks often at conferences, etc., and he told me that he had no problem funding a plan based on pre-participation compensation. The regs were issued a few years after the Code, and perhaps were intended to correct the Code? - I know the Code is primary source, but it seems you should be able to rely on the Regs. It doesn't seem "fair" to use participation, since comp often goes down when funding a 1-person DB plan, if you think of the old idea of "replacement" income from a pension plan as being the general socioeconomic intent. Also, if in doubt, get a letter on the plan document and make sure the 415 limit language includes pre-participation comp. My DATAIR prototype documents, one of the most widely used, specifically says "all years of service with the employer" are used in determing the Hi-3 years. I wonder what the IRS LRM's say?

You might want to also look at his prior earned income history, in case it was higher. The Code says for 415 3-yr comp use years of participation, the regs say service, the Examination Guidelines just quote both w/o taking a position. Probably not relevant though due to the aforementioned 404a8C deduction limit, if he is a sole proprietor (but, when you say he could make his salary more than 30K, and use the word "salary", it sounds like he is not a sole proprietor - perhaps you are using that term loosely to describe any 1-person business?).

He may not want to make a contribution if he has no earned income. If the sole proprietor has no net income, he cannot deduct any portion of the contribution due to the 404a8C limit. There is nothing explicit in the Code that allows someone to carry forward the deduction or to establish a tax basis, so what amounts to an after-tax contribution would then be taxed again after distribution from the plan.

I was wondering, from a legal point of view, whether IRS Instructions to a tax form provide any reliance. It seems clear that the K-1 instructions state that the DB deduction is NOT to be allocated based on the partnership percentage, but rather on some measure of the benefit given to the partner. I have not seen any disclaimer statement on IRS form instructions that says: "where the code or regs differ from these instructions, the code or regs must be followed." Anyone thought about this before? Doug: Thanks for the FSA. I've added it to my reference collection.

Issue 1: No workaround possible, since it is simply data that must be acquired, right? Issue 2: Are you are saying that Treasury Reg. section 1.404(e)-1A(f)(2) does not permit any allocation of deduction in a DB plan other than one based on partnership percentage? If so, I would disagree. The section goes on to say "see section 704 . . . and the regulations thereunder." I interpret this to mean that one can avail oneself of the rules under 704, but that if the partnership agreement does not address the allocation of DB plan deductions, then the default is the partnership percentage. Another (well respected) actuary has told me that in his experience IRS auditors have taken this interpretation (I looked, but couldn't find anything in the Examination Guidelines). If instead you are saying you want to be able to allocate the deductions in a different way other than by partnership percentage, and you don't want to modify the partnership agreement, the only justification I can think of is that the Sch K-1 instructions seems to suggest that DB deductions be allocated based on the "amount of benefit for the current tax year" - sufficiently vague to allow for many interpretations. Certainly this is clearly inconsistent with the Regs and maybe therefore allows one to be able to argue any reasonable method. I may be overtired, but should I know what "FSA" stands for? (other than Fellow of the Society of Actuaries, or Funding Standard Account)

Suppose client had a plan terminated in the past with > $100,000 in assets. New plan is established and it has < $100,000 in assets. Plans did not ever exist at the same time. The Form 5500EZ instructions state the following condition for the $100,000 exemption: You have two or more one-participant plans that together had total plan assets of $100,000 or less at the end of every plan year beginning on or after January 1, 1994. Is a Form 5500EZ required for the new plan? The "have" and "together" seem to indicate that you do not apply the test to plans that never coexisted, so the answer would be NO. Anyone disagree?

Probably you are referring to the 415 and 401a17 comp limits that would allow for larger contributions in the funding calculations? Assuming the effective date of the EGTRRA amend provisions is Jan 1 2002 or earlier, the changes cannot be reflected in the funding calcs for 2002 if the amendment was adopted after Mar 15 2003. If adopted between Jan 1 2003 and Mar 15 2003, a 412c8 election must be signed by the Plan Administrator and attached to the Form 5500.

