IRC 404(a)(3)(A)(i)(I) - c.ymcdn.comc.ymcdn.com/sites/ · PDF file6 Defined Contribution Plans • Who is benefiting under the (401(k)) plan? • Since the IRC 404 regulations do not

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404 Deduction Rules for DB/DC Plans Tuesday, April 30, 2013

Kevin J. Donovan, CPA, MSPA

Pinnacle Plan Design, LLC

Defined Contribution Plans

• For defined contribution plans

deduction limited to 25% of

compensation paid to beneficiaries

of the plan during tax year

• IRC §404(a)(3)(A)(i)(I)

• Compensation measurement period

tax year not plan year

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• Reg. §1.404(a)-9(b) further explains the compensation included in the 25% limit, as follows:

―the limitation shall be based on the compensation otherwise paid or accrued by the employer during such taxable year of the employer to the employees who, in such taxable year of the employer, are beneficiaries of the trust funds accumulated under the plan.‖


• Plan‘s definition of compensation not relevant

(Revenue Ruling 80-145)

• Example. Calendar year employer, calendar

year plan. Employer maintains profit sharing

plan using traditional dual entry system.

Employees who enter the plan mid-year receive

an allocation based only on their compensation

earned while a participant. For purposes of the

25% deduction limit, the individual‘s

compensation for full year is still included.

3


• Example. An employer maintains a plan

which defines compensation for

allocation purposes as ―base‖

compensation, therefore excluding

overtime and bonuses. Nevertheless,

for deduction purposes all

compensation, including bonuses and

overtime, is counted.


• Compensation includes elective deferrals • IRC §404(a)(12)

• Compensation limited to $250,000 for 2012; $255,000 for 2013 • IRC §404(l)

• Exclude compensation of participants not eligible for allocation (e.g. due to EOY employment requirement) – they are not beneficiaries under the plan • RR 65-295

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• Impact of elective deferrals (Post EGTRRA)

IRC §404(n):

• ―Elective deferrals … shall not be subject to

any limitation contained in paragraph (3), (7),

or (9) of subsection (a), and such elective

deferrals shall not be taken into account in

applying any such limitation to any other

contributions.” (emphasis added)

• e.g., post EGTRRA deferrals not employer

contributions for deduction purposes


• 401(k) plan participants receiving no employer contributions (e.g., early entry for deferrals, last day requirement, etc.) • Pre-EGTRRA -- IRS clear compensation counted

in determining deduction limit

• IRS/ASPA #82 1996; #32 1995

• Post EGTRRA (i.e. now that deferrals are not in the limit) – are these participants ―beneficiaries under the plan” for purposes of IRC §404(a)(3)(A)(i)(I) ?

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• Use IRC §410(b) ‗benefiting‘ as guideline?

• Effectively done in Rev Rul 65-295

• Those eligible to defer considered to be benefiting for purposes of 401(k) portion of plan [Reg. §1.410(b)-3(a)(2)(i)]

• Nothing in IRC §404 suggests need to disaggregate into separate plans

• But really …


• My take … look at §404(n) again • ―Elective deferrals … shall not be taken into account

in applying any … limitation to any …contributions.”

• All that should matter is whether employee received allocation of employer dollars • If yes, count compensation

• If no, don‘t

• Deferring, not deferring, eligible to defer, etc. N/A

• BUT … • http://www.irs.gov/pub/irs-tege/epche903.pdf

• IRS Examination handbook; Page 9-18, next slide • (Who knows when this was updated!!??)

http://www.irs.gov/pub/irs-tege/epche903.pdf



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• Who is benefiting under the (401(k)) plan?

• Since the IRC 404 regulations do not define who is ―benefiting‖, the IRC 410 regulations governing coverage and how to determine which participant is considered benefiting should be used to make this determination. In general, in order to be considered benefiting an employee must share in the employer contribution...

• With a 401(k) plan, participants only have to be eligible to defer to be considered benefiting. Therefore participants who are eligible to make salary deferrals during the tax year (whether or not deferrals are actually made) are considered to be benefiting and their compensation is included in determining the limits under IRC 404(a)(3). See T.R. 1.410(b)-3(a)(2).

• Let’s recall this when we speak of combined plan limits and ½ employees in DB, ½ in DC but all deferring in 401k. Certainly we won’t want the deferral only folks to be considered benefiting in the DC plan for that reason now will we!?


• Update – PLR 201229012

• ―… an employee who is treated as benefitting (for 410(b) purposes)

under a section 401(k) plan for a plan year, but who is not eligible for

any employer contributions other than elective deferrals, would not

be considered a beneficiary of the trust for purposes of section

404(a)(3)(i)(l) since section 404(n) of the Code requires the limits on

deductible contributions to be applied without regard to the existence

or absence of elective deferrals …‖

• ―… Accordingly, the deductible limit under section 404(a)(3)(A) of the

Code … is determined based on compensation paid or accrued

during the taxable year to all employees who are beneficiaries under

… the Plans during the taxable year… taking into account only those

employees who have allocations other than elective deferrals …‖

• So at least one person at the IRS believes you must receive

employer allocations to have your comp. included.

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• Multiple plans, IRC 404(a)(3)(A)(iv):

• ―If the contributions are made to 2 or more stock bonus or profit-sharing trusts, such trusts shall be considered a single trust for purposes of applying the limitations in this subparagraph. ―

• See PLRs 9635045 and 199909060


• Example. Company X has 10 union employees. Total compensation of such employees is $400,000. It has only 2 non-union employees - owner and spouse - each of whom earn $40,000. Under collective bargaining agreement company X makes profit sharing contribution of 10% of compensation for union employees, for a total of $40,000. Separate plan exists for the non-union employees. Deduction limit for the plans is 25% of $480,000 or $120,000. With $40,000 to union plan there‘s room for $80,000 for PS plan for owner and spouse.

• As there are no other non-union employees, discrimination and coverage are not an issue. With 100% of comp. 415 limit, $40,000 can be allocated to each spouse.

