Deduction for Terminating Plan

[ac]

I have a client that has a defined benefit plan with a September 30 plan year end. The client's fiscal year also ends September 30. The plan was terminated on Febuary 25, 2002 and the benefits were paid out in April 2003. The owner had to forego his entire benefit and had to contribute an additional $70,000 to fully fund the non-owner benefits in April 2003. The plan was covered by the PBGC. There were no unfunded guaranteed benefits (IRC 404(g)). For the October 1, 2002 actuarial valuation, we prorated the charges to the funding standard account as required by Rev. Proc. 79-237. The maximum tax-deductible contribution was $45,000, which was contributed in April 2003. When and how can the remaining $25,000 be deducted.

Can the owner deduct the $25,000 for the fiscal year ending September 30, 2003 under IRC 404(a)(1)(D), unfunded current liability?

[David MacLennan]

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

[ac]

A corporate resolution was adopted to terminate the plan effective February 25, 2002. The plan was filed with the IRS and the owner wanted to wait as long as possible to pay out the benefits.

[Mike Preston]

If the plan was terminated as of February, 2002, then there was no need to do a minimum funding valuation for the period 10/1/2002 through 9/30/2003. Minimum funding standards don't apply to a plan year that begins after the end of the plan year that contains the plan termination date There is no pro-ration for maximum deductible purposes, is there? See if 404(a(1)(D) doesn't create a situation where the entire $75,000 is deductible.

[ac]

oops, the valuation mentioned above was the October 1, 2001.

[Mike Preston]

Did you pro-rate the maximum? If so, the problem is solved as the maximum is not subject to being pro-rated.

[ac]

Ok, Rev Proc 79-237 does only address the charges and credits to the 412 FSA, but does'nt 404 require you to use the same assumptions and methods as used for 412? Would this requirement to prorate under 79-237 be considered a method that must also be used under 404?

Has any one had problems with the IRS on this issue?

[Blinky the 3-eyed Fish]

Mike is right that the 404 normal cost and bases are not prorated. While you are correct that the same assumptions must be used in developing 412 and 404 costs, this is not an assumption, but rather a methodology. It's along the same lines as requiring different 412 bases to have one set of amortization periods, while 404 bases are over 10 years.

What problems with the IRS would you have on this issue. If someone went ahead and prorated the bases for 404 they would simply be understating their maximum deductible contribution and penalizing themselves possibly. The IRS wouldn't care about that.