Pension surplus transfer avoided employer reversion tax

Plain-English summary

An employer terminated a frozen defined benefit plan that unexpectedly had surplus assets after all liabilities were satisfied. It proposed transferring the entire surplus directly to separate bargaining-unit and non-bargaining-unit 401(k) plans in proportion to the former plan participants active in each replacement plan. The IRS allowed the two 401(k) plans to be treated together as one qualified replacement plan under section 4980. The transferred amounts could fund nonelective contributions and reasonable plan expenses through suspense accounts allocated at least ratably over the required period. The transfer was not income or deductible to the employer, was not an employer reversion, and was not subject to section 4980 excise tax, but the IRS gave no opinion under ERISA Title I.

Ruling snapshot

• Question: Could the employer transfer all surplus pension assets to two 401(k) plans as one qualified replacement plan without employer reversion tax?
• Outcome: approved, with the transfer excluded from income and section 4980 reversion treatment
• Key authorities: IRC § 4980(d)(2) and (5)(D); Rev. Rul. 2003-85

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201935003                                              Third Party Communication: None
Release Date: 8/30/2019                                        Date of Communication: Not Applicable
Index Number: 4980.02-00
                                                               Person To Contact:
-----------------------------------------------                -----------------------, ID No. -------------------
-----------------------------------------------                ---------------------------------------------------
--------------------------------------------                   Telephone Number:
---------------------------                                    ----------------------
                                                               Refer Reply To:
                                                               CC:EEE:EB:QP2
                                                               PLR-103736-19
                                                               Date:
                                                               June 04, 2019


Legend:

Company                             =      -----------------------------------------------
Hourly Plan                         =      -----------------------------------------------------------------------------------------
                                           ---------
Bargaining Unit 401(k)              =      -----------------------------------------------------------------------------------------
Plan                                       ------------------------
Non-Bargaining Unit                 =      -----------------------------------------------------------------------------------------
401(k) Plan                                ----------------------
Salaried Plan                       =      ---------------------------------------------------------------------------
                                           --------------
Date 1                              =      -----------------------
Date 2                              =      ----------------------
Date 3                              =      ---------------------------
Date 4                              =      -------------------
Date 5                              =      ------------------------
Date 6                              =      ---------------------------
Date 7                              =      -------------------
Date 8                              =      ---------------------
Amount 1                            =      ------------------


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

This letter is in response to your request, submitted by your authorized representative,
in which you request rulings concerning the proper treatment under section 4980 of the
Internal Revenue Code (“Code”), of a transfer of surplus assets from a terminated
defined benefit plan to two ongoing 401(k) plans together designated as a “qualified
replacement plan”.
PLR-103736-19                                         2

The following facts and representations have been submitted under penalties of perjury:

The Company established the Hourly Plan on Date 1. The Hourly Plan is a defined
benefit plan which, since its inception, has been qualified under section 401(a).

The Hourly Plan covers two groups of employees that will be referred to for purposes of
this ruling as bargaining unit employees and non-bargaining unit hourly employees.

All benefit accruals under the Hourly Plan were discontinued effective as of Date 3 and
the Hourly Plan continued in operation thereafter as a frozen plan.

As part of the collective bargaining that resulted in the freeze of the Hourly Plan, the
Company agreed to establish a replacement defined contribution plan for bargaining
unit employees effective as of Date 2. The negotiated replacement plan, the Bargaining
Unit 401(k) Plan, is a qualified plan which includes a 401(k) feature and an employer
non-elective contribution feature pursuant to which the Company makes weekly
contributions on behalf of participants at negotiated rates.

Non-bargaining unit hourly employees were already included in a qualified defined
contribution plan when the Hourly Plan was frozen on Date 3. The Company
significantly enhanced that plan, effective as of Date 2, by redesigning the plan as a
401(k) plan with a safe-harbor employer non-elective contribution feature and a
discretionary employer matching contribution feature. The enhanced plan, the Non-
Bargaining Unit 401(k) Plan, serves as a replacement plan to the Hourly Plan for non-
bargaining unit hourly employees as well as for other non-bargaining unit employees
who were participants in the Salaried Plan, a qualified defined benefit plan maintained
by the Company under which all benefits accruals were also discontinued effective as of
Date 3.