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• Effect of overlapping Plan/Tax Year • Recall 25% limit based on tax-year compensation

• Example • Calendar plan-year

• June 30 tax-year

• Participant comp. June 30, 2013 = $400,000

• Employer contribution for 2012 plan-year = $75,000

• If timely, $25,000 of contribution for 2013 plan year could be deducted in tax-year-ended June 30, 2013

• But not matching cont. on post 6/30/13 deferrals • Revenue Rulings 90-105; 2002-46

• See later discussion re IRC 404(a)(6) and RR 76-28

Defined Benefit Plans

• Maximum deduction greater of:

• §430 minimum [§404(o)(1)(B)]

• Basically Target Normal Cost plus amortization (or less excess of assets over Funding Target)

• IRC 430(a)

• IRC 430(j)(2) requires adjustment for interest –

• As this may require deposit greater than ‗minimum‘ is there reasonable basis for deducting full amount where maximum = minimum?

• Likely not issue for next few years with MAP 21

• §404(o)(2) amount [§404(o)(1)(A)]

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• Target Normal cost

• ―… present value of all benefits … earned … during the

plan year‖

• IRC §430(b) ; Reg. §1.430(d)-1(b)(1)

• Funding Target

• ―…the present value of all benefits … earned, or

otherwise allocated to years of service prior to the first

day of the plan year…‖

• IRC §430(d)(1); Reg. §1.430(d)-1(b)(2)

• New plan gets FT (and cushion) by crediting prior svc


• PVs determined by use of three funding ―segment

rates‖ prescribed by law

• First segment rate (S1) applied to payments projected

to be made within 5 years of valuation date

• Second segment rate (S2) applied to payments

projected to be made within next 15 years

• Third segment rate (S3) applied to payments projected

to be made thereafter

• May use rates in effect for month of valuation date or

up to 4-month ‗lookback‘

• IRC 430(h)(2)

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• Deduction determined with respect to plan year ending with or within taxable year

• Similar language in §404(a)(1) pre PPA

• Plan Year ≠ Tax Year – pre PPA • Limit based on plan year beginning within tax year

• Limit based on plan year ending within tax year

• Weighted average of above based on number of months of each plan year falling within tax year

• Reg. §1.404(a)-14(c)

• Is this still a valid reg post PPA 2006?

• Absent contrary guidance likely reasonable to assume yes


• Title IV (PBGC covered) plan may deduct contribution needed to fully fund benefit liabilities in termination year – IRC §404(o)(5) • What if termination process completed too

late to make contribution deductible ―‘in‘ ‗termination year‘‖? • What is ―termination year‖ anyway?

• With separate 404 FT/TNC under MAP 21 stronger argument separate 404 FT/TNC continue to exist post termination-year?

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• ―§404(o)(2) amount‖ = sum of:

• Target normal cost,

• Funding target, and

• Cushion amount, over

• Actuarial value assets

• §404(o)(2)(A)

• BE CAREFUL NOT TO OVER-FUND AND RUN AFOUL OF 415 LIMITS


• Cushion amount [IRC §404(o)(3)] sum of:

• 50% of Funding Target (FT), plus

• Increase in FT where future compensation increases considered

• Where benefits not effected by future compensation (e.g. flat dollar) allow for expected increases based on prior 6 years benefit increases

• N/A for accumulation/most cash balance plans

• §404(l) comp. limit and §415 benefit limit taken into account – but PBGC plan may ignore §404(l)

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• When calculating 50% cushion, plans

with less than 101 participants exclude

from funding target any liability due to

benefit increases for HCEs from

amendments ―made or effective‖

(whichever is later) in last 2 years

• IRC §404(o)(4)


• Plans NOT at-risk, IRC §404(o)(2) amount not less than: • FT, as if plan at risk; plus

• TNC, as if plan at risk; less

• Actuarial value of assets

• IRC §404(o)(2)(B)

• ―At-risk‖ status is from funding rules and relates to large (over 500 participants) plans that are under 80% funded. Such plans are subject to more stringent funding assumptions. Above rules allow use of such assumptions in determining maximum deductible amount for all plans

• Cash balance plans usually grant no past service. Such plans allowing for immediate LS should be able to use this rule to get deduction for full contribution in year 1 • Example later in outline

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• At risk rules

• FT & TNC, determined in normal manner, but with

additional assumptions (following slide), PLUS

• Load of $700 per participant added to FT

• Load of 4% of Non-at risk amt added to FT & TNC

• Loads only if at risk 2 of prev. 4 years

• Application of loads to 404(o)(2)(B) rule? – likely

reasonable to add loads absent contrary guidance

• IRC §§ 430(i)(1)(A); 430(i)(1)(C); 430(i)(2)

• Reg §§ 1.430(i)-1(c)(2) ; 1.430(i)-1(d)(2)


• Assumptions used for at-risk FT/TNC

• All employees eligible to commence distribution

within 10 years after current year assumed to retire

at earliest retirement date (ERD) and commence

(most valuable form of) distribution at ERD

• ERD is earliest date participant may receive fully

vested immediate distribution (Reg. §1.401(a)-20

QA 17(b))

• But not before end of current plan year

• IRC §430(i)(1)(B)(i)

• Reg §§ 1.430(i)-1(c)(3)(ii)(C) / 1.430(i)-1(d)(2)(i)

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Defined Benefit Plans – MAP 21

• In a moment we will show examples

of the use of the cushion as well as

use of the at-risk rules

• First however let‘s look at MAP-21


• MAP 21 provides for modification of interest rates for purposes of funding beginning in 2012 (or 2013 if employer elects)

• Subjects segment rates for determining FT & TNC to floor and ceiling based on 25 year average • As opposed to current 24 month average

• 25 year period ends 9/30 of prior calendar year • So all rates for a calendar year subject to same

limiting range of rates

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• For plan years beginning in -

