Merged replacement plan may receive pension surplus tax-free

Plain-English summary

An employer terminated a defined benefit plan and transferred its entire remaining surplus to a defined contribution plan formed by merging separate bargaining-unit and non-bargaining-unit plans. The IRS ruled that the merged plan qualified as a replacement plan under Section 4980 because it met the participation, transfer, and allocation requirements. The transfer is not income to the employer, is not deductible, and is not an employer reversion subject to excise tax. The suspense account may fund specified matching contributions tied to deferrals made before the surplus transfer, but not matching contributions tied to later payrolls. A delay of more than one year while liabilities and the ruling request were resolved did not void the terminated plan or create a wasting trust.

Ruling snapshot

• Question: Can the merged defined contribution plan receive the terminated pension plan's surplus without employer reversion tax?
• Outcome: Approved, including the represented suspense-account allocations and delayed transfer.
• Key authorities: IRC §§ 401, 415, and 4980(d); Treas. Reg. § 1.401(m)-1; Rev. Rul. 2003-85

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202111004 Third Party Communication: None
Release Date: 3/19/2021 Date of Communication: Not Applicable
Index Number: 4980.02-00
Person To Contact:
------------------ ----------------, ID No. -----------------
--------------------------------------- Telephone Number:
--------------------------- -------------------
----------------------------------------------- Refer Reply To:
-------------------------- CC:EEE:EB:QP1
PLR-112381-20
Date:
December 21, 2020

Legend

Company = ---------------------------
DB Plan = ---------------------------------------------------------------------
--------------------------------------------------------
DC BU Plan = ---------------------------------------------------------------------
---------------------------------------------------------------------
----------------
DC NBU Plan = ---------------------------------------------------------------------
---------------------------------------------------------------------
Merged Plan = ---------------------------------------------------------------------
-------------------------------------------
Date 1 = -------------------------
Date 2 = -------------------
Date 3 = --------------------------
Date 4 = --------------------------
Date 5 = ---------------------------
Date 6 = ---------------------
Date 7 = ---------------------------
Date 8 = --------------------------
Date 9 = -----------------
Date 10 = ---------------------
Date 11 = ------------------
Date 12 = ---------------------
Date 13 = ---------------------------
Date 14 = -----------------------
Date 15 = -------------------------
Date 16 = -----------------------
Amount 1 = ---------------
Amount 2 = ---------------
PLR-112381-20 2

Amount 3 = ---------------

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

This letter is in response to your request dated May 26, 2020, as supplemented by
correspondence dated November 10, 2020, November 19, 2020, December 9, 2020,
and December 15, 2020, in which you request rulings concerning the proper treatment
under § 4980 of the Internal Revenue Code of a transfer of surplus assets from a
terminated defined benefit plan to an ongoing defined contribution plan.

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

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

The DB Plan is an amalgamation of a number of separate defined benefit plans for both
bargaining unit and non-bargaining unit employees that were merged over many years
into one plan with numerous benefit schedules. The DB plan was terminated in a
standard termination under section 4041(b) of the Employee Retirement Income
Security Act of 1974, effective Date 5 (the Termination Date), and a Standard
Termination Notice was filed with Pension Benefit Guaranty Corporation (PBGC) for the
DB Plan on Date 6. On the Termination Date, the only active employees covered by the
DB Plan were two separate groups of bargaining unit employees and two separate
groups of non-bargaining unit employees. Prior to the Termination Date, the benefits of
one group of active bargaining unit employees were frozen on Date 2 and the benefits
of the second group of active bargaining unit employees were frozen on Date 4. The
benefits of both groups of non-bargaining unit were frozen on Date 3. After Date 4, the
DB Plan continued in operation as a frozen plan.

Whenever defined benefit accruals were frozen under one of the Company’s defined
benefit plans, Company-sponsored defined contribution benefits for affected active
employees were provided or enhanced. The DC BU plan is a qualified volume
submitter defined contribution plan which includes 401(k) deferrals, fixed employer
nonelective contributions and fixed employer matching contributions. It received a
favorable opinion letter from the Internal Revenue Service (IRS) dated Date 10. The
terms of the DC BU plan provided that it serves as a replacement plan to the DB plan
for the bargaining unit employees.

