Pension may retain litigation reserve, but annual filings continue

Plain-English summary

An employer terminated a defined benefit plan but retained enough surplus assets to cover a contingent litigation liability outside its control. The IRS ruled that this reserve would not undo the termination or turn the trust into a wasting trust if every remaining dollar was transferred to a replacement plan as soon as administratively feasible after the liability was resolved. The trust would remain tax-exempt, and Schedule SB would not be required after the termination year. The IRS did not grant the request to stop all annual filings: Form 5500 remained due while assets stayed in the trust, and Form 8955-SSA remained due when deferred vested participants had to be reported. It also approved the two-stage surplus transfer as a qualified replacement plan transaction, with neither transfer treated as an employer reversion and each subject to its own seven-plan-year allocation period.

Ruling snapshot

• Question: May a terminated pension plan retain a litigation reserve and later transfer all surplus to a replacement plan without losing terminated-plan treatment or triggering reversion tax?
• Outcome: Mixed, the structure was approved but Form 5500 and some Form 8955-SSA filing duties continue
• Key authorities: IRC §§ 401(a), 4980(d)(2), 501(a), 6057, 6058, and 6059; Rev. Rul. 89-87

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201626003                                            Third Party Communication: None
Release Date: 6/24/2016                                      Date of Communication: Not Applicable
Index Number: 4980.02-00
                                                             Person To Contact:
-------------------------                                    ---------------------, ID No. ----------------
------------------------------------                         Telephone Number:
---------------------------------------------                --------------------
-----------------------------------                          Refer Reply To:
                                                             CC:TEGE:EB:QP2
                                                             PLR-123182-15
                                                             Date:
                                                             March 23, 2016


Taxpayer A               = -------------------------------------
Company B                = -----------------------
Parent Company           = ------------------------------------------------------
Plaintiffs               = ---------------------------------------------------------------------------------------
                           -------------------------------------------------------------------------
Plan X                   = ----------------------------------
Plan Y                   = ---------------------------------------------------------------------------------------
Trustee C                = ------------------------------------------------
Month 1                  = -------------
Amount 1                 = --------------
Amount 2                 = --------------
Amount 3                 = --------------
Amount 4                 = --------------

Dear ---------------:

This letter responds to your request dated June 26, 2015, as supplemented by
correspondence dated November 30, 2015, December 9, 2015, December 15, 2015,
and February 25, 2016, submitted on your behalf by your authorized representatives
regarding the proper treatment of surplus assets in Plan X following its termination
under section 4980 of the Internal Revenue Code (“Code”) and Revenue Ruling 89-87,
1989-2 C.B. 81 (Rev. Rul. 89-87).

The following facts and representations were submitted under penalty of perjury on your
behalf:

Taxpayer A is a limited liability company that is a disregarded entity for tax purposes
and that provides services to affiliated companies within the U.S. consolidated group of
corporations with Parent Company. Taxpayer A sponsors Plan X, a defined benefit

PLR-123182-15                                        2

pension plan, and Plan Y, a defined contribution retirement plan with section 401(k),
section 401(m), and employee stock ownership plan (ESOP) features. Both Plan X and
Plan Y have current favorable determination letters.

In Month 1, Plaintiffs, ----------------------------------------------------------------------------------------
---filed lawsuits ------------------------------------------------------------------------------------------------
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In addition, the Defendants, -------------------------------------------------------------------------------
-----------------------------------------------------------------------------have been named as
defendants in an adversary proceeding ----------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
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------------------------------------

---------------------------------------------------------------------------------------------------------------------
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-------------------------------------------------------------------------------------------Plan X remains a
defendant in the litigation -------------------------------------------------------------------------. It
should be noted that Plan X is merely one of many defendants in the litigation. As a
defendant in the litigation, Plan X has a contingent liability with respect to the litigation
(the “Contingent Liability”). Taxpayer A represents that no further efforts to resolve the
litigation are warranted pending resolution of the Plaintiffs’ appeal -----------------------------
--------------------------and the motion to dismiss --------------------------------------------------------
----------Taxpayer A further represents that resolution of the Contingent Liability is
outside of its control.