• 2012 corridor 90-110%

• 2013 corridor 85-115%

• 2014 corridor 80-120%

• 2015 corridor 75-125%

• 2016 (and later) corridor 70-130%

• Of the 25-year average


• 1/1/12 Adjusted Segment Rates (zero look back month) as follows:

• Unadjusted 1.98 / 5.07 / 6.19

• 25-year avg 6.15 / 7.61 / 8.35

• 90% floor 5.54 / 6.85 / 7.52

• These rates will apply for all valuation dates for plan years beginning in 2012 (unless election out)

• IRS Notice 2012-55

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• Change effective for

• Funding (2012 optional)

• AFTAP (2012 optional)

• Change not effective for

• Deduction limits under Section 404(o)

• PBGC variable rate premiums

• PBGC reportable events

• 417(e) and 415


• EXAMPLE:

• End of year valuation

• One participant plan effective in 2012

• No prior service; 2012 Comp = $250K

• EOY Age 58, NRA 62

• Accrued Benefit EOY = $1,666.67

• Full/Immediate vesting

• Plan Actuarial Equivalence

• Pre retirement interest 5%, mortality - none

• Post retirement int. 5.5%, 2012 417(e) table

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• 404 S1 = 1.75%; S2 = 4.62%; S3 = 5.72% • Sept 2012 rates – using 4th month prior

• 430 S1 = 5.54%; S2 = 6.85%; S3 = 7.52% • Per Notice 2012-55

• 415 $ limit 62 (NRA) $1,666.67

• 415 $ limit 58 (AA) $1,261.81

• APR 62 = 148.820; APR 58 = 161.004

• Max LS NRA = $248,033; AA = $203,157 • With immediate vesting latter = at risk TNC


• 430 TNC = MRC • LS NRA 430 rates 417(e) table - $216,370

• Obtained by running 430 rates through 417(e) table

• LS NRA Plan rates - $248,033 • 1666.67 * 148.820

• LS NRA 415 max - $248,033 • 1666.67 * 148.820

• TNC $248,033/1.0554^4 = $199,913 • Greater of first two (417(e) or plan), limited to last

(415), discounted back at ―MAP adjusted‖ S1

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• 404 TNC • LS NRA 404 rates 417(e) table- $257,477

• Obtained by running 404 rates through 417(e) table

• LS NRA Plan rates - $248,033 • 1666.67 * 148.820

• LS NRA 415 max - $248,033 • 1666.67 * 148.820

• TNC $248,033/1.0175^4 = $231,405 • Greater of first two (417(e) or plan), limited to last

(415), discounted back at ―unadjusted‖ S1


• First plan year and no prior service granted • so no FT and no cushion

• Maximum deductible contribution therefore greater of • 404 TNC ($231,405) or

• At-risk amount ($213,113) • At risk = $203,157 (at-risk TNC from above) + $700 +

(231,405 * .04)

• Latter two pieces ―loads‖ discussed previously

• Min / max range = $199,913 -> $231,405

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Defined Benefit Plans – Use of Cushion

• Example – ―One Big Hit‖ trial lawyer

• Age 58 at 1/1/13, 15 years prior svc

• No other employees – Reg. §1.401(a)(4)-5(a)(3) N/A

• Wants to retire 12/31/2017 at age 62

• Consistently earned $250K annually

• 2013 will earn $550K

• Likely back to $250K in 2014 →

• And he needs it all to live

• Wants to shelter the $300K excess

• But with no future obligation


• ―One Big Hit‖ trial lawyer (cont)

• Adopts DB plan

• Normal retirement age 62

• Monthly benefit $100 per year of service • Benefit at 1/1/13 effective date $1,500

• Annual accrual thereafter $100

• Total benefit at retirement $2,000

• Assume lump sum, 5% 2013 417(e) table

• B.O.Y. valuation • January 2013 unadjusted S1 - 1.62%

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• FT = $215,996

• 1,500 * 156.045 * 1.0162 ^ (-5)

• TNC = $14,400

• 100 * 156.045 * 1.0162 ^ (-5)

• Max deduction = $338,394

• FT + Cushion (50% FT) + TNC

• (215,996) + (215,996 * .5) + 14,400



• Deposit of $300,000 will be enough to cover

all 20 years of benefits

• Assuming deposit 12/31/2013 & ROR of at

least ~~ 1%

• No future funding requirement

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• i.e. benefit at age 62 will be $2,000

• Value (liability) at age 62 (assuming current

table) will be $312,090 (2,000 * 156.045)

• At 1% ROR assets will grow to $312,181

• Greater growth fine

• Maximum lump sum under IRC 415 at age 62

with 5 years in plan exceeds $1.25 million

• We did this in 2012 with an author who had

first big seller

Defined Benefit Plans – Use of At Risk Rules

• Cash bal example:

• First year theoretical contribution = $100,000;

Assume employee will take payment at NRA

• 13 years from retirement – so use S2 for discounting

• Interest crediting rate 4%

• Future value at 4% = $166,507

• Present value at 4.67% = $91,991

• 4.67% = Aug 2012, unadjusted second segment rate (S2)

• Unadjusted S1 = 1.77% (used on next slide)

• Represents 404 TNC and in year 1 would = minimum

required cont. (MRC) for deduction purposes (post MAP)

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Defined Benefit Plans – Use of At Risk Rules

• At risk rules • Assume full vesting end of year 3 (i.e., 2 years from

EOY val date) • This becomes ―earliest retirement date‖ and is date used to

determine ―at risk‖ TNC and FT

• TNC with additional assumptions = $104,430 • $100K * (1.04 ^ 2) / (1.0177 ^ 2)

• TNC Load = $3,680 (4% * 91,991)

• FT load = $700 (one participant) + (4% * 0)