I have a few thoughts I could add to help pensionnewbee: DB plans are not any different than other qualified plans with respect to investments. However, it is sometimes advised to put conservative investments into the DB plan to avoid an unexpected underfunded status. Also, keep in mind only cash can (generally) be contributed to DB plans (the 404 - 412 spread can allow for some non-cash contributions). What kind of investments can qualified plans make? Any kind! Yes, it's true . . . only some investments have penalties attached to them! The only exception I can think of is that an ERISA plan's investments must be within the reach of US courts, so this generally prohibits "foreign" investments. There are 2 groups of penalties: prohibited transactions excise taxes, and unrelated business excise taxes. PT's can in some cases have the severe penalty of disqualification, but the IRS seems to reserve this for only the most extreme example of violation of the exclusive benefit rule. "unrelated business" refers to the trust engaging in a business - when tax exempt trusts engage in a business they are taxed at corporate rates. A sub-class of unrelated business transactions is debt financed income - tax exempt entities are generally not allowed to make money by borrowing money. PT's are discussed in many references. For unrelated business activity, a good primer may be to read the IRS Examination Guidelines on the topic. Here is an excerpt: (a) Generally, the unrelated business activities in which a qualified trust engages take the form of either a trade or business or debt-financed income. Examination Steps Techniques are provided on unrelated business income of all types and the Form 990-T filing requirements. Below also, are examples which may aid in detecting the same or similar issues during an examination. Analyze financial statements and/or tax returns prepared by the trust for evidence of the existence of a trade or business. Receipts derived from business operations may be buried in investment income, i.e., interest or dividend and may only be revealed by examining the trusts' books and records. (a) An IRC 401(a) trust may be engaged in the same business activity as the creator corporation. The management of the trust is, directly or indirectly, the same as that of the employer. Consequently, there is a tendency to apply the trade or business expertise of corporate management to the trust's business activities. (b) The trust may engage in an activity which complements the employer's business. For instance, the employer may be engaged in the manufacture of a product and permit the trust to perform all or a part of the marketing functions. Sales of Lots: Corporations which are in the business of developing and improving real estate for sale to customers will often contribute land to their employee trusts which is adjacent to their own development projects. Or, they will contribute cash and require the trust to invest in such subdivisions. In this manner, the employer's salespeople can promote and sell the trust's subdivided and improved real property along with their own and escape taxation on the portion of the activity attributable to trust ownership. (a) If this activity is being carried on in sufficient volume on a regular and continuous basis, the trust is also engaged in the real estate business and is subject to the unrelated business income tax under IRC 511. Vending Machines: The operation of a vending machine route (large or small) is a trade or business. Trusts find this additional activity appealing as a revenue producer because little effort is required on their part to derive financial benefits. The existence of this type of income is often hidden in the trust's financial statements as miscellaneous income, income from sources other than investments, or some similar caption. All income accounts must be analyzed to make a determination. Commissions and Fees: An employee trust may earn commissions or fees for services rendered. Income from these sources commonly stems from sales commissions (real estate as well as personal property) and finder's or agency fees of various sorts. The income from such activities are subject to the unrelated business income tax under IRC 511. Factors: Factoring is a trade or business. The profits derived from this operation do not constitute interest on investments as may be shown on the financial statements. Fruit Orchards and Citrus Groves: Some trusts own property and may operate the activity rather than lease the property. Timber: In a raw material industry, IRC 482 may apply as well as IRC 513(b). For example, if the creator corporation is a paper company, ascertain that the price the employer pays the trust for the timber is reasonable. Rental of Personal Property: The income derived from the lease or rental of personal property (other than that leased with real property) constitutes income from operation of a trade or business. Some examples are: tank cars, boats, automobiles, fishing and skiing equipment, signs and vending machines. Option Income: Revenue received from unexercised stock options (puts and calls) regularly issued on stocks held in the trust's portfolio constitutes unrelated trade or business income under IRC 513. See Rev. Rul. 66-47. Since this income is commonly shown on the financial statements as "capital gains," carefully review the broker's confirmation documents which will reveal the existence of such stock option sales. Partnerships: If a partnership of which the trust is a member is engaged in a trade or business, the trust has unrelated business income with respect to its portion of distributable income. Verify this by reviewing the information return for an entry reported as investment income. Miscellaneous Business Enterprises: Other ventures in the trade or business category which have been uncovered are retail stores, cafeterias, parking lots, and mineral interests, etc.

