Employer Deduction

March 13, 2024

3937 / How is an employer’s deduction limited for qualified plan contributions?

<div class="Section1"> The amount of an employer’s deduction for contributions to a qualified plan depends on the type of plan being maintained. The maximum amounts an employer may deduct are explained at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3735">3735</a> for pension plans, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3750">3750</a> for profit sharing or stock bonus plans, and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3824">3824</a> for employee stock ownership plans (“ESOPs”). If an employer contributes to two or more plans covering any common participants, it is subject to the limits explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3942">3942</a>. Rules that govern the timing of an employer’s deduction are explained at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3939">3939</a>. Other more specific requirements that may affect an employer’s ability to deduct contributions or plan expenses are explained at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3940">3940</a>. Special rules governing contributions of property are explained at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3938">3938</a>.The 10 percent penalty on nondeductible contributions is explained at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3943">3943</a>. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.416-1, T-39. </div></div>

March 13, 2024

3941 / Are plan expenses deductible by an employer?

<div class="Section1"> Broker fees paid by a qualified plan are not separately deductible by an employer and are subject to the deduction limits of IRC Section 404(a) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3735">3735</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3750">3750</a>).<a href="#_ftn1" name="_ftnref1">1</a> Amounts that an employer reimburses a plan trustee for amounts paid to an investment manager to manage and invest plan assets also are not deductible under IRC Sections 162 or 212. Amounts that an employer pays directly to an investment manager in connection with the management of a plan’s assets apparently are deductible and are not treated as plan contributions under IRC Section 404.<a href="#_ftn2" name="_ftnref2">2</a> The distinction appears to be that brokers’ fees are directly related to the purchase of an asset and thus are part of the cost of the securities, but that investment managers’ fees, as well as legal, accounting, and trustee fees, are recurring administrative expenses that do not vary with the number or volume of investment transactions.<a href="#_ftn3" name="_ftnref3">3</a> Some plans allocate plan expenses to the accounts of participants. The IRS has issued guidance permitting such plans to pay these expenses on behalf of active employees while charging the accounts of former employees their proportionate share of such expenses.<a href="#_ftn4" name="_ftnref4">4</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Rev. Rul. 86-142, 1986-2 CB 60. <a href="#_ftnref2" name="_ftn2">2</a>.  Let. Ruls. 9124036, 9124035, 8941009, 8940013. <a href="#_ftnref3" name="_ftn3">3</a>.  Let. Rul. 9252029. <a href="#_ftnref4" name="_ftn4">4</a>.  Rev. Rul. 2004-10, 2004-7 IRB 484. </div></div>

March 13, 2024

3947 / Are contributions to a qualified plan subject to Social Security taxes?

<div class="Section1"> Amounts that a regular (i.e., common law) employee elects to contribute under a cash or deferred arrangement under IRC Section 401(k), a section 403(b) plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3760">3760</a>), and SIMPLE IRA plans are treated as wages subject to Social Security tax.<a href="#_ftn1" name="_ftnref1">1</a> Payments to, from, or under a qualified retirement plan are specifically excluded from the definition of wages under the Social Security law. Consequently, neither employer contributions to, nor distributions from, a qualified retirement plan are subject to Social Security taxes.<a href="#_ftn2" name="_ftnref2">2</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC §§ 3121(v)(1); 3121(a)(5)(H). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 3121(a)(5). </div></div>

March 13, 2024

3946 / Is an employee taxed on current contributions to a plan that has lost its tax qualification?

<div class="Section1"> Contributions to a plan that has ceased to be tax qualified are taxed to an employee in the first year in which his or her right to such amounts is no longer subject to a substantial risk of forfeiture.<a href="#_ftn1" name="_ftnref1">1</a> Thus, an employee is taxed on these contributions to the extent that the employee is vested. If a plan fails to be tax qualified solely because it does not satisfy either the minimum participation rule (in the case of a defined benefit plan, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3716">3716</a>) or the coverage requirements ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3842">3842</a>), then contributions on behalf of non-highly compensated employees will not be includable in their income. Highly compensated employees must include in income their vested accrued benefits (other than their basis in the account).<a href="#_ftn2" name="_ftnref2">2</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC §§ 402(b)(1). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 402(b)(4). </div></div>

March 13, 2024

3939 / When may an employer take a deduction for contributions made to a pension, profit sharing, or stock bonus plan?

<div class="Section1"> An employer’s contribution generally is deductible only in the taxable year it is paid, except for certain carry-forwards ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3735">3735</a>).<a href="#_ftn1" name="_ftnref1">1</a> Both cash and accrual basis employers, including self-employed individuals, are deemed to have made a contribution in the preceding tax year if the payment is on account of that year and is made no later than the due date, including extensions, of the employer’s tax return.<a href="#_ftn2" name="_ftnref2">2</a> In contrast, minimum funding rules may require that a contribution be made earlier than the time at which it is deductible ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3742">3742</a>). A payment will be considered made on account of the preceding tax year if the plan treats it as if received on the last day of that year and either the employer designates, in writing, that the payment is made on account of the previous year or the employer claims it as a deduction on its tax return for the preceding tax year. This kind of designation is irrevocable.<a href="#_ftn3" name="_ftnref3">3</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3724">3724</a> for requirements of quarterly estimated contribution payments applicable to certain plans. A delayed payment is deductible for the prior year only if the payment would have been deductible had it actually been made on the last day of the prior taxable year.<a href="#_ftn4" name="_ftnref4">4</a> Thus, where an employer’s taxable year ended June 30 and the plan year ended December 31, the employer could not deduct elective deferrals and matching contributions attributable to compensation earned by plan participants after June 30 because the contributions were not compensation for services rendered in the prior taxable year of the employer ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3940">3940</a>).<a href="#_ftn5" name="_ftnref5">5</a> Where an employer’s taxable year ended January 31, 1998, and the plan year was the calendar year, the employer could deduct elective deferrals and matching contributions attributable to compensation earned by plan participants during January 1998 on its return for its fiscal year ending January 31, 1998, even though that was the first month of the 1998 plan year.<a href="#_ftn6" name="_ftnref6">6</a> Regulations under IRC Section 401(k) provide that contributions made in anticipation of future performance of services generally will not be treated as elective contributions; thus, no deduction is available for these amounts. The regulations essentially make it clear that contributions made pursuant to a cash or deferred election must be made after the employee’s performance of services with respect to which the compensation is payable ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3753">3753</a>).<a href="#_ftn7" name="_ftnref7">7</a> The liability to make a contribution need not have accrued in the preceding year, but the plan must have been in existence before the end of the preceding tax year.<a href="#_ftn8" name="_ftnref8">8</a> Likewise, the trust must be in existence within the taxable year for which deductions for contributions are claimed ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3838">3838</a>).<a href="#_ftn9" name="_ftnref9">9</a> If a plan trust is complete in all respects on the last day of the taxable year except that it has no corpus, the trust is deemed to have been in existence in the taxable year if the initial contribution is made within the grace period.<a href="#_ftn10" name="_ftnref10">10</a> In the case of a nontrusteed annuity plan evidenced only by a contract with an insurance company, the plan is not in effect until the contract is executed and issued. Where the plan is separate from the insurance contract, the plan will be considered in effect by the close of the taxable year if: (1)  the contract has been applied for and the application accepted by the insurance company; (2)  a contract or abstract has been prepared outlining the terms of the plan; (3)  a part payment of premium has been made; and (4)  the plan has been communicated to the employees.<a href="#_ftn11" name="_ftnref11">11</a> If the plan year of a defined benefit plan and the employer’s tax year are not the same, the employer may claim a deduction for a contribution made for the plan year that either ends or begins in the tax year or may use a weighted average such as the number of months in each plan year falling in the tax year. The same method must be used consistently.<a href="#_ftn12" name="_ftnref12">12</a> Where a short taxable year with no plan year beginning or ending within it resulted when an employer changed its taxable year to a calendar year, the IRS approved a method giving the employer a prorated deduction for the length of the short year.<a href="#_ftn13" name="_ftnref13">13</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 404(a). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 404(a)(6). See, e.g., Let. Rul. 199935062. <a href="#_ftnref3" name="_ftn3">3</a>.  Rev. Rul. 76-28, 1976-1 CB 106, as modified by Rev. Rul. 76-77, 1976-1 CB 107. <a href="#_ftnref4" name="_ftn4">4</a>.  Rev. Rul. 90-105, 1990-2 CB 69; Lucky Stores, Inc. v. Comm., 153 F.3d 964 (9th Cir. 1998). <a href="#_ftnref5" name="_ftn5">5</a>.  Rev. Rul. 90-105, 1990-2 CB 69. See also American Stores Co. v. Comm. 108 TC 178 (1997), aff’d, 170 F.3d 1267 (10th Cir. 1999). <a href="#_ftnref6" name="_ftn6">6</a>.  CCA 200038004, 2000 IRS CCA LEXIS 101. <a href="#_ftnref7" name="_ftn7">7</a>.  See Treas. Reg. § 1.401(k)-1(a)(3)(iii). <a href="#_ftnref8" name="_ftn8">8</a>.  Rev. Rul. 76-28, as modified by 76-77, 1976-1 CB 107; Engineered Timber Sales, Inc. v. Comm., 74 TC 808 (1980), appeal dismissed (5th Cir. 1981). <a href="#_ftnref9" name="_ftn9">9</a>.  Catawba Indus. Rubber Co. v. Comm., 64 TC 1011 (1975); Attardo v. Comm., TC Memo 1991-357. <a href="#_ftnref10" name="_ftn10">10</a>.  Rev. Rul. 81-114, 1981-1 CB 207. <a href="#_ftnref11" name="_ftn11">11</a>.  Rev. Rul. 59-402, 1959-2 CB 122; Becker v. Comm., TC Memo 1966-55. <a href="#_ftnref12" name="_ftn12">12</a>.  Treas. Reg. § 1.404(a)-14(c). <a href="#_ftnref13" name="_ftn13">13</a>.  Let. Rul. 8806053. </div></div>