• Maximum deduction = $108,810 • At-risk TNC + At-risk FT - assets

• ($104,430 + 3,680) + (0 + 700) – 0

• Full $100K contribution credit therefore deductible

Defined Benefit Plans – Post-year end amendments

• Often a plan fails coverage or non-discrimination testing and a plan amendment is made after year-end to correct • Reg. Section 1.401(a)(4)-11(g) allows such an

amendment to be considered for testing if, among other requirements, such amendment is non-discriminatory on a standalone basis

• The regulation specifically says that the amendment is not considered for purposes of the funding or deduction rules

• So absent some other provision, contributions made per corrective amendments not deductible in year for which they are made

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• For pension plans that other provision is Code Section 412(d)(2):

• ―For purposes of this section, any amendment applying to a

plan year which—

• (A) is adopted after the close of such plan year but no later

than 2 1/2 months after the close of the plan year …,

• (B) does not reduce the accrued benefit of any participant

determined as of the beginning of the first plan year to which

the amendment applies, and

• (C) does not reduce the accrued benefit of any participant

determined as of the time of adoption …,

• shall, at the election of the plan administrator, be

deemed to have been made on the first day of such plan

year.”


• Note that this provision has been used to increase deductions even for DB plans that were not failing any testing • E.g. owner only or safe harbor formula plans looking to

increase contribution and therefore increased benefits (within 2 ½ months of) post year-end to get there

• Until the IRS made a comment at the 2011 EA meeting it was generally accepted that this was permissible • MAYBE BECAUSE THE LAW CLEARLY ALLOWS IT!!??

• The following 9 slides trace through some regulation sections and the actual IRS comment at the EA meeting

• We will not go through them at this point, but they are there for your later review if you care

• Further comments from the IRS are expected on this issue

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• Reg. 1.430(d)-1(d)(1)(i)

• “Plan provisions adopted by valuation date.

Except as otherwise provided in this paragraph

(d), a plan‘s funding target and target normal cost

for a plan year are determined based on plan

provisions that are adopted no later than the

valuation date for the plan year and that take

effect on or before the last day of the plan year.‖


• Reg. 1.430(d)-1(d)(1)(ii)

• “Plan provisions adopted after valuation date. If a plan

administrator makes the election described in section 412(d)(2)

… the plan amendment is treated as having been adopted on

the first day of the plan year for purposes of this paragraph (d).

Section 412(d)(2) applies to any plan amendment adopted no

later than 2-1/2 months after the close of the plan year,

including an amendment adopted during the plan year. Thus, if

an amendment is adopted after the valuation date for a plan

year … but takes effect by the last day of the plan year, the

amendment is taken into account in determining the plan‘s

funding target and target normal cost for the plan year…‖

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• Reg. 1.430(d)-1(d)(1)(iii)

• “Determination of when an amendment takes

effect. For purposes of this paragraph (d)(1), the

determination of whether an amendment that

increases benefits takes effect and when it takes

effect is determined in accordance with the rules

of section 436(c) and §1.436-1(c)(5) … the

determination of when an amendment takes

effect is unaffected by an election under

section 412(d)(2).”


• Reg. 1.436-1(c)(5)

• “Rule for determining when an amendment takes

effect. For purposes of section 436(c) ... in the

case of an amendment that increases benefits,

the amendment takes effect under a plan on the

first date on which any individual … would obtain

a legal right to the increased benefit if the

individual were on that date to satisfy the

applicable requirements for entitlement to the

benefit …‖

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• Preamble to Reg. 1.436-1(c)(5)…

• ―... if an amendment is adopted to provide

increased benefits retroactively with respect to a

prior year, but no participant's benefits are

increased until the amendment is adopted, the

amendment takes effect at the time of

adoption and must satisfy the requirements of

section 436(c) for the plan year the amendment is

adopted.‖


• 2011 Graybook Q&A 4 - QUESTION

• ―The final §430 regulations provide that a plan

amendment is reflected in FT and TNC if adopted

no later than the valuation date for the plan year.

In the case of an amendment adopted after the

valuation date, the amendment is reflected in FT

and TNC if the plan administrator makes the

election in §412(d)(2).‖

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• 2011 Graybook Q&A 4 – QUESTION (cont) • ―However, in both cases, the amendment is taken into account only if

it takes effect on or before the last day of the plan year. Assume a

discretionary amendment (i.e., an amendment that is neither required

for qualification nor integral to an amendment that is required for

qualification) is adopted within the §412(d)(2) period of 2 ½ months

after the end of the prior plan year to increase the benefit formula for

prior service for all participants that worked at any time during the

prior plan year. If the plan administrator makes the §412(d)(2)

election, can the amendment be reflected in FT and TNC? Does the

answer depend on whether a §436 contribution is required? On

whether plan operations had actually reflected the amendment in the

prior year? On whether the amendment is reflected for coverage and

nondiscrimination purposes?‖


• 2011 Graybook Q&A 4 - RESPONSE

• ―In this situation the amendment is only reflected

if it is adopted and takes effect by the end of the

prior plan year. In general, if a discretionary

amendment is adopted after the plan year that

provides for increases in the prior year, there is

no legal right to the increased benefits until

adoption. Such an amendment takes effect when

adopted (assuming §436 permits), and could be

taken into account for the adoption year if a

§412(d)(2) election is made for that year.‖

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• 2011 Graybook Q&A 4 – RESPONSE (cont)

• ―If a discretionary amendment is implemented

operationally during a plan year (thus creating a legal right

in the plan year) adoption is required by the end of that

plan year [see Rev. Proc. 2007-44]. Any corrective

amendment that meets the requirements of §1.401(a)(4)-

11(g) that is adopted after the end of the plan year is

treated as being effective in the year preceding the year

the amendment is adopted for purposes of coverage and

nondiscrimination, but that treatment will not apply for

minimum funding (or deductions) as noted above.‖

• [note last phrase is consistent with 1.401(a)(4)-11(g)(5)]

Combined Plan Deduction Limits

• Applies where employer contributes

to both DB and DC plan for same tax

year [IRC §404(a)(7)(A)]; AND

• At least one employee is a beneficiary

in both plans [IRC §404(a)(7)(C)(i)]

