PLR 200851045: A surplus left by a cautious actuary goes back to the employer without the 20 percent reversion tax

Plain-English summary

A carpet manufacturer bought assets from another company, and in the process part of the seller's pension plan was spun off into a new single-employer defined benefit plan of its own. Accruals under that plan were later frozen, and the company then moved to terminate it in a standard termination, the route available only where the plan has enough money to cover every benefit it owes.

To get there the company had to put money in. Its enrolled actuary calculated what was needed, and deliberately used conservative assumptions so the plan could not fall short. The company contributed that figure. Lump sums were paid out, thirteen annuities were bought from a commercial provider to cover the rest, and when every benefit liability had been satisfied there was money left over. The estimate had been good but not exact, and the plan was overfunded by the difference. The company wanted that difference back, and asked for two rulings.

The first is about the exclusive benefit rule. Section 401(a)(2) bars diverting trust assets to anything other than the benefit of employees and their beneficiaries before all liabilities to them are satisfied, which sounds like a flat prohibition on money going back to an employer. The regulations carry a long-standing qualification. Treas. Reg. 1.401-2(b)(1) lets the employer reserve the right to recover, at termination of the trust and only then, any balance left because of erroneous actuarial computations, and it defines that phrase in a way that carries no criticism: the surplus arising because actual requirements differ from expected requirements, even where the expectation rested on reasonable assumptions and correct procedures and was formed by someone competent to form it. A careful actuary who guesses high produces exactly that kind of balance. Since the remaining amount fits the definition and nothing would come back to the company until every liability to employees and beneficiaries had been satisfied, the return does not violate section 401(a)(2).

The second ruling is about the excise tax and is the more interesting half. Section 4980(a) imposes a tax of 20 percent on any reversion of plan assets to the employer from a qualified plan, payable by the employer under section 4980(b), and the plan is a qualified one because it holds a favorable determination letter. The definition of employer reversion in section 4980(c)(2)(A) is broad enough to catch the payment. The exclusion in section 4980(c)(2)(B)(ii) rescues it: a distribution allowable under section 401(a)(2) is not an employer reversion where it is made by reason of the failure of the contributions to be deductible. The surplus was not deductible under section 404, because section 404(a)(1)(D)(iv) caps the deduction for a terminating plan at the amount required to make the plan sufficient for benefit liabilities and this money was over that line. So the excise tax does not apply.

The logic is worth stating plainly, because the two answers depend on each other. The money escapes the reversion tax precisely because the contribution that created it bought no deduction. Having overshot, the company gets the excess back untaxed under section 4980, but it never got a deduction for putting it in.

The ruling is narrow by its own terms. It addresses only the two questions asked, and expressly declines to express any opinion on whether any particular contribution to the plan is deductible under section 404(a). Every figure and date is redacted, so the size of the contribution, the size of the surplus and the timing are not in the public text.

The scan is rough. The index-number line in the letterhead, a running page number and several stray marks from the margins were misread and have been corrected, the statutory reference to section 412(l) was read with a capital letter and has been restored, and the signature is not legible, so it is marked [illegible]. Left as released: "over funded" and "over funding" as two words; "spun-off" hyphenated; the defined term "Code" in quotation marks; and the redaction legend with its empty values. The scan carries no legible release-date stamp, so the release date recorded above is the one the IRS index assigns.

Ruling snapshot

• Question: On a standard termination, may the surplus left after all benefit liabilities are satisfied be returned to the employer without violating section 401(a)(2), and is that return an employer reversion taxable under section 4980?
• Outcome: Approved on both counts. The surplus arose from erroneous actuarial computations within the meaning of Treas. Reg. 1.401-2(b)(1), because actual requirements differed from expectations formed on reasonable assumptions and correct procedures, and nothing is returned until all liabilities to employees and beneficiaries are satisfied, so section 401(a)(2) is not violated. The surplus was not deductible under section 404 because it exceeded the amount required to make the plan sufficient for benefit liabilities, so it falls in section 4980(c)(2)(B)(ii) and is not an employer reversion. No opinion is expressed on the deductibility of any particular contribution.
• Key authorities: IRC sections 401(a)(2), 404(a)(1)(D)(i) and (iv), 412(l), 4980(a), 4980(b), 4980(c)(1)(A), 4980(c)(2)(A) and 4980(c)(2)(B); Treas. Reg. 1.401(a)-2 and 1.401-2(b)(1).

Full text (IRS public release)

Significant Index Nos. 401.00-00 & 4980.00-00

200851045

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND

GOVERNMENT ENTITIES SEP 22 2008

DIVISION

In re:

Company =
Prior Company =
Prior Plan =

Date 1 =
Date 2 =
Date 3 =
Date 4 =
Date 5 =
Date 6 =
Date 7 =
Amount 1 =
Amount 2 =

Dear

This letter is in response to your request for a ruling concerning the Plan which was submitted by your authorized representative on December 14, 2007, and modified June 9, 2008.

The Company is one of the world’s leading manufacturers of carpet. On Date 2, the Company purchased certain assets and assumed certain liabilities from the Prior Company. In connection with this transaction, assets and liabilities of the Prior Plan were spun-off to the Plan. The Company is not related to the Prior Company.

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The Plan is a single-employer, defined benefit pension plan established by the Company on Date 2, as a spin-off of the Prior Plan. The latest determination letter received by the Plan is dated Date 5. Benefit accruals to the Plan ceased effective Date 1.