The DC NBU Plan is a qualified prototype defined contribution plan for non-bargaining
unit employees. The Company significantly enhanced the DC NBU Plan, effective as of
Date 4, by adding a ----- percent Company non-elective contribution. The DC NBU Plan
was further enhanced a year later by increasing the Company fixed non-elective
contributions to ------- percent and the fixed match from ----percent to ----percent on the
first ---- percent deferred. The DC NBU Plan was amended on Date 9 to eliminate fixed
non-elective employer contributions and fixed matching contributions, but to retain
PLR-112381-20 3

discretionary nonelective employer contributions and revised discretionary matching
contributions. The DC NBU Plan received a favorable opinion letter from the IRS on
Date 11. Its terms provided that it serves as a replacement plan to the DB Plan for non-
bargaining unit employees.

On Date 12, the DC BU Plan was merged into the DC NBU Plan to form the Merged
Plan. On the merger date, each participant's account balance in the Merged Plan
immediately after the merger was equal the participant's account balances in the DC
NBU Plan or the DC BU Plan immediately prior to the merger, the Merged Plan
continues to be designated as a qualified replacement plan under § 4980(d). The
Merged Plan is a calendar year plan.

The IRS issued a favorable determination letter as to the effect of the termination of the
DB Plan on its qualified status on Date 7. On Date 8, annuities were purchased from
insurance carriers. The finalization of the annuity contracts and distribution of all
annuity certificates to participants, surviving spouses, other beneficiaries, and
alternative payees was expected to be mostly completed within approximately --- days
after the date of the favorable determination letter with a final true-up expected to be
completed within approximately ----- year of Date 7.

Prior to the plan termination, the actuary for the DB Plan estimated that the plan had a
deficit on a termination basis. Accordingly, in August -------, the Company made a
contribution of Amount 1 for the plan year -------. By Date 8, the actuary estimated that
the DB Plan had changed from a deficit to a surplus status of approximately Amount 2,
principally because of investment returns, window period distributions, and favorable
annuity market conditions on the annuitization date. On Date 13, following a final true-
up of liabilities, the remaining surplus in the DB Plan was Amount 3.

The DB Plan was amended in conjunction with its termination to permit the Company, in
its discretion, to use all or part of any surplus funds in any other manner permitted by
law, including, for example, and without limitation, transfer to a qualified replacement
plan and/or a pro rata increase in accrued benefits of participants in the resulting plan
as provided in § 4980(d).

Immediately after the termination of the DB Plan on Date 5, ------ percent of the
participants in the DB Plan who remained as current employees of the Company were
active participants in either the DC BU Plan or the DC NBU Plan. As of Date 8, -------
percent of those participants who remained as current employees of the Company were
active participants in either the DC BU Plan or the DC NBU Plan.

On Date 14, the Board of Directors of Company adopted a resolution authorizing certain
discretionary matching contributions and discretionary nonelective contributions under
the Merged Plan.
PLR-112381-20 4

On Date 15, after all plan liabilities had been satisfied and the true-up was finalized, and
before the reversion of any surplus funds to the Company, the trustee of the DB Plan
made a direct transfer from the DB Plan to the Merged Plan of an aggregate amount
equal to the total amount of the DB Plan's remaining surplus.

The surplus transferred on Date 15 to the Merged Plan was credited to a suspense
account in the Merged Plan. The suspense account will be used to fund (after the offset
of forfeitures) all or a portion of employer fixed non-elective contributions due in
accordance with the terms of the Merged Plan and discretionary non-elective
contributions permitted under the terms of the Merged Plan. In addition, the suspense
account will be used to fund discretionary matching contributions and true-up matching
contributions with respect to elective deferrals made from payrolls paid from Date 9 up
to and including Date 16. Date 16 is prior to Date 15. The suspense account will not be
applied to fund employer matching contributions with respect to elective deferrals made
from payrolls paid after Date 16. The allocation from the suspense account will be no
less rapidly than rapidly as ratably over the ---------plan-year period beginning with the
year of the transfer, as 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 account in the Merged Plan attributable to
the transfers from the DB Plan and any income earned thereon will be treated as
employer contributions for purposes of §§ 401 and 415.

The business reason for the proposed transactions outlined above is to effectuate the
Company's objective to maintain, operate, and provide assured funding for the Merged
Plan as an appropriate replacement plan to the DB Plan by applying 100 percent of the
DB Plan's surplus funds in accordance with the terms of the replacement plan.

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

1. The Merged Plan constitutes a "qualified replacement plan" for purposes of
  § 4980(d)(2) that has been established and maintained in connection with the
  termination of the DB Plan.