PBGC Op Ltr 75-104: LETTER: This is in response to your letter of June 12, 1975 asking confirmation of your understanding that incorporated animal hospitals, being professional corporations, need not file form PBGC-1. A professional service employer is any entity (it need not be a corporation) owned or controlled by professional individuals, as defined in Section 4021© (2) (B), where both the entity and the professional individuals are engaged in the performance of the same professional service. Licensed veterinarians are "licensed practitioners of the healing acts" under Section 4021© (2) (B). Accordingly, a plan maintained by an employer entity engaged in providing veterinary services that is owned or controlled by a licensed veterinary or veterinaries is a plan maintained by a professional service employer. Pursuant to Section 4021(b)(13), such a plan is excluded from Title IV coverage if it does not at any time subsequent to the enactment of the Employee Retirement Income Security Act of 1974 have more than 25 active participants. Plans which are excluded from coverage under Title IV do not need to file form PBGC-1. I hope this information will prove useful to you. Henry Rose General Counsel

TAG has posted Rev Proc 2003-72. The TAG summary emailed to me says essentially what KJohnson posted above. The filing deadline is now January 31 2004 for those who need a det ltr to qualify for the extended RAP.

One issue would be that RMD's start in the year age 70.5 is attained - client should be aware of this. The RMD calculation (final regs are still pending) for a DB plan is based on the benefit, not the assets, so it is important the benefit formula is designed so that the benefit value as much as possible accrues over time in step with the assets. That is just good plan design in general. Another possible issue is the length of time the plan would be in effect, minimum 3-5 years being a common rule of thumb. However, based on my experience this concern is often overstated and should not deter a client. If they are funding at the 100% limit, overfunding can be more of a concern, because in that case the lump-sum 415 limit value goes down 3% or so each year, due to increasing age and decreasing value of an annuity payable at that age. So, you must be careful in selecting a funding target and then terminate the plan in a timely fashion, and watch the assets carefully.

I would check to make sure your "Prior Year Vested Percent" on Screen 30 and the "Prior Year Accrued Benefit" on Screen 31 are filled in. Have you tried DATAIR help? They also have a message board on their web site.

Thanks everyone for the comments. This is a bit of a tangent, but has anyone noticed the counterintuitive result that the variable rate premium can sometimes be reduced by lowering the CL interest rate? I haven't done the analysis, but apparently this can happen because of the way the PBGC Alternative Calculation Method tries to extrapolate present value of vested benefits under the PBGC interest rate from the prior year Sch B CL info, and perhaps because in my case the owner has reached NRA and is getting half the vested benefits. Before I would have assumed the higher interest rate would give the lowest premium payment under the ACM.

I was wondering how actuaries on the boards here choose the CL interest rates used in the valuation for a particular client, in relationship to the other funding assumptions, and other factors. As we all know, the choice can have a dollar impact on PBGC covered clients, via the ACM on Schedule A.

I would be surprised if the source of income doesn't matter, even for those on the list of professions. "A professional service employer is any entity (it need not be a corporation) owned or controlled by professional individuals, as defined in § 4021©(2)(B). where both the entity and the professional individuals are engaged in the performance of the same professional service. " (PBGC Op Ltr 75-20) Does being on the list of professions confer any special status - according to PBGC opinion letters it shouldn't, since they refer to it as just a sample list of representative professional service employers. However, it may (wrongly) confer special status to PBGC employees, so flosfur may be correct in the practical sense.