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• Deduction limited to greater of

• 25% of compensation paid to beneficiaries of the plans during the tax year; or

• Contributions to DB plan to extent not in excess of minimum funding requirement

• Not less than funding target over assets

• IRS has indicated that MAP does apply for this purpose (IRS phone forum)

• i.e. new (higher) rates used resulting in lower FT

• No big deal as rarely if ever used

• IRC §404(a)(7)(A)


• Limit does not apply -

• To extent employer contributions to DC plan do not exceed 6% of compensation (of DC plan ‗beneficiaries‘)

• IRC §404(a)(7)(C)(iii)

• To multiemployer plans • IRC §404(a)(7)(C)(v)

• To PBGC plans • IRC §404(a)(7)(C)(iv)

30


• IRS Notice 2007-28

• Q&A 8 - where DC contributions exceed

6% of comp, only DC contributions over

6% considered in determining 25% limit

• Effectively translates to 31% limit

• BUT, only consider compensation of DC

beneficiaries in determining the 6%

• 6% is aggregate number

• i.e., individual participants may get greater than 6%


• DB Plans exempt from PBGC coverage

• Plans of professional group if plan never

covered more than 25 active participants

• Physicians, dentists, D.O.s, O.D.s, lawyers,

CPAs, P.E.s, architects, actuaries, others

where license requires ―advanced study‖

• Not APAs, QPAs, RIAs, real estate prof, etc.

• ERISA Title IV §§ 4021(b)(13), 4021(c)(2)

31


• DB Plans exempt from PBGC coverage

• Plans covering only ―substantial‖ owners

• A ―substantial owner‖ is an individual who (at

any time during the prior 60-months) owns:

• the entire interest in a sole proprietorship

• more than 10% of either a capital or profits interest

in a partnership, or

• more than 10% in value of either the voting or all

stock of a corporation

• ERISA Title IV §§ 4021(b)(9), 4021(d)


• Attribution rules of IRC §§ 1563 and 414(c) apply

in determining ownership

• Under IRC §1563(e) ―An individual shall be

considered as owning stock owned … by … his

children who have not attained the age of 21 years,

and, if the individual has not attained the age of 21

years, the stock owned … by … his parents‖

• Children not deemed to own the stock of their

parents via above rules are not ―substantial owners‖

and therefore could cause coverage

• 60-month rule basically requires child to be age 26

for this rule to cause coverage

32

Simple DB/DC using PBGC coverage to our advantage

2012

Comp.

AAC

BOY

AAC

EOY

YOS

EOY

Age

Owner $ 250,000 $211,667 $223,167 6 60

Son 32,000 31,929 31,965 2 26

NHCE 1 100,000 5 49

NHCE 2 30,000 5 45

Total

$ 412,000


• 2012 very big year so looking for large deduction;

unsure about future

• DC plan is PS only, no 401(k)

• Historically has contributed maximum PS for owner

plus 5-10% for employees

• 2012 contributions to DC plan

• Maximize Owner

• 0% to son

• $7,500 each to NHCEs

33


• In 2012 add a DB plan

• Owner benefit = 2% X AAC X YOS first 5 years, 1%

thereafter (recall 5 prior years of service)

• Son benefit = .5% X AAC X YOS

• Exclude Non-key employees

• NRA 62; QJSA 50%

• Act. eq. 5% pre / 5.5% 2012 417(e) table post

• For funding, beginning accrued benefits determine

FT while increase used for TNC

• Though for testing full year-end amount considered


• DB (monthly) benefits beginning of year 1:

• Owner-

• AAC * benefit/year * YOS ÷ 12

• $211,667 * 2% * 5 ÷ 12 = $1,763.89

• Limited by IRC 415 to $1,666.67

• $200,000/12 = $16,666.67

• One year of participation so limit to 1/10th

• Son –

• $31,929 * .5% * 1 ÷ 12 = $13.30

34


• DB (monthly) benefits end of year 1:

• Owner-

• Limited by IRC 415 to $1,666.67

• SO NO INCREASE –> BOY benefit = EOY benefit

• THEREFORE no Target Normal Cost for owner

• Son –

• $31,965 * .5% * 2 ÷ 12 = $26.64

• Increase = 26.64 – 13.30 = $13.34


• S1 - 1.77%; S2 - 4.67%; S3 - 5.78%

• Showing max only so using ―unadjusted‖ rates (for

August 2012 – 4 month lookback)

• Funding Target:

• Owner (NRA 62, AA 60) -

• AB * APR / (1+S1)^(NRA-AA)

• $1,666.67 * 148.820 / 1.0177^2 = $239,481

• Son (NRA 62, AA 26) -

• 13.30 * 148.820 / 1.0578^36 = $262

• Target Normal Cost (Son only): • 13.34 * 148.820 / 1.0578^36 = $263

35


• DB maximum

• TNC + FT + cushion – assets

• Cushion = 50% of FT (we‘re ignoring increase in FT

from compensation increases as owner at max)

• $263 + ($239,481+$262)*1.5 – 0 = $359,878

• Should cover owner accruals through NRA

• $223,167 * [(2%*5)+(1%*3)] ÷ 12= $2,417.64

• $2,417.64 * 148.820 = $359,793 (owner LS at NRA)

• Since DB covered by PBGC combined plan

deduction not limited to 25%/31%


2012

Comp.