2. The direct transfer from the DB Plan to the Merged Plan of an aggregate amount
  equal to 100 percent of the maximum amount that the Company could receive as
  an employer reversion from the DB 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

PLR-112381-20 5

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

3. The allocation of the aggregate amount of the direct transfer from the DB Plan in
  accordance with the terms of the Merged Plan, is consistent with the treatment of
  the Merged Plan as a qualified replacement plan for the purposes and
  requirements of section 4980(d)(2).

4. The crediting of the amounts transferred from the DB Plan to a suspense account
  in the Merged Plan and the allocation of the suspense account to fund (after the
  offset of forfeitures) all or a portion of the periodic employer fixed non-elective
  contributions due in accordance with the terms of the Merged Plan, any
  discretionary non-elective contributions permitted under the terms of the Merged
  Plan, and certain discretionary matching contributions with respect to elective
  deferrals made from payrolls paid between Date 9 and Date 16, no less rapidly
  than ratably over a -------- plan-year period beginning with the year of transfer
  and ending on the last day of the -------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 account 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 § 4980(d)(2)(C).

5. In view of the fact that the NBU Plan and the BU Plan were separate plans on the
  Termination Date and Annuitization Date and that § 4980 does not expressly
  authorize two replacement plans to be treated as a single qualified replacement
  plan absent the Secretary’s ruling under § 4980(d)(5)(D), and the delays in
  finalizing the true-up, retaining the surplus either in the DB plan trust or in the
  suspense account for the Merged Plan for more than one year after receipt of a
  favorable determination letter as to the DB Plan's qualified status upon its
  termination will not be treated as a failure to distribute plan assets as soon as
  administratively feasible, will not void the DB Plan's termination, and will not
  cause the DB Plan trust to be treated as a wasting trust, where distribution of the
  surplus was delayed pending finalization of annuity contracts, true-up premium
  and possible receipt of a private letter ruling on the transfer of the surplus to a
  replacement plan, and all plan benefits have been distributed and liabilities
  assumed within said one-year period.

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 § 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
PLR-112381-20 6

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 §§ 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
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 such 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 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 § 415, any
amount credited to a suspense account under § 4980(d)(2)(C)(i)(ll) 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 § 415.
PLR-112381-20 7

Section 4980(d)(2)(C)(iii) provides that any income on any amount credited to a
suspense account under § 4980(d)(2)(C)(i)(ll) 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) regarding limitation under § 415).

Section 4980(d)(2)(C)(iv) provides that if any amount credited to a suspense account
under § 4980(d)(2)(C)(i)(ll) 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 subclause (I) by
reason of such limitation, such portion shall be treated as an employer reversion to
which § 4980 applies.

Revenue Ruling 2003-85, 2003-32 I.R.B. 291 (Rev. Rul. 2003-85), provides that in
accordance with § 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 IRS 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 IRS concluded that
any amount that the employer received would be subject to the 20 percent excise tax
under § 4980(a) and would be includible in income under § 61.

Under § 501(a), an organization described in § 401(a) (that is, a trust which is part of a
qualified pension, profit-sharing or stock bonus plan) is generally exempt from taxation.

Section 401(m)(4)(A) defines matching contributions as employer contributions made to
a defined contribution plan on behalf of an employee on account of an employee
contribution made by such employee, or on account of an employee’s elective deferral.

Section 1.401(m)-1(a)(2)(i) provides that matching contributions are, (A) any employer
contribution (including a contribution made at the employer's discretion) to a defined
contribution plan on account of an employee contribution to a plan maintained by the
employer; (B) any employer contribution (including a contribution made at the
employer's discretion) to a defined contribution plan on account of an elective deferral;
and (C) any forfeiture allocated on the basis of employee contributions, matching
contributions, or elective deferrals.

Section 1.401(m)-1(a)(2)(ii) provides, in pertinent part, that whether an employer
contribution is made on account of an employee contribution or an elective deferral is
determined on the basis of all the relevant facts and circumstances, including the
relationship between the employer contribution and employee actions outside the plan.
PLR-112381-20 8

Section 1.401(m)-1(a)(2)(iii)(A) provides generally that employer contributions are not
matching contributions made on account of elective deferrals if they are contributed
before the cash or deferred election is made or before the employees' performance of
services with respect to which the elective deferrals are made (or when the cash that is
subject to the cash or deferred elections would be currently available, if earlier). In
addition, an employer contribution is not a matching contribution made on account of an
employee contribution if it is contributed before the employee contribution.

