Returning a pension plan's actuarial surplus to a tax-exempt employer is allowed and not a taxable reversion

Plain-English summary

A tax-exempt employer set up a defined benefit pension plan for its employees
and later decided to terminate it, pay out everyone, and complete a standard
termination through the Pension Benefit Guaranty Corporation. After all
promised benefits are paid, a surplus will be left in the trust, which the
employer says came from its actuary miscalculating how much needed to be
contributed. The plan document has long allowed leftover money from "erroneous
actuarial computation" to revert to the employer once all liabilities are
satisfied. The employer asked the IRS two things: whether taking the surplus
back would violate the exclusive-benefit rule of section 401(a)(2), and whether
it would be a taxable "employer reversion" subject to the section 4980 excise
tax. The IRS said no on both. Because the money is a genuine actuarial surplus
and will be returned only after every benefit obligation is met, the return
does not violate 401(a)(2). And because this employer has always been exempt
from income tax, the plan is not a "qualified plan" for section 4980 purposes,
so the return is not an employer reversion and no excise tax applies. This
matters to tax-exempt employers winding down overfunded pension plans: they can
recover a true surplus without the reversion penalty that would hit a taxable
employer.

Ruling snapshot

• Question: Can a tax-exempt employer recover a terminated pension plan's actuarial surplus without violating section 401(a)(2), and is that return an employer reversion under section 4980?
• Outcome: approved (return does not violate section 401(a)(2); not an employer reversion under section 4980)
• Key authorities: IRC §§ 401(a)(2), 4980(c)(1)(A), 4980(c)(2)(A); 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: 201847008 Third Party Communication: None
Release Date: 11/23/2018 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-114584-18
Date:
August 27, 2018

Employer = ------------------------------------------------
Plan = ---------------------------------------------------------------------------------------------------
Date 1 = -------------------
Date 2 = ----------------------
Amount = ------------------
Amount 2 = ------------------
Amount 3 = ------------------

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

This letter is in response to your request for a ruling concerning the Plan which was
submitted by your authorized representative on April 24, 2018.

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)(1). Employer
has always been a tax-exempt organization and has never been subject to unrelated
business taxable income within the meaning of section 512. 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.

Employer plans to adopt resolutions to terminate the Plan and pay out all participants
and beneficiaries. Employer also plans to complete a standard termination of the Plan
by filing with the Pension Benefit Guaranty Corporation. 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
PLR-114584-18 2

computation, such balance shall be returned to the Employer. This provision has been
in the Plan document for more than five years.

Based on the ------- valuation, the Plan’s total liabilities are Amount 1 and the Plan’s
assets are Amount 2. After the Plan is terminated and all liabilities of the Plan are
satisfied, approximately Amount 3 will remain in the Plan and trust (“Excess Amount”).
Employer believes the Excess Amount results from errors made by the Plan’s actuary
when calculating the amount to be contributed to the Plan.

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

   (1) The return of the Excess Amount to Employer will not violate section
       401(a)(2); and
   (2) The return of the Excess Amount to Employer will not constitute an employer
       reversion 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.

Section 1.401(a)-2 of the Income Tax 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) which remain 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 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 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.
PLR-114584-18 3

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.

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 a qualified plan.

With respect to your first ruling request, the Plan’s total liabilities are Amount 1 and the
total plan assets are Amount 2. As a result the Excess Amount, approximately
Amount 3, will remain in the Plan until 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 section 1.401-2(b)(1). The Plan document
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 of the Excess Amount to Employer will not violate section
401(a)(2).

With respect to your second ruling request, Employer represents that it has, at all times
been exempt from tax under subtitle A. Therefore the Plan is not a qualified plan within
the meaning of section 4980(c)(1)(A), and the return to Employer of Amount 3 will not
constitute an employer reversion under section 4980.

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) of the Code
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, as specified in Rev. Proc. 2018-1, 2018-1 I.R.B. 1,
section 7.01(16)(b). This office has not verified any of the material submitted in support
of the request for ruling, and such material is subject to verification on examination. The
Associate office will revoke or modify a letter ruling and apply the revocation
retroactively if there has been a misstatement or omission of controlling facts; the facts
at the time of the transaction are materially different from the controlling facts on which
the ruling was based; or, in the case of a transaction involving a continuing action or
series of actions, the controlling facts change during the course of the transaction. See
Rev. Proc. 2018-1, section 11.05.
PLR-114584-18 4

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,



                                   Keith R. Kost
                                   Senior Technician Reviewer
                                   Qualified Plans Branch 2
                                   Office of Associate Chief Counsel
                                   (Tax Exempt and Government Entities)

cc: