Pension surplus may move to a replacement plan without employer-reversion tax

Plain-English summary

A public corporation terminated a defined benefit pension plan and proposed
to transfer all surplus assets, after paying benefits and expenses, to its
defined contribution plan. At least 95 percent of the former plan's active
participants who remain employees also participate in the receiving plan. The
surplus will be allocated in the transfer year or through a suspense account
over no more than seven years, without satisfying employer matching
obligations. The IRS ruled that the receiving plan is a qualified replacement
plan under IRC § 4980(d)(2). The transfer is not employer income, does not
generate a § 404 deduction, is not an employer reversion, and is not subject to
the § 4980 excise tax. Amounts placed in a suspense account become annual
additions under § 415 only when allocated to participant accounts.

Ruling snapshot

• Question: What tax consequences follow when a terminated pension plan's
  surplus is transferred to a qualified replacement defined contribution plan?
• Outcome: Approved, all seven requested rulings granted
• Key authorities: IRC §§ 404, 415, and 4980(c)-(d); Rev. Rul. 2003-85

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202045002 Third Party Communication: None
Release Date: 11/6/2020 Date of Communication: Not Applicable
Index Numbers: 4980.00-00, 4980.02-00,
415.02-01 Person To Contact:
----------------- -----------------, ID No. -----------------
-------------------------------------------------- Telephone Number:
------------------------------------ --------------------
--------------------------------------------- Refer Reply To:
---------------------------------------------- CC:EEE:EB:QP1
PLR-104069-20
Date:
Re: ------------------------------------- August 10, 2020

Taxpayer = ------------------------------------
Plan X = ------------------------------------------------------
Plan Y = ----------------------------------------------------------------------------------------------
---------------------
Date A = ---------------------
Date B = ------------------
Date C = --------------------------
Amount = --------------

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

This is in response to a request for a letter ruling submitted on behalf of Taxpayer by its
authorized representatives on December 20, 2019, as supplemented by
correspondence dated May 27, 2020, and July 7, 2020, regarding the proper treatment
of the transfer of surplus assets to Plan Y under § 4980 of the Internal Revenue Code
(Code) following the termination of Plan X.

Facts

Taxpayer is a publicly-traded corporation. Taxpayer sponsors two plans qualified under
§ 401(a), Plan X and Plan Y. Plan X is a defined benefit pension plan. Plan X received
a favorable determination letter dated Date A. Plan Y is a defined contribution plan that
incorporates both a cash or deferred arrangement under § 401(k) and an employee
stock ownership plan (ESOP) under § 4975(e)(7). Plan Y received a favorable
determination letter dated Date B. Taxpayer terminated Plan X effective as of Date C.
Plan X assets will be liquidated, and all benefits will be paid to Plan X participants. After
payment of all Plan X benefits and expenses, all excess assets remaining in Plan X will
be transferred to Plan Y. No excess Plan X assets will be transferred to Taxpayer.
Taxpayer estimates that the amount transferred may be as much as Amount.
PLR-104069-20 2

Taxpayer represents that at least 95 percent of the active participants in Plan X who
remain as employees of Taxpayer after Plan X was terminated and Plan X benefits are
distributed are active participants in Plan Y. Taxpayer will either allocate the transferred
funds from Plan X to the accounts of Plan Y participants, in the plan year in which the
transfer occurs, treating the transferred funds in the same manner as a non-elective
contribution to Plan Y by Taxpayer, or in the alternative, credit the transferred funds to a
suspense account in Plan Y. If the transferred funds are credited to a suspense
account, the transferred funds will be allocated from the suspense account to
participants’ accounts in Plan Y no less rapidly than ratably over a 7-year period,
beginning with the year in which the transfer occurs, and the transferred funds will be
treated in the same manner as a non-elective contribution by Taxpayer. In no event will
Taxpayer use or apply any transferred funds or any funds in the suspense account to
satisfy any matching contribution obligation Taxpayer may have with respect to Plan Y.

In addition, Taxpayer represents that Plan Y is being amended to provide that it will not
engage in, and there will not be, any leveraged ESOP transaction involving Plan Y
within the meaning of § 4975(d)(3) and Treas. Reg. § 54.4975-7(b) while a § 4980
suspense account continues to exist and is in effect in Plan Y.

