Unfunded Current Liability Limit Under 404

[Gary]

I am trying to understand the practical value of 404(a)(1)(D)(ii).

If a plan has less than 100 participants, the unfunded current liability for HCEs does not apply the liability due to benefit increases (presumably includes entire CL for new plans) for two years.

The only explanation for this is that the IRS does not want an excessive plan deduction for a given year, because if the plan were to terminate then the plan sponsor could fund all liabilities at that time anyway.

The first question is does this apply to new plans, since they do not explicitly reference new plans?

The next question is provided by means of an example.

Say a plan is implemented 1/1/2005 with only one HCE participant.

Say we use the aggregate funding method and we only recognize the 100% of CL and not 150% CL for purposes of this example.

Year 1

minimum = 100,000

full funding limit = 200,000

unfunded current liability = 200,000

Say company contributes 200,000.

They are left with a credit balance of 100,000 a deduction of 100,000 and no excise tax on contribution above the minimum since contribution is less than FFL.

Year 2

minimum =100,000 before credit balance

minimum = 100,000 - 100,000 =0 after reflecting credit balance (ignore interest for the example)

FFL = 200,000

CL = 350,000

UCL = 250,000 (based on plan assets of 100,000 from prior year deductible contribution)

We now assume that the two year period is complete and the entire CCL can be reflected for the HCE.

It appears that if they contribute 150,000, they can deduct the full 250,000 from the 100,000 caryover and the 150,000 cash contribution.

So after two years they can fully deduct the entire CL of 350,000, by means of 100,000 and 250,000.

Without the two year wait the deductions could have been 200,000 and 150,000 for the same total of 350,000.

Are we in agreement with that analysis and ultiimately what was the point of the two year wait?

Thanks

[Blinky the 3-eyed Fish]

The IRS has said repeatedly at conferences and I believe the Gray Book that the adoption of the plan counts as an amendment for 404(a)(1)(D)(ii) purposes. Thus the UCL is not available in years 1 or 2 and potentially year 3 depending on when the document is adopted.

I am not sure I understand your example since if you can't fund the UCL, you don't have the same funding in year 2 if you could.

[Mike Preston]

How is it not also unavailable in year 3? Since the language of the code specifies that it is with respect to the later of the adoption or effective date, with an effective date of 1/1/03 (year 1), we find that the effective date of the plan falls in the second previous plan year when referencing the 2005 plan year (year 3).

Note that this is how the IRS manages to make something that sounds like "two" mean "three". For no good reason, IMO.

[Blinky the 3-eyed Fish]

I don't think I have heard that extreme an interpretation before if the plan is adopted before the effective date. The statutory language is "....resulting from a plan amendment which is made or becomes effective, whichever is later, within the last 2 years". I could certainly argue in your example the plan is effective 12:00 AM on 1/1/2003 and the 2 years ended the moment it became 12:00 AM on 1/1/2005.

Where have you heard there is a 3 year wait in this instance?

[Gary]

Ok, so instead, perhaps the first two plan years are limited, but by the end of the third year (end of year valuation) the entire UCL can now be funded. So it all ends up to be the same maximum deduction (assuming the UCL is greater than the cumulative minimums) after three years; it is just that the deductions must be delayed due to the two-year wait.

Bottom line, don't really understand the practical purpose of the 2 year rule, but I guess since when are many of the laws logical?

[John Feldt ERPA CPC QPA]

At the Annual ASPPA conference, Larry Deutsch asked Jim Holland how the 2 years is counted when running the valuation, suppose the valuation is a beginning of year valuation. Jim appeared to indicate that the valuation date is when we are determining the liabilities, so any amendments in the 2 prior before the valuation year would be disregarded.

I can't remember if it was Larry or someone else who pointed out that the 412(c )(8) would allow us to count amendment in the current year then? Jim said no, and this now made it look like 3 years of amendments cannot be included when the language specifically states two. Jim Holland then left it as needing formal guidance.

[FAPInJax]

The 2 years are counted from the beginning of the current plan year backwards. Therefore, a valuation date of 1/1/2007 or 12/31/2007 still measures everything from the beginning of the plan year - 1/1/2007. Any amendment increasing benefits or new plan execution date (not the effective date) after 1/1/2005 would apply.

[Mike Preston]

It seems like people are arguing that an amendment executed before the beginning of the year would somehow escape being treated as within the scope of an amendment that must be ignored. Leaving aside the fact that it is extremely unusual to adopte a plan or amendment before the beginning of the year it is effective within (although I fully admit it is possible), I just don't see how the language of the statute allows one to ignore such an amendment: "resulting from a plan amendment which is made or becomes effective, whichever is later" seems pretty clearcut to me.

Blink, I like the argument. I don't think it would stand up, but I like it nonetheless!

[ak2ary]

Mike, I agree with your interpretation of 2 years.

It appears that the provision is simply to prevent small employers from dumping huge sums of money into a plan in good years unless they have 2 or 3 or 4 years of foresight into the timing of good years. My understanding is that the service is finalizing a package of deduction guidance and was led to understand that they will take a formal stand on "newplan = amendment" and from what I understand they are under pressure to reconsider their gray book stance

[SRM]

It will be nice to have some guidance in this area. It is funny that IRS has indicated that amendment = new plan when most definitions of "amendment" imply a change to something already in existence which is not the case for a new plan.

[Guest lerieleech]

To me, "within the last two years" reads as within the two-year period ending at the given date. And since current liability is calculated at the end of the plan year for this purpose, that would mean within the two-year period ending on the last day of the plan year.

Which would mean that in year 3, the current liability attributable to HCEs that results from the adoption of the original plan document would apply toward the limit.

That's just what makes sense to me.

[mwyatt]

Just a thought here on the HCE issue and plan amendment. What are thoughts on "automatic" amendments in plans to reflect COLA increase in the 415 and salary limitations. Are we to calculate the CL for these HCEs based upon the limits in effect 2 years prior?

[SoCalActuary]

We try to use language that refers to the current year values as published.

This is not an amendment from the perspective of the plan sponsor, and I would not try to

force the current liability to be measured on three year old 415/401(a)(17) limits.

[Guest lerieleech]

See IRS Notice 2007-28.

Looks like, in general, the IRS backed off its informal position that a new plan counts as an amendment, which pretty much mootens (my own word) the two year/three year debate...

http://www.irs.gov/pub/irs-drop/n-07-28.pdf

[tymesup]

Notice 2007-28 discusses a new plan that covers an employee in an existing plan. Consequently, it implies that if you have an amendment any time in 2004 or 2005, you can't reflect it in a 2006 valuation. There is no reference to the effective date or adoption date of the amendment, nor to the valuation date.

Excerpted from A-5

Thus, for an employer with a taxable year that is the calendar year, if an HCE was covered by

a defined benefit plan of the employer at any time during 2004 or 2005, a new

plan established during the 2006 taxable year that covers that HCE would be

considered a plan amendment for purposes of § 404(a)(1)(D)(ii).