Taxpayer A terminated Plan X effective as of June 30, 2014. Taxpayer A applied for a
favorable determination letter with respect to Plan X’s termination and received a
favorable determination letter dated July 23, 2015.

Taxpayer A intends to distribute assets, either by payment of lump sums to plan
participants or by the purchase of irrevocable commitments from an insurance company
to pay annuities to plan participants, sufficient to satisfy all of Plan X’s benefit liabilities
as soon as administratively feasible.

PLR-123182-15                             3

After the satisfaction of all of Plan X’s benefit liabilities, Plan X’s Trust will have assets
remaining (Surplus Assets). With respect to the Surplus Assets, Taxpayer A’s Board of
Managers has adopted a resolution under which any and all assets remaining in the
Plan X Trust after Plan X has terminated with respect to all participating employers and
after all Plan X liabilities have been satisfied shall be transferred to a qualified
replacement plan (within the meaning of section 4980(d)(2)) as soon as administratively
feasible. The Board further resolved that the assets shall be transferred to the qualified
replacement plan as follows: (1) retain in Plan X’s Trust an amount deemed [by
Taxpayer A] sufficient to pay Plan X’s maximum estimated potential Contingent Liability;
(2) transfer the balance of the Surplus Assets, which will be at least 25 percent of the
Surplus Assets, as soon as administratively feasible to a qualified replacement plan, as
defined in section 4980(d)(2); and (3) as soon as administratively feasible following the
satisfaction of the Contingent Liability, transfer any remaining assets to a qualified
replacement plan as defined in section 4980(d)(2). Thus, no Plan X assets will revert to
Taxpayer A.

Taxpayer A anticipates that after satisfaction of all benefit liabilities, approximately
Amount 2 will remain in the Plan X Trust, of which approximately Amount 3 will be
withheld for the Contingent Liability and approximately Amount 4 will be transferred, as
soon as administratively feasible, to Plan Y as the qualified replacement plan.

Plan Y provides a discretionary contribution of from 0 percent to 3 percent of
compensation (DC1) as well as a discretionary contribution of from 0 percent to 6
percent of compensation (DC2). No DC2 contributions are made unless DC1
contributions are made in an amount equal to 3 percent of compensation. At least 95
percent of the employee participants in Plan X will participate in Plan Y and be eligible
to receive DC1 contributions. Somewhat less than 95 percent of the employee
participants in Plan Y will receive DC2 contributions because a certain group of highly
compensated employees, as defined in section 414(q), are not eligible under the terms
of Plan Y to receive DC2 contributions, although this group is eligible to receive DC1
contributions.

Based on the foregoing, you request the following rulings:

    1. The retention in Plan X’s Trust, after all benefit liabilities have been satisfied, of
      assets in an amount sufficient to satisfy the Contingent Liability will not void Plan
      X’s termination nor will it cause the Plan X Trust to be treated as a wasting trust.
      Benefit distributions made after receipt of the favorable determination letter with
      respect to the Plan X termination will be treated as made on account of the Plan
      X termination, and Plan X will not be required to be updated for changes in
      applicable law or regulations occurring after June 30, 2014, the Plan X
      termination date.
    2. During the period the Plan X Trust retains assets to satisfy the Contingent
      Liability, the Plan X Trust will continue to be a tax-exempt trust pursuant to

PLR-123182-15                            4

      sections 401(a) and 501(a) and the assets held therein will not be a reversion
      under section 4980.

    3. No Form 5500 will need to be filed under sections 6057, 6058 and 6059 for any
      year after the year in which all benefit liabilities are satisfied, and no other annual
      returns otherwise required under the Code will need to be filed for any such year.
    4. The initial transfer of assets from Plan X’s Trust to Plan Y in an amount at least
      equal to 25 percent of the Surplus Assets will constitute a transfer of amounts to
      a qualified replacement plan under section 4980, notwithstanding that when such
      transfer occurs, the Contingent Liability will not have been satisfied and assets
      will remain in the Plan X Trust.
    5. Any transfer of assets from the Plan X Trust to the qualified replacement plan
      after the Contingent Liability has been satisfied will not constitute a reversion
      under section 4980 and will be subject to a 7-plan-year allocation period under
      section 4980(d)(2)(C)(i)(II) beginning with the plan year in which such transfer
      occurs.
    6. Because at least 95 percent of all employee participants in Plan X are, or will
      become, participants in Plan Y entitled to DC1 contributions, the participation
      requirement of section 4980(d)(2)(A) will be satisfied even though somewhat less
      than 95 percent of all employee participants in Plan X will be eligible to receive
      DC2 contributions. Additionally, if this participation requirement is met at the time
      of the initial transfer of Surplus Assets, it will be deemed to be met when the
      second transfer is made following satisfaction of the Contingent Liability.

With respect to ruling requests (1), (2) and (3), under section 401(a), a trust created or
organized in the United States and forming a part of a qualified stock bonus, pension, or
profit-sharing plan of an employer shall constitute a qualified trust only if the various
requirements set out in section 401(a) are met.

Under section 501(a), an organization described in section 401(a) (that is, a trust which
is part of a qualified pension, profit-sharing or stock bonus plan) is generally exempt
from taxation.

Under § 1.411(d)-2(c)(2) of the Income Tax Regulations (“Regulations”), for purposes of
section 411, a plan to which title IV of the Employee Retirement Income Security Act of
1974 (ERISA) applies is considered terminated as of a particular date if as of that date it
was terminated under section 4041 or section 4042 of ERISA. For such plans, the date
of termination is the date of termination determined under section 4048 of ERISA.
Under § 1.411(d)-2(c)(3), a plan that is not subject to title IV is considered terminated on
a particular date if, as of that date, it is voluntarily terminated by the employer or
employers maintaining the plan.

Section 1.416-1, T-4, of the Regulations defines a terminated plan as one which has
been formally terminated, under which crediting service has ceased for vesting and

PLR-123182-15                             5

benefit accruals, and under which plan assets have been, or are being, distributed as
soon as is administratively feasible. Under § 1.416-1, T-5, under a plan for which the
assets are not distributed as soon as administratively feasible, minimum contributions or
benefit accruals are required under section 416.

Under Revenue Ruling 69-157, 1969-1 C.B. 115 (Rev. Rul. 69-157), a trust that is part
of a qualified plan will not retain its qualified status after the plan has been terminated.
Further, a plan is not considered terminated in fact where the plan continues in effect
until all the assets have been distributed to participants in accordance with the terms of
the plan.

Under Revenue Ruling 79-237, 1979-2 C.B. 190 (Rev. Rul. 79-237), once applicable,
the minimum funding standards described in section 412 apply to a pension plan
through the date of its termination. Rev. Rul. 79-237 defines the date of termination for
plans subject to title IV as the date described in section 4048 of ERISA.

Rev. Rul. 89-87, clarifying Rev. Rul. 69-157 and modifying Rev. Rul. 79-237, states that
in order to terminate a qualified plan, the date of termination must be established, the
benefits of plan participants and other liabilities under the plan must be determined with
respect to the date of plan termination, and all plan assets must be distributed to satisfy
those liabilities in accordance with the terms of the plan as soon as administratively
feasible after the date of termination. A plan that is amended to terminate and to cease
benefit accruals has not, in fact, been terminated under the Code if the assets are not
distributed as soon as administratively feasible after the stated date of plan termination,
regardless of whether the plan is treated as terminated under other federal law,
including title IV of ERISA. Whether a distribution is made as soon as administratively
feasible is to be determined under all the facts and circumstances of the given case but,
generally, a distribution which is not completed within one year following the date of
plan termination specified by the employer will be presumed not to have been made as
soon as administratively feasible.