Taxpayer states that it does not anticipate that any amounts to be allocated from the
transferred funds will exceed the limits under § 415, whether allocated in a single year,
or placed in the suspense account and allocated ratably over multiple plan years.
Taxpayer further represents that if the limits imposed by § 415 prevent the allocation of
any amount in the suspense account to a participant before the close of the 7-year
period, that amount will be allocated to the accounts of other participants. If any portion
of the suspense account amount may not be allocated to other participants by reason of
any limitation, it will be allocated to participant accounts as otherwise provided under
§ 415. Taxpayer requests the following rulings:

1. Plan Y is a “qualified plan” within the meaning of § 4980(c)(1).
2. Based on Taxpayer’s compliance with the requirements in § 4980(d)(2)(A) and
   (B), Plan Y is a “qualified replacement plan” within the meaning of § 4980(d)(2).
3. The excess assets transferred from Plan X to Plan Y will not be includible in the
   gross income of Taxpayer.
4. With respect to the transfer of the excess assets from Plan X to Plan Y, no
   deduction is allowable to Taxpayer under § 404 and the amount transferred will
   not offset the maximum deductible amount otherwise available to Taxpayer
   under § 404.
5. The excess assets transferred from Plan X to Plan Y will not constitute or be
   treated as a reversion to Taxpayer.
6. No amount of the excess assets transferred from Plan X to Plan Y will be subject
   to any excise tax under § 4980.
7. The excess assets transferred from Plan X to Plan Y will not be treated as annual
   additions to Plan Y under § 415 until allocated to participant accounts.
   PLR-104069-20 3

Applicable Law

Section 61 provides that, except as otherwise provided in Subtitle A of the Code, gross
income means all income from whatever source derived.

Section 415(c) provides that contributions and other additions with respect to a
participant exceed the limitation of this subsection if, when expressed as an annual
addition to the participant's account, such annual addition is greater than the lesser of
$40,000 (as indexed in accordance with § 415(d)(1)(C)), or 100 percent of the
participant's compensation.

Section 415(c)(2) provides that, for purposes of § 415(c)(1), the term “annual addition”
means the sum for any year of employer contributions, employee contributions, and
forfeitures.

Section 4980(a) imposes a 20 percent excise tax on the amount of any employer
reversion from a qualified plan. Under § 4980(d)(1), the excise tax under § 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)(1) generally defines a “qualified plan” as any plan meeting the
requirements of § 401(a) or § 403(a), other than a plan maintained by an employer if
such employer has, at all times, been exempt from tax under Subtitle A, or a
governmental plan (within the meaning of § 414(d)).

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.

Section 4980(d)(2) defines a “qualified replacement plan” as 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 § 4980(d)(2)(A),
(B), and (C).

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 § 4980(d), over (ii)
the amount equal to the present value of the aggregate increases in the accrued
PLR-104069-20 4

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.

Section 4980(d)(2)(B)(iii) provides that in the case of the transfer of any amount under
§ 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 the transfer, and the
transfer is not treated as an employer reversion for purposes of § 4980.

Section 4980(d)(2)(C)(i) provides that 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.

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

Section 4980(d)(2)(C)(iii) provides that any income on any amount credited to a
suspense account under § 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 § 4980(d)(2)(C)(i)(II) (after application of § 4980(d)(2)(C)(ii)).

Section 4980(d)(2)(C)(iv) provides that if any amount credited to a suspense account
under § 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 § 415 shall be allocated to the accounts of other participants, and (II) if any
portion of such amount may not be allocated to other participants under the preceding
subclause by reason of such limitation, that portion shall be treated as an employer
reversion to which § 4980 applies.

Section 4980(d)(4)(A) provides that a benefit may not be increased under
§ 4980(d)(2)(B)(ii) or § 4980(d)(3)(A), and an amount may not be allocated to a
participant under § 4980(d)(2)(C), if such increase or allocation would result in a failure
to meet any requirement under § 401(a)(4) or § 415.

Section 4980(d)(4)(B) provides that any increase in benefits under § 4980(d)(2)(B)(ii) or
§ 4980(d)(3)(A), or any allocation of any amount (or income allocable thereto) to any
PLR-104069-20 5

account under § 4980(d)(2)(C), shall be treated as an annual benefit or annual addition
for purposes of § 415.