Is there anything improper about providing some employees with more information on their DB plan participant benefit statements than other employees? For example, the lump-sum present values? Client fears some ees will quit just to collect their DB benefit. For select employees, client wants to inform them of the value of their benefit and the annual increase, in more meaningful terms than the annuity amount payable at NRA. I was considering sending 2 sets of statements, and the client could then pick and choose. I'm going to recommend he consult with legal counsel, but was hoping to get opinions here.

I believe he would be exempt, unless his business is substantially something other than providing medical/health services. For example, if he sells dietary supplements, and this is more than half his business income, then he would be covered under PBGC insurance. You can always ask for a coverage determination if in doubt.

To my knowledge: There is no Code Section that says a contribution made for a year that could have been deducted in that year can be deducted in a future year. There is a code section that says a contribution made by the due date of the return is deductible for the prior year (if the contribution is assigned to the prior year), and there is a code section that says a contribution is deductible in the year made if it is required to reduce an accumulated funding deficiency (IRC 412) from a prior year, and there is a code section that says a contribution can be deducted in the current year if it was made for a prior year, but was not deductible in the prior year due to not being contributed by the due date of the return ("includible" contribution). There is no code section that says that, if a contribution is made after the end of the plan year for that plan year, but before the due date of the employer's return, the employer can elect which year to deduct it in. Can the CPA show a loss and carryforward the loss? Another issue: when you say "needed to fund approx $300,000", was it required under 412, or allowable under 404, or was it just necessary to fund accrued benefits? If the latter is the case, it may not all be deductible in a single year, and must be amortized over future years.

I came upon this old thread, and MGB's explanation of the proper use of the individual account method under the old regs was eye-opening. No matter how much you think you know this stuff, something always surprises you. What if the plan document allows for partial lump-sums, and the distribution forms allow the participant to elect partial lump-sum annual payments determined under the individual account rules in 1987 regs. Would this be a proper use of the individual account rule for DB plans? Also, assuming the answer to the above question is yes, can one use the new tables in the 2002 regs? Or, to be considered in compliance with the 1987 proposed regs, must you use the old tables (I'm thinking of the transitional relief mentioned in Notice 2003-2).

Another approach you may want to use to reinforce the deduction: there was another topic on the message boards here where someone pointed out that Sal Tripoldi in the ERISA Outline Book stated that IRS spokespeople have repeatedly made statements at conferences that it is acceptable to make a plan effective on the first day of the plan year, even if it predates the existence of the business entity sponsoring the plan. Seems to run against common sense, but this could be a fallback position on the 404. You would however lose a nice credit balance.

Mike, I realize my last post was off tangent a little, since the subject was accrued ctbs rather than advance ctbs. But I was wondering how proponents of #1 would handle an EOY val - one would reduce assets by advance ctbs after the 20% corridor limit is applied, or before?

In applying #1, if the valation is end-of-year, then end-of-year assets are reduced by the contributions made during the plan year BEFORE applying the corridor percentages? This seems to be what would be consistent with arguments made by proponents of #1, since you are again applying the corridor percentages to valuation assets.

I don't have cites for you, but #2 is the common-sense answer from my point of view. Perhaps another DB person on the boards will give their opinion and provide a cite such as a gray book Q&A.

Did you mean the plan termination date was Feb 25 2003, rather than 2002?

Thank you all for your help on this. Indeed, the QDRO was worded to say the alternate payee's benefit was the actuarial equivalent of 1/2 the value of the assets as of a agreed upon date. My thinking was along the lines of what happens during a plan termination, where benefits are paid only to the extent funded. QDRO's in my 1-person DB plans seem to be relatively common. I wonder if a plan provision worded to the effect that the alternate payee's benefit would be paid only "to the extent funded" would have worked in this case to help avoid exacerbating the underfunding problem. Then, the QDRO would award the AP half of the accrued benefit, but she would only be paid half the assets (?). However, as in a plan termination, for 412 it seems this would still have to be ignored, and for 415 the participant would be considered to have received the full 1/2 AB (?). Very confusing, and probably not worth much more thought. If there's a lesson in this, it is yet another reason to not let liabilities get too far out of sync with assets, even in a 1-person DB plan.