Rev. Rul. 89-87 further states that a plan under which all assets are not distributed as
soon as administratively feasible is an ongoing plan and must meet the requirements of
section 401(a) in order to continue its qualified status. Such a plan remains subject to
the minimum funding requirements of section 412, where applicable. Also, in any year
in which the trust assets have not been distributed, the plan is subject to the information
reporting requirements of sections 6057 and 6058 and, in the case of a defined benefit
plan, the actuarial reporting requirements of section 6059.

Form 5500, Annual Return/ Report of Employee Benefit Plan, is filed in order to satisfy
the reporting requirements of section 6058. The Instructions to Form 5500 state that a
final Form 5500 may not be filed until all assets have been distributed.

PLR-123182-15                            6

Schedule SB (Form 5500), Single-Employer Defined Benefit Plan Actuarial Information,
is filed in order to satisfy the reporting requirements of section 6059. The Instructions to
Schedule SB (Form 5500) state that it must be filed for any year in which the plan is
subject to the minimum funding standards. Pursuant to Rev. Rul. 79-237, the minimum
funding standards do not apply to a terminating plan after the end of the plan year
containing the plan’s termination date.

Form 8955-SSA, Annual Registration Statement Identifying Separated Participants With
Deferred Vested Benefits, is filed in order to satisfy the reporting requirements of
section 6057(a). The Instructions to Form 8955-SSA state that the form is filed to report
information on separated participants who have deferred vested benefits. The form only
needs to be filed for a year if there is information to report.

With respect to ruling requests (1), (2), and (3), in order for Plan X to be a terminated
plan, the date of termination must be established, the benefits of plan participants and
other liabilities under the plan must be determined with respect to the date of plan
termination, and all plan assets must be distributed to satisfy those liabilities in
accordance with the terms of the plan as soon as administratively feasible after the date
of termination. In the present case, Taxpayer A took action to terminate Plan X effective
as of June 30, 2014, and to determine the benefits of plan participants and liabilities
under Plan X. Plan X received a favorable determination letter on its termination on
July 23, 2015. All that remains to complete the termination is to distribute plan assets
as soon as administratively feasible. Whether a distribution is completed as soon as
administratively feasible has been interpreted in Rev. Rul. 89-87 generally to require
distribution within one year of the date of termination.

Exceptions to the one-year rule are limited and depend on the facts and circumstances
of the plan termination. In analogous guidance, § 1.430(a)-1(f)(5)(ii)(B) provides that in
order to determine the termination date for plans not subject to title IV, a plan is not
treated as failing to meet the requirement to distribute plan assets as soon as
administratively feasible to the extent that a delay in distributing plan assets is
attributable to either: (1) circumstances beyond the control of the plan administrator; or
(2) the period of time necessary to obtain a determination letter from the Commissioner
of Internal Revenue on the plan's qualified status upon its termination.

Taxpayer A has represented that it is unknown when the Contingent Liability will be
resolved and the amount of the Contingent Liability determined. Taxpayer A has further
represented that the timing of the distribution of any amount remaining after the
Contingent Liability is resolved is outside of its control. However, Taxpayer A is legally
required, pursuant to the resolution of the Board of Managers, to transfer any remaining
assets in the Plan X Trust to Plan Y as soon as administratively feasible following the
satisfaction of the Contingent Liability.

PLR-123182-15                             7

Based on the facts and circumstances as represented by Taxpayer A, we conclude that
Plan X will not be treated as failing to meet the requirement to distribute plan assets as
soon as administratively feasible as a result of the fact that assets relating to the
Contingent Liability and any related earnings will remain in the Plan X Trust for a period
of time after all other benefits and liabilities have been distributed, provided that any
amounts remaining in the Plan X Trust after the Contingent Liability is resolved are
thereafter transferred to Plan Y as soon as administratively feasible in accordance with
the resolution adopted by the Board of Managers.

Accordingly, we rule that the retention in Plan X’s Trust, after all benefit liabilities have
been satisfied, of assets in an amount sufficient to satisfy the Contingent Liability will not
void Plan X’s termination nor will it cause the Plan X Trust to be treated as a wasting
trust, provided that any amounts remaining in the Plan X Trust after the Contingent
Liability is resolved are transferred to Plan Y as soon as administratively feasible in
accordance with the resolution adopted by the Board of Managers. As a result, benefit
distributions made with respect to the Plan X termination will be treated as made on
account of the Plan X termination, Plan X will not be required to be updated for changes
in applicable law or regulations occurring after June 30, 2014 (the Plan X termination
date), the Plan X Trust will continue to be a tax-exempt trust pursuant to sections 401(a)
and 501(a), and Schedule SB (Form 5500), Single-Employer Defined Benefit Plan
Actuarial Information, will not need to be filed for years after 2014, the year containing
the Plan X termination date. However, Form 5500, Annual Return/ Report of Employee
Benefit Plan, will need to be filed for Plan X with respect to each year that any assets
remain in the Plan X Trust. In addition, Form 8955-SSA, Annual Registration Statement
Identifying Separated Participants With Deferred Vested Benefits, will need to be filed
for each year that there are deferred vested participants to be reported.

With respect to ruling requests (4), (5), and (6), section 4980(a) imposes a 20 percent
excise tax on the amount of any reversion from a qualified plan. Under section
4980(d)(1), the excise tax under section 4980 is increased to 50 percent with respect to
an employer reversion from a qualified plan unless the employer either establishes or
maintains a “qualified replacement plan”, or the plan provides for certain benefit
increases which take effect on the termination date.

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

Under section 4980(d)(2), a “qualified replacement plan” is a qualified plan established
or maintained by the employer in connection with a qualified plan termination, which
satisfies the participation, asset transfer, and allocation requirements of sections
4980(d)(2)(A), (B), and (C).

PLR-123182-15                             8

Section 4980(d)(2)(A) requires that at least 95 percent of the active participants in the
terminated plan who remain as employees of the employer after the termination be
active participants in the replacement plan.

Section 4980(d)(2)(B) requires that a direct transfer from the terminated plan to the
replacement plan be made before any employer reversion, and that the transfer be an
amount equal to the excess (if any) of (i) 25 percent of the maximum amount which the
employer could receive as an employer reversion without regard to section 4980(d),
over (ii) the amount equal to the present value of the aggregate increases in the
accrued benefits under the terminated plan of any participants or beneficiaries pursuant
to a plan amendment adopted during the 60-day period ending on the date of
termination of the qualified plan, and which takes effect immediately on the termination
date.

Under section 4980(d)(2)(B)(iii), in the case of the transfer of any amount under section
4980(d)(2)(B)(i) from a terminated plan, such amount is not includible in the gross
income of the employer, no deduction is allowable with respect to such transfer, and the
transfer is not treated as an employer reversion for purposes of section 4980.

Under section 4980(d)(2)(C)(i), if the replacement plan is a defined contribution plan,
the amount transferred to the replacement plan must be (I) allocated under the plan to
the accounts of participants in the plan year in which the transfer occurs, or (II) credited
to a suspense account and allocated from such account to accounts of participants no
less rapidly than ratably over the 7-plan-year period beginning with the year of the
transfer.

Under section 4980(d)(2)(C)(ii), if by reason of any limitation under section 415, any
amount credited to a suspense account under section 4980(d)(2)(C)(i)(II) may not be
allocated to a participant before the close of the 7-plan-year period, such amount shall
be allocated to the accounts of other participants, and if any portion of such amount
may not be allocated to other participants by reason of such limitation, it shall be
allocated to the participant as provided in section 415.

Under section 4980(d)(2)(C)(iii), any income on any amount credited to a suspense
account under section 4980(d)(2)(C)(i)(II) shall be allocated to accounts of participants
no less rapidly than ratably over the remainder of the period determined under
section 4980(d)(2)(C)(i)(II) (after application of section 4980(d)(2)(C)(ii)).