Revenue Ruling 2003-85, 2003-32 I.R.B. 291, provides that the direct transfer from a
terminating plan that did not provide for increases in the accrued benefit of participants
to a plan intending to be a qualified replacement plan satisfied the requirements of
§ 4980(d)(2)(B) when the amount transferred was at least 25 percent of the maximum
amount that the employer could receive as an employer reversion.

Analysis

With respect to Taxpayer’s first request, Taxpayer represents that Plan Y has received
a determination letter, which indicates that it satisfies the requirements of § 401(a) and
is thus, a qualified plan. In addition, Taxpayer represents that Plan Y is neither
sponsored by an employer that is exempt from tax under Subtitle A, nor is it a
governmental plan as defined in § 414(d). Therefore, Plan Y is a “qualified plan” within
the meaning of § 4980(c)(1).

With respect to Taxpayer’s second request, Taxpayer represents that at least 95
percent of the active participants in Plan X who remain as employees of Taxpayer after
Plan X was terminated and Plan X benefits are distributed are active participants in Plan
Y. In addition, Taxpayer represents that all remaining excess assets in Plan X will be
transferred to Plan Y, and all of those assets could revert to Taxpayer if not transferred
to Plan Y. Further, Taxpayer represents that Plan Y will satisfy the participation, asset
transfer, and allocation requirements of §§ 4980(d)(2)(A), (B), and (C). Based on those
representations, Plan Y is a qualified replacement plan within the meaning of
§ 4980(d)(2).

With respect to Taxpayer’s third request, Taxpayer represents that Plan X has been
terminated, and after payment of Plan X benefits and expenses, all remaining assets
from Plan X will be transferred to Plan Y. Section 4980(d)(2)(B)(iii) provides that in the
case of the transfer of any amount under § 4980(d)(2)(B)(i) from a terminated plan, that
amount is not includible in the gross income of the employer. Therefore, the amount to
be transferred from Plan X to Plan Y will not be includable in the gross income of the
Taxpayer.

With respect to Taxpayer’s fourth request, with respect to the transfer of excess assets
from Plan X to Plan Y, the assets from Plan X are being directly transferred to Plan Y
pursuant to § 4980(d)(2)(B)(i). Therefore, no deduction is allowable to Taxpayer under
§ 404 under § 4980(d)(2)(B)(iii), and the amount transferred will not offset the maximum
deductible amount with respect to Plan Y otherwise available to Taxpayer under § 404.

With respect to Taxpayer’s fifth request, Taxpayer represents that it will not receive
directly or indirectly any of the excess assets from Plan X. Section 4980(d)(2)(B)(iii)
provides, in part, that in the case of the transfer of any amount under § 4980(d)(2)(B)(i)
PLR-104069-20 6

from a terminated plan, the transfer is not treated as an employer reversion for
purposes of § 4980. Therefore, the transfer of excess assets from Plan X to Plan Y will
not constitute or be treated as a reversion to Taxpayer under § 4980.

With respect to Taxpayer’s sixth request, because the transfer of excess assets from
Plan X to Plan Y will not constitute or be treated as a reversion to Taxpayer, the amount
transferred will not be subject to the excise tax under § 4980.

With respect to Taxpayer’s seventh request, § 4980(d)(4)(B) provides that any
allocation of any amount (or income allocable thereto) to any account under
§ 4980(d)(2)(C), is treated as an annual benefit or annual addition for purposes of
§ 415. Therefore, excess assets transferred from Plan X to Plan Y will not be treated as
annual additions to Plan Y accounts under § 415 until amounts are allocated to Plan Y
participant accounts from the suspense account.

The rulings contained in this letter are based upon information and representations
submitted by Taxpayer’s authorized representatives and accompanied by a penalties of
perjury statement executed by an appropriate party, as specified in Rev. Proc. 2020-1,
2020-1 I.R.B. 1, § 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. 2020-1, § 11.05.

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 letter is directed only to the taxpayer requesting it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.
PLR-104069-20 7

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

                                   Sincerely,




                                   Janet Laufer
                                   Senior Technician Reviewer
                                   Qualified Plans Branch 3
                                   Office of Associate Chief Counsel
                                   (Employee Benefits, Exempt Organizations, and
                                   Employment Taxes)

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