PS DB Total

Owner $ 250,000 $50,000 $239,481 $289,481

Son 32,000 0 525 525

NHCE 1 100,000 7,500 7,500

NHCE 2 30,000 7,500 7,500

Cushion 119,872 119,872

Total $ 412,000 $65,000 $359,878 $424,878

36


• Select DB/DC test results ignoring PD and MVAR -

• Owner Normal Accrual Rate = 10.78%

• DB: 1,667 * 12 / 250,000 = 8.00%

• DC: 50,000 * 1.085^2 / 8.477 / 250,000 = 2.78%

• 8.5% = standard interest rate

• 2 = Years from attained age (AA) to testing age (TA)

• 8.477 = Testing APR based on ‗71GAM 8.5% age 62

• NHC 2 Normal Accrual Rate = 11.8%

• DC only: 7,500 * 1.085^17 / 8.477 / 30,000 = 11.8%

• IRC §401(a)(26) passed as 2 of 4 persons covered

Combined Plan Limits – Beneficiaries under plan

• ―Beneficiaries under the plan‖

• Recall from above combined plan limits only apply if

at least one employee benefiting in both DB & DC

• RR 65-295 and IRS position in DC plan arena

consistent with notion of benefiting under §410(b)

• In DB arena maintenance of accrued benefit – even

if frozen – appears to suffice

• 2005 greybook Q&A 15

• Logical as DB funding really considers all benefits and

not just those accruing in particular year

37


• Consider ‗carve out‘ DB & 401(k) trying to avoid combined deduction limit while allowing everyone to defer

• Recall IRC §404(n):

• ―Elective deferrals … shall not be subject to any limitation contained in paragraph (3), (7), or (9) of subsection (a) … and such elective deferrals shall not be taken into account in applying any such limitation to any other contributions.” (emphasis added)


• Employer sponsors DB plan & 401(k) PS plan

• Employees in DB plan eligible for deferrals only in 401(k)

• Others in 401(k) PS plan receive PS contributions (but are

not in DB plan)

• i.e., absent deferrals no one benefits in both plans

• 2005 IRS/ASPPA Q&A #21 IRS indicated that the

combined plan limit did not apply

• Of course it doesn‘t – 404(n) controls

• BUT this requires conclusion that deferral only

participants are NOT beneficiaries in DC plan

• And therefore comp. not considered in DC limit

38

Cash Balance/401(k) Combo

Compensation Age

HCE 1 – owner $ 255,000 60

HCE 2 – non owner 255,000 44

NHCE 1 30,000 30

NHCE 2 30,000 46

NHCE 3 30,000 60

NHCE 4 30,000 60

NHCE 5 30,000 44

NHCE 6 30,000 31

Total

$ 690,000

Cash Balance/401(k) Combo – Ex.1 DC over 6%

• Components of Design – DC plan

• 3% non-elective safe harbor 401(k)/PS

• Maximize Owner

• 3% total to non-owner HCE

• Additional 4% PS to NHCEs (7% with SH)

• Suggest no safe harbor to HCEs

• HCEs defer max, NHCEs do not defer

• Same for all examples

39



• For PS allocation each participant in own group for

flexibility & gateway requirements

• No last day or hour requirement for PS allocation

• If not 401(k) SH possibly use 501 hours or last day

• Combo designs generally require loss of

requirements such as 1,000 hours and last day for

PS allocation

• Gateway must go to any NHC receiving allocation of

employer DC or accrual in DB (more later)

• 5% Top-Heavy in profit sharing plan


• Components of Design – DB plan

• Cash balance plan with pay credits as follows:

• Owner - 61% of compensation (exclude non-owner

HCE)

• NHCEs – 2.5% of compensation

• Interest crediting rate = 5% (same for all

examples)

• Plan AE = 5%, 2012 417(e) table (same for all)

• QJSA = 50% J&S (same for all)

40


• Components of Design – DB plan (same for all)

• NRA later age 65 / 5th anniv. participation

• Should be same as DC

• Though likely fine if DC earlier

• Require 1,000 hours to receive pay credit

• May not have an EOY requirement in a DB plan

• Would violate DOL requirement that year of service

with 1,000 or more hours may not be ignored for

benefit accrual

• DOL Reg §§2530.204-1; 2530.204-2


PS/SH

Cash

Balance

Total

Employer

401(k)

Total

HCE 1 $ 33,500 $155,550 $ 189,050 $ 23,000 $ 212,050

HCE 2 7,650 -0- 7,650 17,500 25,150

NHCE 1 2,100 750 2,850 2,850

NHCE 2 2,100 750 2,850 2,850

NHCE 3 2,100 750 2,850 2,850

NHCE 4 2,100 750 2,850 2,850

NHCE 5 2,100 750 2,850 2,850

NHCE 6 2,100 750 2,850 2,850

Total

$ 53,750

$160,050

$213,800

$ 40,500

$ 254,300

41


• Employer deduction total $213,800

• less than 31% of compensation

• $690,000 * 31% = $213,900

Cash Balance/401(k) Combo – Ex.2 DC not over 6%


• 3% non-elective safe harbor 401(k)/PS

• $21,150 Owner


• Additional 4% PS to NHCEs (7% with SH)

• Components of Design – DB plan • Cash balance plan with contribution credits as follows:

• Owner - 76% of compensation (exclude non-owner HCE)


42


PS/SH

Cash

Balance

Total

Employer

401(k)

Total

HCE 1 $ 21,150 $193,800 $ 214,950 $ 23,000 $ 237,950

HCE 2 7,650 -0- 7,650 17,500 25,150

NHCE 1 2,100 750 2,850 2,850

NHCE 2 2,100 750 2,850 2,850

NHCE 3 2,100 750 2,850 2,850

NHCE 4 2,100 750 2,850 2,850

NHCE 5 2,100 750 2,850 2,850

NHCE 6 2,100 750 2,850 2,850

Total

$ 41,400

$198,300

$239,700

$ 40,500

$ 280,200


• Employer deduction total $239,700

• Greater than 31% of comp

• But DC not in excess of 6% of comp

• 6% * $690,000 = $41,400 = Employer DC

• 25%/31% limit therefore not applicable

• Important that HCEs receive employer $$s in DC to use comp. in applying 6% limit

43

Cash Balance/401(k) Combo – Ex.3 DB PBGC Covered

• Components of Design – DC plan • 3% non-elective safe harbor 401(k)/PS

• Maximize Owner


• 4% PS to NHCEs

• Components of Design – DB plan • Cash balance plan with contribution credits as follows:

• Owner - 76% of compensation (exclude non-owner HCE)



PS/SH

Cash

Balance

Total

Employer

401(k)

Total

HCE 1 $ 33,500 $193,800 $ 227,300 $ 23,000 $ 250,300

HCE 2 7,650 -0- 7,650 17,500 25,150

NHCE 1 2,100 750 2,850 2,850

NHCE 2 2,100 750 2,850 2,850

NHCE 3 2,100 750 2,850 2,850

NHCE 4 2,100 750 2,850 2,850

NHCE 5 2,100 750 2,850 2,850

NHCE 6 2,100 750 2,850 2,850

Total

$ 53,750

$198,300

$252,050

$ 40,500

$ 292,550

44


• Employer deduction exceeds 31% of comp.