Under section 4980(d)(2)(C)(iv), if any amount credited to a suspense account under
section 4980(d)(2)(C)(i)(II) is not allocated as of the termination date of the replacement
plan, (I) such amount shall be allocated to the accounts of the participants as of such
date, except that any amount which may not be allocated by reason of any limitation
under section 415 shall be allocated to the accounts of other participants, and (II) if any

PLR-123182-15                             9

portion of such amount may not be allocated to other participants under the preceding
subclause by reason of such limitation, such portion shall be treated as an employer
reversion to which section 4980 applies.

Under Revenue Ruling 2003-85, 2003-32 I.R.B. 291, the direct transfer from a
terminating plan that did not increase benefits to a plan intending to be a qualified
replacement plan satisfied the requirements of section 4980(d)(2)(B) when the amount
was at least 25 percent of the maximum amount that the employer could receive as an
employer reversion.

In the present case, Plan Y will be a qualified replacement plan if it is maintained by
Taxpayer A in connection with a qualified plan termination that satisfies the
participation, asset transfer and allocation requirements of sections 4980(d)(2)(A), (B),
and (C). As discussed above, the proposed transfer of assets will occur in connection
with a qualified plan termination. In addition, Taxpayer A has represented that at least
95 percent of the active participants in Plan X will remain as employees of Taxpayer A
after the termination of Plan X and will be eligible for DC1 contributions under Plan Y,
thus satisfying the participation requirement of section 4980(d)(2)(A) that at least 95
percent of Plan X participants be active participants in Plan Y. Taxpayer A has also
represented that 100 percent of the assets remaining in the Plan X Trust will be
transferred to Plan Y. Although the transaction is expected to take place in two
transfers, the resolution adopted by the Board of Managers binds Taxpayer A to transfer
the entire amount. Therefore, the transfer of Surplus Assets (and any related earnings)
to Plan Y will be treated as a single transaction involving at least 25 percent of the
Surplus Assets upon termination of Plan X for purposes of satisfying the asset transfer
requirement of section 4980(d)(2)(B). Finally, each of the two transfers will be subject
to a 7-plan-year allocation period under section 4980(d)(2)(C)(i)(II) beginning with the
plan year in which the transfer occurs.

Accordingly, we rule that the initial transfer of assets from Plan X’s Trust to Plan Y in an
amount at least equal to 25 percent of the Surplus Assets will constitute the transfer of
an amount to a qualified replacement plan under section 4980, notwithstanding that
when such transfer occurs, the Contingent Liability will not have been satisfied and
assets will remain in the Plan X Trust. In addition, any transfer of assets from the Plan
X Trust to Plan Y after the Contingent Liability has been satisfied will not constitute a
reversion under section 4980 and will be subject to a 7-plan-year allocation period
under section 4980(d)(2)(C)(i)(II) beginning with the plan year in which such transfer
occurs. Finally, because at least 95 percent of all employee participants in Plan X will
remain as employees of Taxpayer A after the termination of Plan X and will be eligible
for DC1 contributions under Plan Y, the participation requirement of section
4980(d)(2)(A) will be satisfied even though somewhat less than 95 percent of all
employee participants in Plan X will be eligible to receive DC2 contributions.
Additionally, if this participation requirement is met at the time of the initial transfer of

PLR-123182-15                            10

assets, it will be deemed to be met when the second transfer is made following
satisfaction or elimination of the Contingent Liability.

Except as specifically set forth above, no opinion is expressed or implied concerning the
federal 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) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, copies of this letter are
being sent to your authorized representatives.

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.

                                       Sincerely,


                                       Laura B. Warshawsky
                                       Senior Tax Law Specialist
                                       Qualified Plans Branch 2
                                       Office of Associate Chief Counsel
                                       (Tax Exempt and Government Entities)


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