With respect to ruling requests 1, 3, and 4, in order for the Merged Plan to constitute a
qualified replacement plan for purposes of § 4980(d)(2), the Merged Plan must satisfy
the requirements of § 4980(d)(2)(A) through (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. You have represented that ------ percent of
the active participants of the DB Plan who remained employees of Company on Date 5,
the DB Plan Termination Date, were eligible to participate in either the DC BU Plan or
the DC NBU Plan, and that the Merged Plan continued to meet the 95 percent
requirement as of Date 15. Therefore, the Merged Plan satisfies the requirements of
§ 4980(d)(2)(A).

You have also represented that the Company transferred to the Merged Plan an
aggregate amount equal to the total amount of the DB 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 the maximum amount which the employer could receive as an
employer reversion satisfies the requirement of § 4980(d)(2)(B).

Further, you have represented that the amount transferred from the DB Plan to the
Merged Plan is expected to be allocated under the plan to the accounts of participants
in the plan year in which the transfer occurs, or credited to a suspense account in the
plan and allocated to accounts of participants no less rapidly than ratably over a ----------

year period including the year of the transfer, and that the allocations will otherwise be
made in accordance with the requirements of § 4980(d)(2)(C). Therefore, we conclude
that the crediting of the amounts transferred from the DB Plan to the suspense account
in the Merged Plan and the allocation of such suspense account to fund (after the offset
of forfeitures) all or a portion of any periodic employer fixed non-elective contributions
due in accordance with the terms of the Merged Plan or any discretionary non-elective
contributions permitted under the terms of the Merged Plan no less rapidly as ratably
over a ---------year period beginning with the year of transfer and ending on the last day
of the ------ 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 account at least as rapidly as ratably on the same periodic basis over the
PLR-112381-20 9

remainder of such allocation period under the same procedure, will satisfy the allocation
requirement of § 4980(d)(2)(C).

With respect to the use of a portion of the amount of surplus transferred to the Merged
Plan to fund discretionary matching contributions, § 1.401(m)-1(a)(2)(iii)(A) generally
prohibits an employer from funding a matching contribution before the deferral elections
are made or the services to which the elective deferrals relate are performed (or when
the cash that is subject to the cash or deferred elections would be currently available, if
earlier). However, in this case, the surplus was used to fund only matching
contributions that relate to elective deferrals made from payrolls paid up to and including
Date 16, a date which is prior to the transfer of the surplus to the Merged Plan, so that
the surplus was contributed after the deferral elections/performance of services.
Therefore, the matching contributions are not disallowed under § 1.401(m)-
1(a)(2)(iii)(A). Accordingly, we rule that the fund in the suspense account may be used
to fund discretionary matching contributions and true-up matching contributions with
respect to elective deferrals made from payrolls paid from Date 9 up to and including
Date 16. However, the suspense account may not be applied to fund employer
matching contributions with respect to elective deferrals made from payrolls paid on or
after Date 15.

Based on the above analysis, we rule that the Merged Plan constitutes a qualified
replacement plan within the meaning of § 4980(d)(2).

With respect to ruling request 2, because the Merged Plan constitutes a qualified
replacement plan within the meaning of § 4980(d)(2), the direct transfer from the DB
Plan to the Merged Plan of an aggregate amount equal to 100 percent of the maximum
amount that the Company could have received as an employer reversion from the DB
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 § 4980, and the Company will not be subject to excise tax under § 4980(a)
with respect to that amount.

Regarding ruling request 5, we rule that the transfer of the surplus assets in the DB Plan
to the suspense account for the Merged Plan on Date 15, which was more than a year
after the DB Plan received a favorable determination letter from the IRS on its
termination and prior to receiving this private letter ruling, will not be treated as a failure
to distribute plan assets as soon as administratively feasible, will not void the DB Plan's
termination, and will not cause the DB Plan trust to be treated as a wasting trust.
PLR-112381-20 10

The rulings contained in this letter are based on the representation that the DB Plan, the
DC BU Plan, the DC NBU Plan, and the Merged Plan are or were qualified under
§ 401(a) and that their related trusts are or were tax-exempt under § 501(a) at all times
relevant to this ruling letter.

The rulings contained in this letter are based upon information and representations
submitted by you and accompanied by a penalty 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.

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.

                                      Sincerely,



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

cc: