This Issue Snapshot focuses on terminating, underfunded, single-employer defined benefit plans not subject to the Pension Benefit Guarantee Corporation (PBGC). IRC Sections and Treas. Regulations IRC Section 401 IRC Section 412 IRC Section 430 IRC Section 4971 26 CFR 1.430(a)-1 26 CFR 1.411(d)-2 ERISA Sections and Regulations 29 USC Section 1082 (ERISA 302) 29 USC Section 1083 (ERISA 303) 29 USC Section 1103 (ERISA 403) 29 USC Section 1202(b) (ERISA 3002) 29 USC Section 1301 through 1310 (ERISA 4001 - 4010) 29 USC Section 1321 (ERISA 4021) 29 USC Section 1344 (ERISA 4044) 29 CFR 4044.10 through 4044.17 Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources) Rev. Rul. 79-237 (as modified by Rev. Rul. 89-87) (funding until termination date) Rev. Rul. 80-229 (allocation) IRM Section 184.108.40.206.1 (processing Form 5330 and waiver of IRC Section 4971) IRM Section 4.72.16 (compliance with minimum funding) IRM Section 7.12 (plan termination) Analysis ERISA Section 4021 exempts certain plans from statutory PBGC coverage. The more common exemptions are as follows: Plans covering only substantial owners (defined in ERISA Section 4022(b)(5)(A)(iii)), Professional service employer plans (defined in ERISA Section 4021(c)(2)) covering fewer than twenty-six employees, Governmental plans including plans maintained by the US federal government, by a state, by a county or by a city, Non-electing church plans, Indian tribal government plans, Plans established and maintained outside of the United States for the purpose of covering non-resident aliens, Excess benefit plans and top hat plans. Most single employer defined benefit plans that are qualified or have ever been qualified are subject to the minimum funding standards of IRC Section 412. Qualified defined benefit plans exempt from IRC Section 412, under IRC Section 412(e), include governmental plans and non-electing church plans. The minimum required contribution for a single-employer plan subject to IRC Section 412 is determined under IRC Section 430. ERISA Sections 302 and 303 are the parallel sections that also contain these same minimum funding standards. IRC Section 4971 imposes taxes on failure to make minimum required contributions based on the minimum funding standards. Pursuant to IRC Section 4971(a), for an employer’s taxable year, a tax is imposed equal to 10% of the aggregate unpaid minimum required contributions (for all plan years) remaining unpaid as of the end of any plan year ending with or within the employer’s taxable year. Pursuant to IRC Section 4971(b), if a tax is imposed on an unpaid minimum required contribution under IRC Section 4971(a) and that unpaid minimum required contribution is not corrected by the end of the taxable period (that is, the earlier of the date of mailing of a notice of a deficiency with respect to that tax or the date on which that tax is assessed), an additional tax equal to 100 percent of the aggregate unpaid minimum required contribution is imposed, to the extent the aggregated unpaid minimum required contribution has not been corrected. Rev. Rul. 79-237 provides that the minimum funding standards (including the obligation to make payments to amortize a funding waiver) under IRC Section 412 apply for plan years through and including the plan year of plan termination, but not for later plan years. A termination does not relieve the employer of the obligation to fund the accumulated funding deficiency as of the end of the plan year in which the plan is terminated. If this deficiency is not reduced to zero, the 100% penalty tax imposed by IRC Section 4971(b) applies. Treas. Reg. Section 1.430(a)-1(f)(5)(ii) defines the termination date for plans not covered by Title IV of ERISA as the plan's termination date established by the plan administrator, so long as the termination date is no earlier than the date on which all actions necessary to effect the plan termination are taken (other than the distribution of plan assets), and so long as the plan assets are distributed as soon as administratively feasible after that date. See also Treas. Reg. Section 1.411(d)-2(c)(3), which provides that a plan not covered by Title IV of ERISA is considered as terminated as of a particular date if, as of that date, the plan is voluntarily terminated by the employer maintaining the plan. Treas. Reg. Section 1.430(a)-1(b)(5) provides that if the plan's termination date occurs before the last day of a plan year, then, for purposes of IRC Section 430, the plan will have a short plan year ending on the termination date, and the valuation date for the plan year must be changed to fall within the short plan year. If a terminating plan’s assets are less than the Present Value of Accrued Benefit (PVAB) of all plan participants, an allocation in accordance with ERISA Section 4044 may be made. This is true whether or not the plan is subject to Title IV of ERISA, which is administered by the Pension Benefit Guarantee Corporation (PBGC). ERISA Section 403(d) requires that a plan that is not covered by PBGC allocate assets on plan termination in accordance with ERISA Section 4044, except as otherwise provided in the regulations of the Secretary of Labor. ERISA Section 4044(a) provides that assets in a terminating defined benefit plan will be allocated to provide benefits under the plan in accordance with the following list of descending priorities: (1) Voluntary participant contributions [ERISA Section 4044(a)(1)], (2) Mandatory participant contributions [ERISA Section 4044(a)(2)], (3) Annuity benefits that (a) were, or (b) could have been, in pay status as of three years before the termination date of the plan [ERISA Section 4044(a)(3)], (4) (a) All other benefits guaranteed under ERISA (i.e., covered by PBGC) [ERISA Section 4044(a)(4)(A)] and (b) additional benefits for majority owners which are limited under ERISA Section 4022(b)(5) [ERISA Section 4044(a)(4)(B)], (5) All other nonforfeitable benefits under the plan [ERISA Section 4044(a)(5)], (6) All other non-vested benefits under the plan [ERISA Section 4044(a)(6)]. ERISA Section 4044 also provides that if the assets are insufficient to allocate under (1), (2) and (3), the assets must be allocated pro rata among such individuals based on the present value (as of the termination date). If assets are insufficient to allocate under (4), the benefits shall be allocated first to benefits in (a) and then allocated to benefits described in (b). If assets are insufficient to allocate, the benefits shall be allocated pro rata among individuals based on the present value of their respective benefits. If the Secretary of the Treasury determines that the allocation results in discrimination prohibited under IRC Section 401(a), assets allocated under (4)(B), (5) and (6) must be reallocated to avoid discrimination. Rev. Rul. 80-229 provides guidelines for determining whether an asset allocation is discriminatory within the meaning of IRC Section 401(a)(4) upon the termination of a defined benefit plan. An allocation of funds required by the priority categories specified in Sections (a)(1), (a)(2),(a)(3) and (a)(4)(A) of ERISA Section 4044 is deemed as non-discriminatory under IRC Section 401(a)(4). For those categories, if possible, the rank and file employee should receive in at least the same proportion of the present value of their accrued benefits (whether or not nonforfeitable) as highly compensated employees. Treas. Reg. Section 1.411(d)-2(a)(2)(ii) also deems this priority allocation as nondiscriminatory. Delegation Order 7-7-1, in accordance with ERISA Section 3002(b) (29 USCS 1202(b)), allows the Secretary of the Treasury to waive all or part of the excise tax imposed under IRC Section 4971(b) on a case by case basis and when circumstances warrant. See also IRM Section 220.127.116.11.1 Issue Indicators or Audit Tips Form 5310 Determination Letter applications: Compare the amount of assets shown on line 20(l) of the Form 5310 application with the amount of Present Value of Accrued Benefit (PVAB) shown on line 25, column (g) of Form 6088. If the plan is underfunded, review how the plan intends to distribute benefits as shown in column (g) of Form 6088 and in the explanation attached to the Form 5310. Determine whether allocation of trust funds was determined according to ERISA Section 4044, and Rev. Rul. 80-229 to ensure that allocation doesn’t violate IRC Section 401(a)(4). Determine if the plan has a funding deficiency that is subject to an IRC Section 4971(a) excise tax. Review Item 17(h) on the Form 5310. Review IRM Section 7.12 for guidance on referring excise tax issues to EP Examination if the excise tax has not been paid. Examinations: Compute the Present Value of Accrued Benefits (PVABs) at plan termination. Verify that the trust balance sheet accurately reflects the fair market value of all assets and liabilities. Review the Form 5500(s), Schedule(s) SBs, to determine if there is an unpaid minimum required contribution for any plan year. If there is an unpaid minimum required contribution for any plan year, determine if a Form 5330 was filed and whether the IRC Section 4971(a) tax has been paid, and whether the unpaid minimum required contribution has been corrected. Review Item 17(h) on the Form 5310 and line 19 regarding the contributions. If the plan sponsor allocated trust funds according to ERISA Section 4044, refer to Rev. Rul. 80-229 to ensure that allocations don’t violate IRC Section 401(a)(4).