Majority Owner Waiving Benefit in DB Plan on Plan Termination

[Guest Grumpy456]

Let's say a DB plan terminates and the value of the plan's liabilities exceeds its assets by $200,000. Let's assume further that a majority owner is due a lump sum as a result of the plan's termination equal to $300,000. The Company doesn't want to or cannot contribute the extra $200,000 so the majority owner agrees to waive $200,000 of his benefit. The majority owner receives $100,000.

Under these circumstances, is the majority owner taxed on the entire amount of his benefit ($300,000) or just the portion of his benefit that he actually received ($100,000)? Does the plan issue a 1099-R for $300,000 or $100,000?

Is the answer different if, instead, the majority owner decided he didn't really need any of his benefit and (1) waived the $200,000 and (2) had the remaining $100,000 used to "gross-up" the distributions made to the other participants? In this case, does the plan even issue a 1099-R?

A CPA told me in passing that when an individual has a vested, legal right to income, they cannot avoid including that amount in their income simply by "turning their back on it". Of course, my response was that it really isn't income, is it, if they do "turn their back on it". The CPA's response was that I was thinking about actual, as opposed to constructive receipt.

Surely this is not a new "issue". How have others handled this sort of situation? Thanks!

[david rigby]

This may not be as simple as saying "I waive...."

Suggested reading would be threads (on this Message Board) which includes the phrase "majority owner" or "substantial owner". For example,

http://benefitslink.com/boards/index.php?showtopic=16104

[thepensionmaven]

Let's say a DB plan terminates and the value of the plan's liabilities exceeds its assets by $200,000. Let's assume further that a majority owner is due a lump sum as a result of the plan's termination equal to $300,000. The Company doesn't want to or cannot contribute the extra $200,000 so the majority owner agrees to waive $200,000 of his benefit. The majority owner receives $100,000.

Under these circumstances, is the majority owner taxed on the entire amount of his benefit ($300,000) or just the portion of his benefit that he actually received ($100,000)? Does the plan issue a 1099-R for $300,000 or $100,000?

Is the answer different if, instead, the majority owner decided he didn't really need any of his benefit and (1) waived the $200,000 and (2) had the remaining $100,000 used to "gross-up" the distributions made to the other participants? In this case, does the plan even issue a 1099-R?

A CPA told me in passing that when an individual has a vested, legal right to income, they cannot avoid including that amount in their income simply by "turning their back on it". Of course, my response was that it really isn't income, is it, if they do "turn their back on it". The CPA's response was that I was thinking about actual, as opposed to constructive receipt.

Surely this is not a new "issue". How have others handled this sort of situation? Thanks!

I believe that as long as the common law employees receive their minimum lump sums the owner can "waive", but the waiver has to be in writing and duly signed bu the owner both as participant and trustee, assuming he is also a plan trustee, and the participant's spouse. I would not have him waive anything until the amounts he has to pay out the common law employees is determined. He's waiving the excess benefit, so in your case the 1099R would be for only the amount he is receiving as that is the amount he is actually getting from the plan.

It would be very generous to "gross-up" the distributions to the common law employees, but in actuality, the y are paid their lump sum equivalents and the boss would take the rest, and waive any amount of plan liability over the plan assets.

And yes, all participants receive 1099Rs.

[Guest Kabert]

Take a look at a case called Gallade. It may be in a Tax Court but I don't recall exactly. I think it dealt with this issue.

[david rigby]

http://www.ustaxcourt.gov/InOpHistoric/GALLADE.TC.TC.WPD.pdf

[Belgarath]

I've seen the "waiver" approach used, and approved, for years and years. However, we recently had a case where the reviewer said that a "waiver" was not possible, but that the owner could sign a statement "foregoing receipt" of the benefit and that this would be accepted. Whatever works...

[SoCalActuary]

For a standard PBGC termination of an underfunded plan, this is the defacto standard method.

For a nonPBGC plan, the plan administrator would have to change the default language in most plans

so that the allocation of assets on termination allows all others to get paid first.

The legal precedent is a little off track, but may be relevant here. If the owner is trying to waive benefits

that are actually funded after considering all other employees' benefits, then the court case makes good

sense. Is the employer trying to use pension money for other purposes without taking taxable income

from the pension distribution? If so, I would agree with the IRS that this is an attempt to avoid taxes.

But looking back at the original posting, the plan sponsor could raise benefits by amendment if it is

before the termination of the plan. If this resulted in the owner getting zero, or near zero benefits (so that

no one else was underfunded at termination), this course of action would not result in taxable transfer

of benefits from the owner's pension to the others who benefit.