Pension surplus returns without reversion excise tax

Plain-English summary

A section 501(c)(3) employer terminated its defined benefit pension plan and fully satisfied participant liabilities through lump sums and an annuity purchase. An excess remained because participant data changed and market performance differed from the actuary's assumptions. The IRS ruled that returning the excess to the employer would not violate section 401(a)(2), because it arose from an erroneous actuarial computation and the plan had long authorized such a return after all liabilities were paid. The IRS also ruled that section 4980's reversion excise tax did not apply because the employer remained exempt from tax under subtitle A despite having unrelated business taxable income.

Ruling snapshot

• Question: Could the terminated plan return its actuarial surplus without violating the exclusive-benefit rule or triggering the section 4980 excise tax?
• Outcome: Approved
• Key authorities: IRC §§ 401(a)(2), 4980; Treas. Reg. §§ 1.401(a)-2, 1.401-2(b)(1)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224
Number: 201538022
Third Party Communication: None
Release Date: 9/18/2015 Date of Communication: Not Applicable

Index Number: 401.01-01, 4980.02-00 Person To Contact:
---------------------, ID No. ----------
-------------------------------------------- Telephone Number:
------------------------------------------------------------ ---------------------
-------------------------------------- Refer Reply To:
----------------------------- CC:TEGE:EB:QP2
PLR-T-103108-15
Date:
Re: ------------------------------------------------------- June 16, 2015

Employer = ----------------------------------------------------
Plan = ------------------------------------------------------------------------------------
Date 1 = ----------------
Date 2 = ------------------
Date 3 = ------------------
Date 4 = --------------------
Date 5 = ---------------------
Date 6 = -------------------
Date 7 = ------------------
Date 8 = -------------------
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 November 4, 2014 as supplemented by
your representative’s letter dated March 2, 2015.

The following facts and representations are submitted under penalties of perjury in
support of your request:

Employer represents that it is an entity that is tax-exempt under section 501(a) of the
Internal Revenue Code as an organization described in section 501(c)(3). On Date 1,
Employer established the Plan, a single-employer defined benefit pension plan for the
benefit of its employees. Benefit accruals under the Plan ceased effective Date 2.

On Date 3, Employer took action to terminate the Plan effective Date 4. Employer filed Form
5310, Application for Determination for Terminating Plan, with the Internal Revenue Service

PLR-T-103108-15 2

(IRS), and IRS issued a favorable determination letter dated Date 5. Employer also filed
Form 500, Standard Termination Notice Single Employer Plan Termination, with the
Pension Benefit Guaranty Corporation (PBGC), and PBGC did not object to the notice.

In connection with the termination of the Plan, Employer intended to contribute up to the
amount necessary to ensure that there were sufficient assets in the Plan to effect a
standard termination, including paying all accrued benefits and liabilities of the Plan. 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, Employer contributed
Amount 1 to the Plan on Date 6 (the Contribution Date). In conjunction with the termination
of the Plan, participants who had not yet begun to receive benefits under the Plan were
given the choice to elect either a lump sum distribution of their benefits or an annuity. The
Employer obtained bids from several annuity providers, and the Plan worked with its actuary
to provide relevant participant data.

After Date 7, the Plan paid lump sum distributions to participants who elected lump sum
distributions. On Date 8, Employer purchased a single-premium group annuity from a
commercial annuity provider to provide benefits to the remaining Plan participants.

After all the benefit liabilities in the Plan were satisfied, approximately Amount 2 remained in
the Plan trust (the “Excess Amount”). This surplus was the result of (1) revisions to
participant data since the actuary first calculated the amount to be contributed, (2) revisions
to participant data based on new information concerning deceased participants affecting
group annuity contract premium prices, and (3) unexpected market performance. The Plan
provides that upon termination of the Plan, if all liabilities with respect to participants and
beneficiaries have been satisfied and there remains a balance in the trust due to erroneous
actuarial computation, such balance shall be returned to the Employer. This provision has
been in the Plan document for more than five years.

Employer further represents that it made contributions to the Plan during periods in which it
also incurred unrelated business taxable income (UBTI) within the meaning of section 512.

Based on the above facts and representations, you request the following rulings:

(1) The return to Employer of the Excess Amount does not violate section 401(a)(2);
and
(2) The return to Employer of the Excess Amount does not constitute an employer
reversion that is subject to the excise tax on reversions of qualified plan assets
under section 4980.

Section 401(a)(2) 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.

PLR-T-103108-15 3

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

Section 1.401-2 provides rules under section 401(a)(2) 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 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 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 4980(a) provides for an excise tax 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) provides, in part, that the term “qualified plan” means any plan
meeting the requirements of section 401(a) or section 403(a) 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) 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.

In Research Corporation v. Commissioner of Internal Revenue, 138 T.C. No. 7 (2012), the
Tax Court held that the taxpayer was a section 501(c)(3) organization exempt from income
tax for the purpose of any law referring to organizations exempt from income taxes,
including Code section 4980, notwithstanding that the organization had been subject to tax
on its UBTI.

With respect to your first requested ruling, Employer made contributions totaling Amount 1
to the Plan in order to effect the standard termination of the Plan. Amount 1 was determined
by the enrolled actuary servicing the Plan using reasonable assumptions and following the
correct procedures related to the method of funding. However, the actual requirements to
fully fund the Plan differed from the expected requirements. As a result, the Excess Amount,
approximately Amount 2, remains in the Plan after all of the Plan’s benefit liabilities are
satisfied. Based on the facts and representations, the Excess Amount is the result of
erroneous actuarial computations within the meaning of §1.401-2(b)(1). The Plan document

PLR-T-103108-15 4

permits the return of excess trust assets due to erroneous actuarial computation if all
liabilities with respect to participants and beneficiaries have been satisfied. In the present
case, the return of the Excess Amount to Employer 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 Employer of the Excess Amount will not violate section 401(a)(2).

With respect to your second requested ruling, Employer represents that it is a 501(c)(3) tax-
exempt entity that incurred UBTI. In accordance with Research Corporation, however, the
existence of UBTI does not prevent Employer from having been, at all times, exempt from
tax under subtitle A for purposes of section 4980(c)(1)(A). Therefore, the Plan is not a
qualified plan within the meaning of section 4980(c)(1), and the return to Employer of
Amount 2 is not subject to the section 4980 excise tax.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

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

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party.

While this office has not verified any of the material submitted in support of the request
for rulings, it is subject to verification on examination.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                    Sincerely,



                                    Laura B. Warshawsky
                                    Senior Tax Law Specialist
                                    Qualified Plans Branch 2
                                    (Tax Exempt & Government Entities)

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