March 13, 2024

3943 / Is there a penalty if an employer contributes more to its qualified plan than it can deduct in a year?

<div class="Section1"> Yes, if the plan is a defined contribution plan. The penalty for making nondeductible contributions also applied to defined benefit plans until 2008. The employer is subject to a tax equal to 10 percent of the nondeductible amount (determined as of the close of the employer’s tax year) made to a defined contribution plan (e.g., a pension, profit sharing, or stock bonus plan, a simplified employee pension plan, or a SIMPLE IRA plan).<a href="#_ftn1" name="_ftnref1">1</a> Nondeductible contributions are the sum of the amounts that the employer contributes to these plans in excess of the deduction limit for the taxable year plus the total amount of employer contributions for each preceding year that were not allowable as a deduction ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3735">3735</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3750">3750</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3939">3939</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3942">3942</a>). Regulations provide two exceptions to this penalty, although they have little practical application. They reduce the nondeductible amounts by the sum of the portion of the amounts returned to the employer during the taxable year and the portion of the amounts that became deductible for a preceding taxable year or for the current year.<a href="#_ftn2" name="_ftnref2">2</a> The amount allowable as a deduction for any taxable year is treated as coming first from carry-forwards from preceding taxable years, in chronological order, and then from contributions made during the taxable year.<a href="#_ftn3" name="_ftnref3">3</a> Defined benefit plan contributions generally are disregarded in determining whether an employer has made nondeductible contributions.<a href="#_ftn4" name="_ftnref4">4</a> Contributions that are nondeductible solely because of the combined plan deduction limits are exempt from the excise tax to the extent of the greater of (1) the amount of contributions not exceeding 6 percent of compensation or (2) the sum of matching contributions under IRC Section 401(m)(4)(A) plus elective deferrals under IRC Section 402(g)(3)(A) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3760">3760</a>).<a href="#_ftn5" name="_ftnref5">5</a> Where amounts contributed in one year to satisfy the preceding year’s funding requirement under a conditional waiver would exceed the deductible limit for that prior year, the employer was permitted to report some of those contributions as contributions for the current year for deduction purposes and avoid the nondeductible contributions penalty.<a href="#_ftn6" name="_ftnref6">6</a> Although the IRC allows the amount of excess contributions to be reduced by the withdrawal of the excess contribution, there are several restrictions for the return of employer contributions to the employer ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3839">3839</a>). Apparently, the penalty applicable to an excess contribution also is eliminated on plan termination because the plan no longer exists. The excise tax does not apply in the case of a governmental plan or an employer that is exempt from income tax.<a href="#_ftn7" name="_ftnref7">7</a> To the extent that an employer has been subject to unrelated business income tax, this exception is inapplicable.<a href="#_ftn8" name="_ftnref8">8</a> Contributions by a tax-exempt employer that was part of a controlled group including at least one non-exempt employer were subject to the excise tax.<a href="#_ftn9" name="_ftnref9">9</a> If a self-employed individual contributes more than he or she is permitted to deduct in a year, the individual is subject to a tax penalty equal to 10 percent of nondeductible contributions under the plan determined as of the close of the individual’s tax year. In the case of a plan that provides contributions or benefits for self-employed individuals, this tax is payable by the employer, which is the sole proprietor or the partnership.<a href="#_ftn10" name="_ftnref10">10</a> Contributions required to meet the minimum funding standards are not subject to this tax even if the self-employed individual cannot deduct them because they exceed his or her earned income.<a href="#_ftn11" name="_ftnref11">11</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 4972(a). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 4972(c)(1). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 4972(c)(2). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC §§ 4972(c)(6), 4972(c)(7). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 4972(c)(6)(A). <a href="#_ftnref6" name="_ftn6">6</a>.  Let. Rul. 9107033. <a href="#_ftnref7" name="_ftn7">7</a>.  IRC § 4972(d)(1)(B). <a href="#_ftnref8" name="_ftn8">8</a>.  Let. Ruls. 9622037; 9304033. <a href="#_ftnref9" name="_ftn9">9</a>.  Let. Rul. 9236026. <a href="#_ftnref10" name="_ftn10">10</a>.  IRC § 4972. <a href="#_ftnref11" name="_ftn11">11</a>.  IRC § 4972(c)(4). </div></div>

March 13, 2024

3945 / Is an employee generally taxed on the employer’s current contributions to a qualified plan?

