Question 282: How do the proposed 415 regulations deal with predecessor employers?
This is the third article dealing with the Who's the Employer aspects of the proposed 415 regulations. The first dealt with the erroneous treatment of Code §415(h). The second dealt with post-severance compensation.
The proposed 415 regulations introduce the concept of "predecessor employers." A plan must aggregate plans of predecessor employers to determine if the plan satisfies the 415 limits. [Prop. Reg. §1.415(f)-1(a).] The proposal goes on to define two types of predecessor employers, which correspond roughly to Code §414(a)(1) and (a)(2).
The first type of predecessor is an employer who maintained a plan the current employer maintains. The proposed regs state:
For purposes of section 415 and the regulations thereunder, a former employer is a predecessor employer with respect to a participant in a plan maintained by an employer if the employer maintains a plan under which the participant had accrued a benefit while performing services for the former employer, but only if that benefit is provided under the plan maintained by the employer. [Prop. Reg. §1.415(f)-1(c).]
This convoluted sentence requires close examination. The determination of whether a former employer is this first type of predecessor employer, and hence aggregated under 415, has several parts:
* This is a participant-by-participant determination. In other words, a former employer can be a predecessor employer with regard to some participants and not others.
* The current employer must maintain a plan under which the participant accrued a benefit (or, presumably, received an annual addition) while performing services for the former employer. From the preamble to the proposed regulations, it is clear that the IRS deliberately chose to use the language of Code §414(a)(1) here, and the word “maintain” should be interpreted the same way. There are essentially two ways an employer can maintain a plan of a predecessor employer: the new employer can adopt the predecessor’s plan, or the employer’s plan can accept a transfer, merger, spin-off, etc. from the predecessor’s plan.
* Finally, the benefit the employee received in the plan of the former employer must now be provided under the plan of the current employer. In other words, it isn’t enough that there was a plan to plan transfer. The benefit of the particular participant under consideration must have been transferred.
Example 1: In 2006, American Vultures buys 60% of the assets of Chicken Little, Inc. As a part of the transaction, many Chicken Little employees (including Wren) become Vultures' employees, and Chicken Little's defined benefit plan transfers the benefits of those employees to the American Vultures plan under Code §414(l). With regard to Wren, Chicken Little is a predecessor employer. For purposes of 415, the Vultures plan counts Wren’s Chicken Little years of service and participation and her Chicken Little compensation. [See Prop. Reg. §1.415(b)-1(g)(2)(B), Code §414(a)(1).]
Example 2: Continuing Example 1, Bob was a Chicken Little employee and quit in 2002. Chicken Little distributed Bob's benefit to him, which he rolled over into an IRA. In 2006 Bob comes to work for American Vultures. Chicken Little is not a predecessor employer with respect to Bob for purposes of Code §415. American Vulures is not maintaining Bob’s Chicken Little benefit.
The second type of predecessor is somewhat more indistinctly defined:
In addition, with respect to an employer of a participant, a former entity that antedates the employer is a predecessor employer with respect to the participant if, under the facts and circumstances, the employer constitutes a continuation of all or a portion of the trade or business of the former entity. This will occur, for example, where formation of the employer constitutes a mere formal or technical change in the employment relationship and continuity otherwise exists in the substance and administration of the business operations of the former entity and the employer. [Prop. Reg. §1.415(f)-1(c).]
The preramble to the proposed regulations cites as authority Lear Eye Clinic, Ltd. v. Commissioner, 106 T.C. 418, 425-429 (1996). Dr. Pallin operated a sole proprietorship starting in 1975. In 1979, he incorporated the clinic and became a 51% shareholder. The other (49%) shareholder had been an employee of the sole proprietorship. Dr. Pallin wanted to count his years of service with the sole proprietorship in calculating his maximum 415 benefit under the corporation’s plan. The Tax Court ruled in his favor, holding that the corporation was merely a formal change, but the substance of the business operations did not change. The opinion did not discusss controlled groups, affiliated service groups, or any other 414 mechanism. It allowed Dr. Pallin to count the service because the corporation was a continuation of the business of the sole proprietorship.