Deductible contributons for terminating DB plan under 404(g)

[Guest Ted Munice]

An underfunded DB plan is being terminated with the plan sponsor agreeing to pay whatever contribution is necessary to fully fund (standard termination). Irrespective of the usual normal cost and 10-year amortization rules, can the contribution be fully deductible immediately to the extent needed to fund PBGC guaranteed benefits? This seems to be what 404(g) implies.

[Guest]

I think a lot depends on how many participants you have in the Plan. 404(a)(1)(D) will permit you to deduct "up to 100% of the unfunded current liability as determined under 412(l)", but this only applies if your plan is not a multiemployer and has more than 100 participants.

This plan termination shortfall deduction issue has always been a problem for small plans and I don't know of any way around it. I have worked with accountants who amortize the deduction over a 10 year period and others who ignore 404 and just deduct it. As an actuary, I typically tell the client what 404 says, but leave the question of the actual tax return to their accountants.

[AndyH]

Our interpretation is that the amount up to the PBGC guaranteed level is immediately deductible, but the remainder should be deducted over 10 years. Of course,we also tell the client to confirm this approach with their accountants.

[Guest]

When you say "PBGC Guananteed" I assume then this could not be used if benefits exceed the PBGC Guaranteed Maximums (ie: 3,221.59 @65)

I have never heard of this Code Section being interpreted this way. Have you ever ran that by the IRS? Are there any RR that confirm it? Can you use if for plans with

[Lorraine Dorsa]

Following up on Keith's comment re 404(a)(1)(D)--does anyone know of any guidance re exactly how this amount is computed in the case of a plan termination?

404(a)(1)(D) itself refers to "unfunded current liability under 412(l)" and 412(l) defines the benefits to be valued and prescribes the range of interest rates and the mortality table to be used.

On an ongoing basis, by applying the 412 rules re funding methods and therefore valuation dates and the statement in 404(a)(1)(A) that methods and assumptions used in 412 apply to 404, it seems pretty clear to me that the unfunded current liability is determined as of the valuation date.

Since I have not found any guidance re any special rules which apply in a plan termination, I assume the same rules apply--specifically, that the calculation is done as of the valuation date.

In my case (100+ life plan), the plan's valuation date was January 1, 1999 and the plan terminated on and assets distributed on December 31, 1999. At this time, the value of the plan assets were less than they were as of January 1 and therefore the plan sponsor had to make a larger than expected contribution to make the plan sufficient to terminate.

He would like to deduct as much of this extra contribution as possible in 1999. If I could use the unfunded CL as of December 31, 1999, his deduction is larger than if I have to use the unfunded CL as of January 1, 1999.

Does anyone know of any guidance which permits use of the unfunded CL as of the date of distribution in determing the deductible limit under 404(a)(1)(D)?

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[mwyatt]

One point to consider:

IRS has confirmed (at the '98 IRS meeting) that anything contributed over the maximum deductible amount in the year of termination is

1) deducted over a 10-year period, and

2) that the 10% excise tax on nondeductible contributions applies for the remaining 10-year period!

As you can imagine, point 2 is a real kick in the pants to the poor sponsor trying to make up the funding at termination. Run the math (say $100,000 put in over and above what is deductible; then year 1 the client gets a $10,000 deduction and pays a $9,000 excise tax). This is a pretty ugly result.

Note also that the over 100 life modification to the Current Liability limit only allows you to bring funding up to Current Liability. Given low interest rates in 1999, what you owe (especially if lump sum options are available) on distribution probably will exceed Current Liability. It helps, but not to the full extent that you may need to settle all lump sums. In any event, small plans can't avail themselves of this relief due to the 100 life limit.

When you work out the excise taxes due, we've found that the client is better served (if possible) going with the Substantial Owner Waiver route and making up the shortfall (the $100,000 extra going in also generates $45,000 in excise taxes which is not very palatable to anyone).

[Guest Ted Munice]

Section 404(g) seems to be offering a completely different alternative

criteria for deductibility upon plan termination. Without any guidance or

revenue rulings and just reading what is in the Code, we think you can

deduct the value of the benefits paid up to the PBGC maximum. Furthermore,

absent any guidance, the "value" can be based on what was actually paid out,

i.e. plan termination lump sum factors. This may, in fact, be greater than a

contribution for unfunded RPA liability. Presumably the rationale behind

this is that if the plan is being terminated under a standard termination

the PBGC will require that the contribution be made to assure that the PBGC

will not incur a liability. I do not know of any prior sessions on deductibility at EA meetings that have ever addressed 404(g) at all!

[AndyH]

Q&A #10 from the 1994 gray book may be helpful to this discussion.

[richard]

Lorriane:

How about changing the valuation date to December 31, either using the automatic approval (if available) or going through the application process?