On Date 3, the Company took action to terminate the Plan effective Date 4. It was the Company’s intention to contribute up to the amount necessary to ensure that there were sufficient assets in the Plan to effect a standard termination. Based on calculations made by the Plan’s enrolled actuary as to the amount necessary to be contributed to the

Plan in order to effect a standard termination, the Company made a contribution to the

Plan in the amount of Amount 1 on Date 6. The distributions of single-sum benefits commenced on Date 7. In addition, 13 annuities were purchased from a commercial annuity provider. After all the benefit liabilities in the Plan were satisfied, Amount 2 remained in the Plan Trust. This surplus was the result of the Plan’s enrolled actuary using conservative estimates of the amount necessary to satisfy all plan liabilities. Consequently, the estimate of the amount necessary to satisfy plan liabilities was greater than the actual benefit liabilities of the Plan once all benefits were paid. Hence, the Plan was over funded at that time. The amount of the over funding will be returned to the Company. .

Accordingly, you have asked us to rule that (1) the return to the Company of Amount 2 will not violate section 401(a)(2) of the Internal Revenue Code (“Code”), and (2) the return to the Company of Amount 2 does not constitute an employer reversion under section 4980 of the Code.

Section 401(a)(2) of the Code generally prohibits, prior to the satisfaction of all liabilities with respect to employees and beneficiaries under the trust, the diversion of trust assets for purposes other than for the exclusive benefit of the employees or beneficiaries for whom an employer maintains a qualified pension plan.

Section 1.401(a)-2 of the Income Tax regulations (“regulations”) provides that

section 1.401-2, a regulation promulgated prior to the Employee Retirement Income Security Act of 1974 (“ERISA”), provides rules under section 401(a)(2) of the Code and that regulation is applicable unless otherwise provided.

Section 1.401-2 of the regulations provides rules under section 401(a)(2) of the Code for the impossibility of diversion under the trust instrument. Section 1.401-2(b)(1) provides that the intent and purpose in section 401(a)(2) of the Code of the phrase “prior to the satisfaction of all liabilities with respect to employees and their beneficiaries under the trust” is to permit the employer to reserve the right to recover at the

termination of the trust, and only at such termination, any balance remaining in the trust

which is due to erroneous actuarial computations during the previous life of the trust. A balance due to an “erroneous actuarial computation” is the surplus arising because

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actual requirements differ from the expected requirements even though the latter were based upon previous actuarial valuations of liabilities or determinations of costs of providing pension benefits under the plan and were made by a person competent to make such determinations in accordance with reasonable assumptions and correct procedures related to the method of funding.

Section 404 of the Code provides for the deduction of employer contributions to a qualified plan. Section 404(a)(1)(D)(i) provides that in the case of any defined benefit plan, except as provided in regulations, the maximum amount deductible under

section 404(a) shall not be less than the unfunded current liability determined under

section 412(l). Section 404(a)(1)(D)(iv) provides that for certain terminating plans, the limitation on the amount deductible under section 404(a)(1)(D)(i) is the amount required to make the plan sufficient for benefit liabilities.

Section 4980(a) of the Code provides for a tax of 20 percent on the amount of any reversion of plan assets to the employer from a qualified plan. Section 4980(b) provides that the tax imposed by section 4980(a) shall be paid by the employer maintaining the plan.

Section 4980(c)(1)(A) of the Code provides, in part, that the term “qualified plan” means any plan meeting the requirements of section 401(a) or section 403(a) of the Code other than a plan maintained by an employer if such employer has, at all times, been exempt

from tax under subtitle A. Such term shall include any plan which, at any time, has been determined by the Secretary of the Treasury to be a qualified plan.

Section 4980(c)(2)(A) of the Code defines the term “employer reversion” to mean the amount of cash and the fair market value of other property received (directly or indirectly) by an employer from the qualified plan.

Section 4980(c)(2)(B) of the Code provides in pertinent part that the term “employer reversion” shall not include (i) except as provided in regulations, any amount distributed to or on behalf of any employee (or his beneficiaries) if such amount could have been so distributed before termination of such plan without violating section 401, or (ii) any distribution to the employer allowable under section 401(a)(2) in the case of a plan other than a multiemployer plan, by reason of mistake of fact, or in the case of any plan, by reason of the failure of the plan to initially qualify or the failure of the contributions to be deductible.

Because the Plan has received a favorable determination letter, the Plan has been determined to be a qualified plan under section 401(a) of the Code.

The Company made contributions totaling Amount 1 to the Plan in order to effect the standard termination of the Plan. This Amount 1 was determined by the enrolled actuary servicing the Plan using conservative assumptions. Although the actuary used

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reasonable assumptions and followed the correct procedures related to the method of funding, the actual requirements to fully fund the Plan differed from the expected requirements. As a result Amount 2 remains in the Plan after all the Plan’s benefit liabilities are satisfied. Amount 2 would be considered the result of erroneous actuarial computations within the meaning of section 1.401-2(b)(1) of the regulations. The return of this portion of the contribution to the Company will not occur until after the satisfaction of all liabilities with respect to employees and beneficiaries of the trust of the plan. Accordingly, the return to the Company of Amount 2 will not violate section 401(a)(2) of the Code.

Amount 2 is not deductible under section 404 of the Code because it exceeded the

amount required to make the plan sufficient for benefit liabilities. Accordingly, Amount 2 is described in section 4980(c)(2)(B)(ii) of the Code, and thus the return to the Company of Amount 2 does not constitute an employer reversion under section 4980 of the Code.

This ruling only addresses the two issues that we have ruled upon. In particular, we are not expressing any opinion as to deductibility of any particular contribution to the Plan under section 404(a) of the Code.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

We have sent a copy of this letter to the Manager,
to the Manager, , and to your
authorized representative pursuant to a power of attorney on file in this office.

If you require further assistance in this matter, please contact

Sincerely yours,

[illegible]

David M. Ziegler, Manager
Employee Plans Actuarial Group 2