AND DC exceeds 6% of comp.

• So requires PBGC coverage

• Therefore assumes not Dr/Professional as

under 25 active participants

• ERISA §4021(b)(13)

• Run any of these scenario through your testing

software and you‘ll see they pass all testing

Plan must be in existence

• Engineered Timber Sales, Inc. v. Comr.,

74 T.C. 808 (July 22, 1980)

• Tax court ruled plan must be in existence &

executed prior to end of employer‘s tax year

in order for a deduction to be taken

• IRS reiterated this in Rev. Rul. 81-114

45


• So using fiscal year plan where plan year

begins in tax year, ends after tax year, and

executing plan before end of plan year but after

end of tax year does not result in deduction in

prior tax year

• Plan year 4/1/12-3/31/13

• Tax year 1/1/12-12/31/12

• Plan signed 3/31/13 cannot take deduction in 2012

irrespective of fact that it‘s signed before end of plan

year that begins in tax year


• The Service also ruled in 81-114 that if, under local law, a valid trust has been created by the end of the taxable year except for the existence of corpus, the trust will be deemed to be in effect if the corpus is furnished no later than the due date (including extensions) of the employer's tax return.

• Accordingly, it is not necessary to open an account for the trust prior to the end of the tax year. It is simply necessary that plan documents are properly executed.

46

Self-employed deduction limit

• IRC §404(a)(8)(C)

• Limits deduction on behalf of SE person to

earned income

• Can preclude deduction for minimum funding

required for defined benefit plan

• IRC §4972(c)(4)

• Provides for exception to excise tax on non-

deductible contributions for amounts required

by §412 but not deductible due to above

Self-employed‘s Earned Income

• ―Earned income‖ = net earnings from self-employment (NESE) less: • Deduction for employer contributions for owner

• But not elective deferrals

• ½ SE tax

• For SE persons earned income = compensation

• only with respect to a trade or business in which personal services of the taxpayer are a material income-producing factor

• IRC §§401(c)(2) / 1402(a)

47


• When determining net earnings from SE

(and therefore SE tax)

• Contribution for owner not deductible

• GCM 39807

• Laflamme v. Comr, TCM 2012-36 2/6/2012

• Gale v. U.S., DC-Northern Ill., 6/27/91

• Contribution for employees is deductible


• Calculation of deduction for ½ SE Tax

• First multiply NESE by 92.35%

• For 2012, tax is calculated as 10.4% up to the Social Security taxable wage base (TWB) for the year ($110,100 for 2012) plus 2.9% of all NESE

• Outside W-2 income serves to reduce SE tax

• Deduction for ½ SE tax is 10.4% portion X 59.6% plus 2.9% portion X 50% • Basically same as 6.2% of amount subject to full tax

plus 1.45% of amount subject to 2.9% only

48

Sole-prop Example

• For 2012 individual has W-2 income of

$60,000 from regular employer

• Also has Schedule C income of $120,000

from outside consulting

• No other employees

• Wishes to maximize contribution to solo

401(k) plan

Sole-prop Example

• Net earnings from SE $ 120,000

• Multiply by .9235 110,820

• Lesser this amount or TWB 110,100

• Outside wages 60,000

• Amount to tax at 10.4% 50,100

• 50,100 X 10.4% 5,210

• 110,820 X 2.9% 3,214

• 1/2 SE tax deduction

• 5,210 X .596 = 3,105

• 3,214 X .50 = 1,607 $ 4,712

49

Sole-prop Example

• Net Earnings from Self Employment $120,000

• ½ SE tax 4,712

• Pre-pension Earned Income 115,288

• Maximum PS (20% of pre-contribution net) 23,058

• Add 401(k) deferral 17,000

• Total 40,058

• Check PS deduction:

$120,000 – 4,712 - $23,058 = $92,230 (comp.)

$ 92,230 x 25% = $23,058

Partnerships

• Reg. §1.404(e)- 1A(f)(1) • ―… in the case of a defined contribution plan, a

partner's … distributive share of deductions allowed the partnership under section 404 for contributions on behalf of a self-employed individual is that portion of the deduction which is attributable to contributions made on his behalf …‖

• i.e., if DC plan, partner deducts on personal tax return amounts contributed on his/her behalf

50

Partnerships

• Reg. §1.404(e)- 1A(f)(2) • ―In the case of a defined benefit plan, a partner's

distributive share of contributions on behalf of self-employed individuals and his distributive share of deductions allowed the partnership under section 404 for such contributions is determined in the same manner as his distributive share of partnership taxable income. See section 704, relating to the determination of the distributive share and the regulations thereunder.‖ (emphasis added)

Partnerships

• IRS/ASPA 2000 - 6.

• Q. Field Service Advice 1999-743 indicates that 1.404(e)- 1A(f)(2), which requires allocations of defined benefit plan deductions to be made in accordance with each partner's profits interest, is still valid. Is this true? Assume a partnership has three equal partners, two of whom are covered under the partnership‘s DB plan at a cost of $75,000 each. There are no other employees. The 404 reg appears to say that each partner is responsible for funding (and deducting) $50,000.

• A. Absent a special allocation in the partnership agreement we agree with the above result. A special allocation in the partnership agreement could result in the deduction being allocated to the two covered employees.