The Company terminated the Hourly Plan effective Date 4.1 The Internal Revenue
Service issued a favorable determination letter as to the effect of the termination of the
Hourly Plan on its qualified status on Date 5. The Hourly Plan was terminated in a
standard termination under section 4041(b) of the Employee Retirement Income
Security Act of 1974 (“ERISA”) and a Standard Termination Notice was filed with
Pension Benefit Guaranty Corporation (“PBGC”) for the Hourly Plan on Date 6. The
distribution of all benefits due to participants, surviving spouses, other beneficiaries, and
alternative payees is expected to be completed by Date 7.

Prior to the plan termination, the actuary for the Hourly Plan estimated that the plan had
a deficit on a termination basis and that the Company would be required to make a
contribution to the plan in order for the plan to be sufficient. In late 2018, the actuary
completed another estimate that indicated that the Hourly Plan had changed from a
deficit to surplus status because of the increase in interest rates for annuities and lump
sums during 2018, and in early 2019, the actuary estimated that the Hourly Plan had a
surplus of Amount 1.
1
    The Company also terminated the Salaried Plan effective as of Date 4.
PLR-103736-19                                       3


The Hourly Plan was amended in conjunction with its termination to permit the
Company, in its discretion, to use all or part of any surplus funds to “…fund a direct
transfer from this plan to one or more ‘qualified replacement plans’ established or
maintained by the Employer in accordance with the provisions of Code Section
4980(d)(2), such direct transfer to be an amount determined by the Employer that
equals or exceeds the minimum amount required by Code Section 4980(d)(2)(B).”

Immediately after the termination of the Hourly Plan on Date 4, 100% of the participants
in the Hourly Plan who remained as current employees of the Company were active
participants in either the Bargaining Unit 401(k) Plan or the Non-Bargaining Unit 401(k)
Plan. As of Date 8, 67.1% of those participants were active participants in the
Bargaining Unit 401(k) Plan and 32.9% were active participants in the Non-Bargaining
Unit 401(k) Plan.

After all plan liabilities have been satisfied and before the reversion of any surplus funds
to the Company, the Company intends to instruct the trustees of the Hourly Plan to
effect a direct transfer from the Hourly Plan to the Bargaining Unit 401(k) Plan and the
Non-Bargaining Unit 401(k) Plan of an aggregate amount equal to the total amount of
the Hourly Plan’s remaining surplus. The Company further intends to direct that this
aggregate amount be divided between the Bargaining Unit 401(k) Plan and the Non-
Bargaining Unit 401(k) Plan in proportion to the number of participants in the Hourly
Plan who remained as current employees of the Company as of Date 8 and were active
participants in each plan as of that date. The Bargaining Unit 401(k) Plan and Non-
Bargaining Unit 401(k) Plan are both calendar year plans.

The Company intends to cause the amount transferred to the Bargaining Unit 401(k)
Plan to be credited to a suspense account in that plan and to allocate amounts from that
account to fund all or a portion of weekly employer non-elective contributions due in
accordance with the terms of the plan (after the offset of forfeitures) and all or a portion
of the plan administrative expenses otherwise payable by the Company. The allocation
from the suspense account will be at least as rapidly as ratably on a periodic basis over
an allocation period beginning on the date of the transfer and ending on the last day of
the sixth plan year after the plan year of transfer. The minimum ratable drawdown of
the suspense account over this allocation period will be measured by the Company on
periodic intervals designated by the Company, which will be at least annual. Any
income earned by the suspense account will be allocated at least as rapidly as ratably
on the same periodic basis over the remainder of the allocation period under the same
procedure.

The Company intends to cause the amount transferred to the Non-Bargaining Unit
401(k) Plan to be credited to a suspense account2 in that plan and to allocate amounts

2
  The Company also intends to effect a direct transfer from the Salaried Plan to the Non-Bargaining Unit
401(k) Plan of all Salaried Plan’s remaining surplus. The amount of this direct transfer will also be
credited to the suspense account in the Non-Bargaining Unit 401(k) Plan and allocated from that account
to fund safe-harbor employer non-elective contributions due in accordance with the terms of the plan and
PLR-103736-19                                       4

from that account to fund all or a portion of the safe-harbor employer non-elective
contributions due in accordance with the terms of the plan and all or a portion of the
plan administrative expenses otherwise payable by the Company. The suspense
account will not be applied to fund employer matching contribution under the Non-
Bargaining Unit 401(k) Plan. The allocation from the suspense account will be at least
as rapidly as ratably on a periodic basis over an allocation period beginning on the date
of the transfer and ending on the last day of the sixth plan year after the plan year of
transfer. The minimum ratable drawdown of the suspense account over this allocation
period will be measured by the Company on periodic intervals designated by the
Company, which will be at least annual. Any income earned by the suspense account
will be allocated at least as rapidly as ratably on the same periodic basis over the
remainder of the allocation period under the same procedure.

Any amounts allocated from the suspense accounts in the Bargaining Unit 401(k) Plan
and the Non-Bargaining Unit 401(k) Plan attributable to the transfers from the Hourly
Plan and any income earned thereon will be treated as employer contributions for
purposes of sections 401 and 415.

Although it is anticipated that all benefits due under the Hourly Plan will be distributed
within one year after the date of the plan’s termination, the remaining surplus assets will
be retained in the trust through which the Hourly Plan is funded pending receipt of the
requested rulings.

The business reason for the proposed transactions outlined above is to effectuate the
Company’s objective to maintain and operate the Bargaining Unit 401(k) Plan and the
Non-Bargaining Unit 401(k) Plan as appropriate replacement plans to the Hourly Plan
by applying 100% of the Hourly Plan’s surplus funds in accordance with the terms of
those replacement plans.

Based on the forgoing facts and correspondence, the following rulings have been
requested:

    1. The Bargaining Unit 401(k) Plan and the Non-Bargaining Unit 401(k) Plan may
       be treated as one plan for purposes of section 4980 pursuant to section
       4980(d)(5)(D) and together constitute a “qualified replacement plan” for purposes
       of section 4980(d)(2).
    2. The direct transfer from the Hourly Plan to the Bargaining Unit 401(k) Plan and
       Non-Bargaining Unit 401(k) Plan of an aggregate amount equal to 100% of the
       maximum amount that the Company could receive as an employer reversion
       from the Hourly Plan will be treated as follows:
    a. the amount transferred will not be included in the gross income of the Company;
    b. no deduction will be allowable with respect to the amount transferred; and


plan administrative expenses otherwise payable by the Company. The suspense account consisting of
surplus funds from both the Salaried Plan and the Hourly Plan will be allocated in accordance with the
procedure described above.
PLR-103736-19                                 5

   c. the amount transferred will not be treated as an employer reversion for purposes
      of section 4980, and the Company will not be subject to excise tax under section
      4980 with respect to such amount transferred.

    3. The allocation of the aggregate amount of the direct transfer from the Hourly Plan
      between the Bargaining Unit 401(k) Plan and the Non-Bargaining Unit 401(k)
      Plan in proportion to the number of participants in the Hourly Plan who remained
      as current employees of the Company as of Date 8 and were active participants
      in each plan as of that date is consistent with the treatment of the Bargaining Unit
      401(k) Plan and the Non-Bargaining Unit 401(k) Plan as a single qualified
      replacement plan for the purposes of section 4980(d)(2) and the requirements of
      that provision.
    4. The crediting of the amounts transferred from the Hourly Plan to suspense
      accounts in the Bargaining Unit 401(k) Plan and the Non-Bargaining Unit 401(k)
      Plan and the allocation of such suspense account to fund all or a portion of the
      periodic employer non-elective contributions due in accordance with the terms of
      each plan and all or a portion of the plan administrative expenses otherwise
      payable by the Company as least as rapidly as ratably on a periodic basis over
      an allocation period beginning on the date of transfer and ending on the last day
      of the sixth plan year after the plan year of transfer, with the minimum ratable
      drawdown of the suspense account measured by the Company on periodic
      intervals designated by the Company over such allocation period, and the
      allocation of any income earned by the suspense accounts at least as rapidly as
      ratably on the same periodic basis over the remainder of such allocation period
      under the same procedure, will satisfy the allocation requirement of section
      4980(d)(2)(C).

Section 4980(a) provides for a 20 percent excise tax on the amount of any reversion
from a qualified plan. Section 4980(d)(1) provides, in pertinent part, that the excise tax
under section 4980(a) shall be increased to 50 percent with respect to any 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 immediately on the termination date.

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

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

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.
PLR-103736-19                                 6

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.

Section 4980(d)(2)(B)(iii) provides that 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.

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 seven-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 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 seven-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 any such limitation,
it shall be allocated to the participant as provided in section 415.

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

Section 4980(d)(2)(C)(iv) provides that if any amount credited to a suspense account
under clause (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 portion
of such amount may not be allocated to other participants under subclause (I) by reason
of such limitation, such portion shall be treated as an employer reversion to which this
section applies.

Section 4980(d)(5)(D)(i) authorizes the Secretary of Treasury to treat two or more plans
as one plan for purposes of determining whether there is a qualified replacement plan.
PLR-103736-19                                 7

Revenue Ruling 2003-85, 2003-32 I.R.B. 291 (Rev. Rul. 2003-85), provides that in
accordance with section 4980(d)(2)(B)(iii), the direct transfer of an amount that is at
least 25 percent of the maximum amount which the employer could receive as an
employer reversion from a terminated plan which was transferred to a qualified
replacement plan is not includible in the employer’s gross income. In addition, the
Service held that no deduction was allowable with respect to the amount transferred,
and the amount transferred was not treated as an employer reversion. Further, the
Service concluded that the amount that the employer received was subject to the 20
percent excise tax under section 4980(a) and was includible in income under
section 61.

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.

Regarding ruling requests numbers 1 through 4, this office must first determine whether
the Bargaining Unit 401(k) Plan and the Non-Bargaining Unit 401(k) Plan can be treated
as a qualified replacement plan under section 4980(d)(2).

Section 4980(d)(5)(D)(i) authorizes the Secretary of Treasury to treat two or more plans
as one plan for purposes of determining whether there is a qualified replacement plan.
Thus, pursuant to this provision, we rule that, assuming the requirements of a qualified
replacement plan under paragraphs (A), (B) and (C) section 4980(d)(2) are satisfied, the
Bargaining Unit 401(k) Plan and the Non-Bargaining Unit 401(k) Plan together may
constitute a qualified replacement plan for purposes of section 4980(d)(2).

Having ruled that the Bargaining Unit 401(k) Plan and the Non-Bargaining Unit 401(k)
Plan together may constitute a qualified replacement plan, we now must determine
whether the requirements of section 4980(d)(2) are satisfied. You have represented
that all active participants of Plan X who remain employees of Company are eligible to
participate in the Bargaining Unit 401(k) Plan and the Non-Bargaining Unit 401(k) Plan.
You have also represented that the aggregate amount of the direct transfer from the
Hourly Plan between the Bargaining Unit 401(k) Plan and the Non-Bargaining Unit
401(k) Plan will be allocated to the Plans in proportion to the number of participants in
the Hourly Plan who remained as current employees of Company on Date 8 and were
active participants in each of the recipient Plans. This is consistent with the treatment of
the Bargaining Unit 401(k) Plan and the Non-Bargaining Unit 401(k) Plan as a single
qualified replacement plan. Therefore, because the Bargaining Unit 401(k) Plan and the
Non-Bargaining Unit 401(k) Plan together will cover 100 percent of the participants of
Hourly Plan who remain in the employ of Company, the requirements of section
4980(d)(2)(A) are satisfied.

