First year deduction

[John Feldt ERPA CPC QPA]

Suppose a company's tax year ends June 30th. On April 30, 2009, they establish a new DB plan. The plan year ends April 30. The effective date of the plan is July 1, 2008 (a 10-month initial plan year).

Thus, we have a valuation on July 1, 2008 and another on May 1, 2009. Both of these plan year beginnings are within the company tax year that ends June 30, 2009. Assume no DC plan.

They make full contributions for the July 1, 2008 short plan year and the May 1, 2009 plan year before their tax return is filed for their tax year ending June 30, 2009.

Under 404, can they deduct both of these contribution on their June 30, 2009 tax return?

[Calavera]

TREATISE, DEFINED-BENEFIT-ANSWER-BOOK, Q 20:41 How is the deductible amount calculated when there is a short plan year?

How is the deductible amount calculated when there is a short plan year?

When the employer changes the plan year, there must be a short year in transition to the new plan year end. With the change in plan year, there will be more than one plan year associated with the same taxable year of the employer or the sum of the number of months of each plan year associated with an employer's taxable year will be different from the number of months in the employer's taxable year. The deductible limit in all such cases must be adjusted.

The deduction limit for the employer's taxable year is adjusted by multiplying the sum of the deduction limits for the associated plan years by a fraction whose numerator, t, equals the number of months in the taxable year of the employer and whose denominator, p, is the aggregate number of months in the plan years associated with the taxable year.

The deductible amount for the short plan year is determined by ratably reducing the otherwise deductible amount for a 12-month plan year in proportion to the number of months in the short plan year. [Rev. Proc. 87-27, 1987-1 C.B. 769]

Example: 1.

Black Rock Inc. has a calendar taxable year and computes the deduction limit for its defined benefit plan on the basis of the plan year beginning October 1 within the calendar year. In 2000, the employer changes the plan year to a calendar year. This results in a short plan year beginning October 1, 2000, and ending December 31, 2000. The plan uses an aggregate funding method and the normal cost for the 12-month plan year beginning October 1, 2000, is $24,000. The deduction limit is not reduced by the full-funding limitation and is not increased by the amount required to meet the minimum required contribution.

The plan year associated with the 2000 calendar year of the employer is the plan year beginning October 1, 2000, and ending December 31, 2000. The deduction limit determined on the basis of this short plan year is $6,000 ($24,000 ´ 3/12 ). The deduction limit applicable to the employer's 2000 tax-able year is $24,000, the deduction limit for the short plan year, $6,000, multiplied by the fraction t/p (12/3 ). For 2001 and subsequent taxable years, the deduction limit is the limit for the plan year coincident with the taxable year.

Example: 2.

The facts are the same as those in Example 1, except Black Rock creates a short plan year beginning October 1, 2000, and ending November 30, 2000, and subsequent plan years begin December 1. The normal cost for the 12-month plan year beginning December 1, 2000, is $38,000.

For the 2000 calendar year of the employer (taxable year), the plan year beginning October 1, 2000, and ending November 30, 2000, and the plan year beginning December 1, 2000, and ending November 30, 2001, are both associated with that taxable year. The number of months in the plan years associated with the taxable year is 14.

The deduction limit determined on the basis of the short plan year beginning October 1, 2000, is $4,000 ($24,000 ´ 2/12 ). The deduction limit for the 12-month plan year beginning December 1, 2000, is $38,000. The deduction limit for the taxable year (calendar year 2000) is $36,000, obtained by multiplying the sum of the deduction limits, $42,000 ($4,000 + $38,000), by 12/14 . For 2001 and subsequent taxable years, the deduction limit is determined on the basis of the deduction limit for the 12-month plan year beginning December 1 within the taxable year (calendar year) of the employer. Thus, for the 2001 taxable year the deduction limit is determined by reference to the deduction limit for the plan year beginning December 1, 2001.

[Mike Preston]

That DB answer is based on old law and regulations. Have they been effectively changed by new 404 language? I don't think there is any guidance, hard or soft, on this issue. Simplify it: Fiscal 6/30, plan adopted 4/1 (full 12 month years) with effective date 4/1. Is deduction 0% in fiscal year that ends 3 months after inception of plan due to new 404 language? 404(o)(1)(A) sure looks like zero to me. 404(o)(1)(B) has potential, but sure looks ambiguous to me. I would think the "safe" approach is to apply the rule cited above to 404(o)(1)(B) (3/12th of the MRC for the first plan year is deductible in the first fiscal ending 3 months after plan's effective date). But a more agressive reading would be that the new law calls for the MRC as of 6/30 (whatever that is) as deductible. Guidance on this stuff would be really welcome.

[John Feldt ERPA CPC QPA]

Thanks.

Mike, how do your clients generally approach this? If your client's tax year-end is June 30, 2009, and if you set up a brand new plan now with an April 1, 2009 effective date (first PYE 3/31/2010), and you provide a beginning of year valuation so they know their full contribution requirement now - do you have a majority of those clients that will take the deduction of the entire amount on their June 30, 2009 return? Or are they a minority, where the majority prorates?

[Mike Preston]

To be honest, I request, and have so far been blessed with clients that agree, to have their limitation years match their plan years which match their fiscal years. I may consider an off fiscal year approach later this year for new plans, but this issue would need to be resolved first.

[Guest Dressageho]

Any thoughts if a client has a corporate structure of three controlled companies: a parent and two subsidiaries. The parent and one subsidiary are calendar year taxpayers as well as the Plan having a calendar year plan year. One subsidiary has to be the non-conformist with a fiscal year ending 3/31.

The proportionate share of the contribution is allocated among all three companies for each Plan Year based on their respective participating-employees. Typically, they've all filed for extensions and made the contributions by 9/15 (even though the fiscal year company had three additional months until its extended tax return deadline). They've just been deducting the contributions on the tax returns coinciding with the Plan Year (i.e. 2008 Plan Year contribution deducted on 4/1/08-3/31/09 tax return for the fiscal year client).

I believe this is perfectly reasonable under 404, but some questions have been raised regarding whether this was appropriate. Does anyone see a problem that I might be missing? Any feedback would be appreciated.