DB deduction and formula amendments

[John Feldt ERPA CPC QPA]

A client with just 2 employees, both owners, has a corporate tax year equal to the calendar year and they set up a defined benefit plan as follows:

1. The effective date of the plan is November 1, 2005

2. The plan document was signed before 12/31/2005

3. That plan document contains a formula of 0.50% x avg pay x participation

4. The only other plan they have is a deferral-only 401(k)

A design is done and it is determined that the formula that suits the client best, based on their goals, is 4.00% x avg pay x participation ($380,000 contribution).

The client wants to deduct this entire $380,000 contribution on their 2005 tax return.

By what date must this amendment to the formula be signed in order to deduct the entire $380,000 on their 2005 tax return?

[Lame Duck]

The date we have always used for this type of amendment is the date set forth in 412©(8)(A). The amendment must be adopted not later than two and one-half months after the end of the plan year in order to be deemed to have been made on the last day of the plan year. For a claendar plan, this would be march 15, 2006.

[John Feldt ERPA CPC QPA]

Can you confirm then, that in this example, if the first plan year is November 1, 2005 to October 31, 2006, then we have until January 15, 2007 to amend the plan, and that formula is then deemed to have been in place as of November 1, 2005 and therefore allows the 12/31/2005 tax return deduction?

[david rigby]

I think there is another item important to the amendment. Using LameDuck's example of a calendar plan year, the amendment must be adopted/signed no later than March 15, 2006, but it must also have an effective date during the 2005 plan year.

[John Feldt ERPA CPC QPA]

I think there is another item important to the amendment. Using LameDuck's example of a calendar plan year, the amendment must be adopted/signed no later than March 15, 2006, but it must also have an effective date during the 2005 plan year.

yes, to clarify, we are talking about an amendment that has a retroactive effective date, 11-1-2005 in this example.

Thanks!

[SoCalActuary]

I'm having a problem with deduction in 2005 from your example.

If the deposit was made during the tax year 2005, with the proper amendment retroactive to a date in 2005, then I agree that it is deductible. However, the contribution made in 2006 is not for the minimum FSA for the year ending in the 2005 tax year. It becomes deductible in 2006.

For a plan year beginning 1/1/2005 and ending 12/31/05, the full amount would have been deductible.

[John Feldt ERPA CPC QPA]

If the deposit was made during the tax year 2005, with the proper amendment retroactive to a date in 2005, then I agree that it is deductible. However, the contribution made in 2006 is not for the minimum FSA for the year ending in the 2005 tax year. It becomes deductible in 2006.

For a plan year beginning 1/1/2005 and ending 12/31/05, the full amount would have been deductible.

It appears that the overlapping plan year is causing a problem then - can you provide some cites that back the statement above?

[Guest Ron Sevcik]

Going back to your original example, you can not wait until 1/15/07 to amend the plan. In order to deduct the contribution on the 2005 tax return, the contribution must be made by 9/15/06 (assuming extensions are gotten). Therefore, you need to amend the plan by 9/15/06 with a retroactive effective date of 11/01/05. When the plan year and tax year do not coincide, there are three options as to how the deduction is determined. You can take the deduction for the plan year that ends within the tax year, take the deduction for the plan year that begins within the tax year, or prorate the deduction for each portion of the plan year within the tax year. Using option 2, you can deduct the $380,000 for 2005 if it is made by 9/15/06 and the plan is amended by then. However, I believe you have to be consistent and continue this pattern each year.

[FAPInJax]

Just to reiterate - 2005 calendar year tax year and plan year 11/1/2005 to 10/31/2006.

The deduction can be claimed for the plan year beginning, ending or prorated to the tax year. However, I would think the amendment must be signed prior to the filing of the tax return for 2005 if the intent is to use the plan year beginning as the basis for the deduction. Therefore, the last date appears to the tax return and extensions (9/15/2006??).

I also agree that the amendment must state that the effective date is the first day of the plan year.

One additional item is that I believe the employer has to sign some kind of statement for 412 purposes which accepts the amendment which is executed after the beginning of the plan year. I may be wrong here because the effective date will be the first day of the plan year.