You have also represented that the Company will transfer to the Bargaining Unit 401(k)
Plan and the Non-Bargaining Unit 401(k) Plan an aggregate amount equal to the total
amount of the Hourly Plan’s remaining surplus after all plan liabilities have been
satisfied. In accordance with Rev. Rul. 2003-85, the transfer of at least 25 percent of
PLR-103736-19                               8

the maximum amount which the employer could receive as an employer reversion
satisfies the requirement of section 4980(d)(2)(B).

Further, you have represented that the amount transferred from the Hourly Plan to the
Bargaining Unit 401(k) Plan and the Non-Bargaining Unit 401(k) Plan is expected to be
allocated under each plan to the accounts of participants in the plan year in which the
transfer occurs, or credited to a suspense account and allocated to accounts of
participants no less rapidly than ratably over a 6 year period beginning with the year of
the transfer, and that the allocations will otherwise be made in accordance with the
requirements of section 4980(d)(2)(C). Therefore, we conclude that the crediting of the
amounts transferred from the Hourly Plan to suspense accounts in the Bargaining Unit
401(k) Plan and the Non-Bargaining Unit 401(k) Plan and the allocation of such
suspense account to fund all or a portion of the periodic employer non-elective
contributions due in accordance with the terms of each plan and all or a portion of the
plan administrative expenses otherwise payable by the Company as least as rapidly as
ratably on a periodic basis over an allocation period beginning on the date of transfer
and ending on the last day of the sixth year after the plan year of transfer, with the
minimum ratable drawdown of the suspense account measured by the Company on
periodic interval designated by the Company over such allocation period, and the
allocation of any income earned by the suspense accounts at least as rapidly as ratably
on the same periodic basis over the remainder of such allocation period under the same
procedure, will satisfy the allocation requirement of section 4980(d)(2)(C).

Accordingly, we rule that the Bargaining Unit 401(k) Plan and the Non-Bargaining Unit
401(k) Plan together constitute a qualified replacement plan within the meaning of
section 4980(d)(2). Therefore, the direct transfer from the Hourly Plan to the Bargaining
Unit 401(k) Plan and the Non-Bargaining Unit 401(k) Plan of an aggregate amount
equal to 100 percent of the maximum amount that the Company could receive as an
employer reversion from the Hourly Plan will be treated as follows:

   a. the amount transferred will not be included in the gross income of the Company;
   b. no deduction will be allowable with respect to the amount transferred; and
   c. the amount transferred will not be treated as an employer reversion for purposes
      of section 4980, and the Company will not be subject to excise tax under section
      4980 with respect to that amount.

Please note that, although we rule that the use of amounts transferred from the Hourly
Plan to the suspense accounts under the Bargaining Unit 401(k) Plan and the Non-
Bargaining Unit 401(k) Plan (and/or the earnings thereon) to pay reasonable
administrative expenses of the Bargaining Unit 401(k) Plan and the Non-Bargaining Unit
401(k) Plan does not violate section 4980(d)(2)(C), we do not express an opinion
regarding whether such use is permitted under Title I of the Employee Retirement
Income Security Act of 1974.

This ruling letter is based on the representation that the Hourly Plan, the Hourly
Bargaining Unit 401(k) Plan, and the Non-Bargaining Unit 401(k) Plan are qualified
PLR-103736-19                                  9

under section 401(a) and that their related trusts are tax-exempt under section 501(a) at
all times relevant to this ruling letter.

The rulings contained in this letter are based upon information and representations
submitted by your authorized representatives and accompanied by a penalty of perjury
statement executed by an appropriate party, as specified in Rev. Proc. 2019-1, 2019-1
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. 2019-1, § 11.05.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

A copy of this ruling letter is being sent to your authorized representative in accordance
with a power of attorney on file in this office.


                                        Sincerely,



                                       Laura Warshawsky
                                       Branch Chief
                                       Qualified Plans Branch 1
                                       Office of Associate Chief Counsel
                                       (Employee Benefits, Exempt Organizations and
                                       Employment Tax)




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