51

Year Deductible

• Plan contribution deemed made on

last day of preceding taxable year if

payment on account of such taxable

year and made not later than due

date for filing tax return for such

taxable year (including extensions)

• §404(a)(6)

Year Deductible

• In order for §404(a)(6) to apply (allowing deduction

in tax year prior to year of deposit):

• Contribution must be treated as a contribution

actually received on last day of tax year would be

treated; and

• No later than due date of tax return, employer either:

• designates payment in writing (to PA or trustee) as ―on

account of‖ employer‘s ―preceding taxable year‖; or

• claims payment as deduction on tax return for

preceding taxable year

• Revenue Ruling 76-28

52

Year Deductible

• Note from above ―Contribution must be treated

as a contribution actually received on last day of

tax year would be treated‖

• This would seem to disallow prior year deduction

for amounts contributed pursuant to post year-

end corrective amendment under Reg.

§1.401(a)(4)-11(g)

• Further, from §1.401(a)(4)-11(g)(5)

• ―… the amendment is not given retroactive effect for

purposes of section 404 …‖

Year Deductible

• A payment may be designated as on account of

preceding taxable year (as provided above) at

any time on or before the due date (including

extensions) of tax return for such year

• SO, where return first filed without taking deduction,

amended return may be filed claiming deduction if

filed before (extended) due date

• CONVERSELY, if deduction claimed on preceding

year return for post year-end deposit, employer may

not amend return to push deduction to current year

53

Year Deductible

• Presume that:

• payment made within 8 ½ months after year-end

• treated as prior year deposit for §412 (minimum funding)

• not deducted on prior year tax return, and

• nothing in writing designates contribution is ―on account of‖

prior tax year

• How about deposit made 10/15 (within 404(a)(6)

period for Sole Prop) for calendar year plan?

• Can contribution be ―on account of‖ one year for

minimum funding purposes and another year for

deduction purposes?

Year Deductible

• Revenue Ruling 77-82

• Taxpayer allowed to take deduction in 1975 for

contribution made within §404(a)(6) period, but

count for §412 (minimum funding) in 1976 (§412 did

not apply until years beginning after 1975)

• Service cited following language in Temp. Reg.

§11.412(c)-12(c)(2) (allowing 8½ month post year-

end period to satisfy minimum funding in case of

pension plans other than single employer DB plans):

54

Year Deductible

• ―The rules of this section relating to the time a

contribution … is deemed made for purposes of

… section 412 are independent from the rules

contained in section 404(a)(6) relating to the time

a contribution … is deemed made for purposes of

claiming a deduction for such contribution under

section 404.‖ [Temp. Reg. §11.412(c)-12(c)(2)]

(emphasis added)

Year Deductible

• PLR 9107033: • For 1988 company maintained three plans – a money

purchase plan, a PS plan and a DB plan

• Contributions to 3 plans exceeded §404(a)(7) limit

• Company wished to treat certain contributions to DB plan made after year-end but prior to extended due date of tax return (and minimum funding deadline) as 1988 contributions for §412 but as 1989 for §404

• Citing Temp. Reg. §11.412(c)-12(c)(2) and RR 77-82, Service allowed taxpayer to treat contributions in above manner

55

Year Deductible

• Note that with contribution considered 404 contribution for subsequent year, limits of §404 for following year will apply • and they will apply to all amounts designated as

being ―on account of‖ such subsequent year

• i.e., contribution is not added to following year‘s limit - it becomes deductible within such limit

• (Presumably) Reg. §1.404(a)-14(d)(2)(i) will require that contribution be excluded from assets when determining deductible amounts for subsequent year

Year Deductible

• 2011 Greybook Q&A 7

• A company has a calendar taxable year and sponsors a

pension plan with a calendar plan year. Which of the

following combinations are acceptable for a contribution

made during the 2010 §404 contribution grace period

(January 1, 2011 to September 15, 2011)?

• a) Deduct in 2010, reflect on 2010 Sched SB?

• b) Deduct in 2010, reflect on 2011 Sched SB?

• c) Deduct in 2011, reflect on 2010 Sched SB?

• d) Deduct in 2011, reflect on 2011 Sched SB?

56

Year Deductible

• 2011 Greybook Q&A 7 (cont)

• RESPONSE

• a), c), and d) are acceptable. IRC §404(a)(6) deems a

contribution made after the last day of a taxable year to

be made on the last day of a taxable year if the payment

is made on account of such taxable year. A contribution is

considered to be on account of the 2011 plan year when

reported on the 2011 Schedule SB and thus cannot be

deducted on the sponsor‘s 2010 tax return

• COMMENTARY TO FOLLOW

Year Deductible

• I respectfully disagree that (b) is not acceptable

• IRC 404(a)(6) and 76-28 do not require contribution to be

on account of preceding plan year

• They require it to be on account of preceding tax year

• As detailed above, there is plenty of authority (e.g. RR 77-

82) providing that they can be different

• e.g. as in (c) where on 2010 SB but 2011 tax return

• If a contribution is within deductible limit for preceding

year, and is made by due date of preceding year tax

return, it should be deductible in preceding year

irrespective of treatment for funding purposes

57

Year Deductible

• Effect of Extension. If a company files its tax return

prior to the original due date, but after obtaining an

extension of time for filing, the due date under

§404(a)(6) is the extended due date. Revenue Ruling

66-144, affirmed by Revenue Ruling 84-18 (see also

2002 IRS/ASPA Q&A #47)

• Important to understand that due date of contribution is

due date of return, NOT prior to filing return

• Conversely, an extension is not valid where the return is

filed prior to the original due date and prior to filing for

the extension. PLR 8336006

Documents

IRC 404(a)(3)(A)(i)(I) - c.ymcdn.comc.ymcdn.com/sites/ · PDF file6 Defined Contribution Plans • Who is benefiting under the (401(k)) plan? • Since the IRC 404 regulations do not