Deduction Issues

[dmb]

I have a DB plan effective 1/1/02. First plan year is short year ending 11/30/02. Plan year is now 12/1-11/30. Fiscal year is calendar. Beginning of year valuation date. If the contributions for the first two plan years are made in 12/02 would they both be deductible for 2002 fiscal year? thanks.

[Blinky the 3-eyed Fish]

This situation doesn't come up in my world too often, but this is how I think it should be done.

When the fiscal year is different from the plan year, you must choose to either take the deduction in the plan year beginning it the tax year, ending in the tax year or a weighted average of the two.

I assume by asking the question, you are looking for the highest deduction, which would be achieved taking the deduction for the plan year beginning in the tax year. You then need to prorate the results. Here is an example.

1/1/02 - 11/30/02 contribution - 50,000

12/1/02 - 11/30/03 contribution - 70,000

Deduction = (50,000 + 70,000) * 12/23 = 62,609

12 represents the number of months in the tax year.

23 represents the number of months in the plan years.

[dmb]

That was my thinking also, actually this situation was brought to my attention by a CPA whose client received this proposal from a firm in Houston. Thanks for the help.

[dmb]

I was thinking some more (dangerous), since both plan years begin in the 2002 fiscal year, would that make this do-able. Thanks again.

[Blinky the 3-eyed Fish]

Yes, that was the premise of my answer that you are taking the deduction for the plan year beginning in the tax year.

[dmb]

Ok, i'm having a brain fart. If the contributions are:

1/1/02 - 11/30/02 = 275,000

12/01/02 - 11/30/03 = 300,000

Can they take the deduction for the full 575,000 or must they pro-rate 575,000 * 12/23 = 300,000 for 2002 calendar year deduction??

Sorry for being so dense. Thanks again.

[Blinky the 3-eyed Fish]

They must prorate and be left with the $300,000 deduction.

[MGB]

Do not confuse the deductible limit for the fiscal year and the contributions. What you are calculating is a deductible limit. You don't need to make the $575,000 contribution to end up with the $300,000 deduction, you only need to contribute $300,000. In fact, if they actually contribute the $575,000 prior to 12/31, they would be subject to an excise tax on the extra $275,000.

The bottom line is that they have the same deductible limit as if they had used a calendar year plan from the beginning (assuming that the annual limit is the same for both of the first two years so that prorating between them resulted in the same number).

In the second fiscal year, they have to wait until the December valuation to determine their deductible limit for the year...the prorated piece from 1/1/03 to 11/30/03 disappears from the calculations and never gets used. In order to make use of it, you need to always use the proration method rather than basing the limit for the fiscal year on the plan year beginning in the fiscal year.

See Revenue Procedure 87-27 which describes the ratio that Blinky correctly used.

[Guest lisbetf]

I thought the excise tax on nondeductible contributions was repealed.

[MGB]

No, it was not repealed.

Modifications to exceptions (there are a few) of the tax were made in EGTRRA to allow a contribution up to the unfunded accrued liability to be carried over without an excise tax. See Code section 4972©(6).