<div class="Section1"> No, unless the contributions are designated Roth contributions under a 401(k) plan. A participant does not have to include contributions made by the employer in gross income when the participant’s rights in the plan become fully vested or when benefits can be paid, if elected by the participant (i.e., if the benefits are constructively received). Rather, there is no taxation until benefits actually are distributed to a participant. Delaying distribution will postpone taxation unless it is delayed too long and minimum distribution requirements are not met ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3891">3891</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3909">3909</a>).<a href="#_ftn1" name="_ftnref1">1</a> Another exception to the general rule that employer contributions are not taxable when contributed is when the plan uses some of those contributions to purchase life insurance on the participant that is payable to a beneficiary of the participant. Basically, the participant reports as income the cost of the pure death benefit under the contract. This cost is determined based on a table referred to as Table 2001. For the method of determining the “cost” of such insurance protection taxable to the employee, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3948">3948</a>. Effective January 1, 2015, premiums paid by a pension, profit sharing trust, stock bonus plan, 401(h) plan, pension plan, or annuity plan on accident or health insurance for an employee are currently taxable to the employee as distributions from the trust.<a href="#_ftn2" name="_ftnref2">2</a> Final regulations effective May 12, 2014 clarify that amounts used to pay accident or health insurance premiums (but not disability insurance that replaces contributions) are taxable distributions, with some exceptions, regardless of whether the employer pays the premium from a current year contribution or forfeitures.<a href="#_ftn3" name="_ftnref3">3</a> Thus, if a trustee of a qualified trust uses employer contributions or trust earnings to purchase insurance to provide postretirement medical benefits in an IRC Section 401(h) account or to pay accident or medical benefits, the amounts applied are not taxable income to the employee for whom the insurance is purchased.<a href="#_ftn4" name="_ftnref4">4</a> In contrast, a direct distribution from a pension, profit sharing trust, stock bonus plan, 401(h) plan, pension plan, or annuity plan to reimburse an employee for medical expenses is not a taxable distribution to the employee.<a href="#_ftn5" name="_ftnref5">5</a> Regulations also clarify that with respect to pension, annuity, profit sharing and stock bonus plans, the payment of disability premiums for insurance that replaces retirement contributions are not distributions.<a href="#_ftn6" name="_ftnref6">6</a> Where a governmental employer “picks up” plan contributions otherwise designated as employee contributions, the contributions are treated as employer contributions.<a href="#_ftn7" name="_ftnref7">7</a> These contributions are excluded from the employee’s income and are not subject to withholding.<a href="#_ftn8" name="_ftnref8">8</a> A state law authorizing various retirement systems to “pick up” contributions is not sufficient to effectuate a “pick up” of employee contributions.<a href="#_ftn9" name="_ftnref9">9</a> A governmental employer must specify that contributions designated as employee contributions are being paid by the employer in lieu of employee contributions, and the employee must not have the option of choosing to receive the contribution directly.<a href="#_ftn10" name="_ftnref10">10</a> The required specification of payment of designated employee contributions by the employer must be completed before the period to which the contributions relate; retroactive “pick up” is not permitted.<a href="#_ftn11" name="_ftnref11">11</a> An employer may “pick up” either pre-tax or after-tax contributions used to repurchase service credit.<a href="#_ftn12" name="_ftnref12">12</a> Where a governmental employer’s plan explicitly stated that mandatory employee contributions, although designated as the participants’ contributions, would be “picked up” by the employer and treated as employer contributions, those contributions were excluded from the employee’s income until the time that they were distributed. Further, the contributions were excluded from wages for income tax withholding purposes. Importantly, the IRS noted that the plan did not give the plan participant the right to choose cash or a deferred election right with respect to the picked up contributions.<a href="#_ftn13" name="_ftnref13">13</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC §§ 402(a), 403(a); Treas. Reg. §§ 1.402(a)-1(a), 1.403(a)-1. <a href="#_ftnref2" name="_ftn2">2</a>.  Rev. Rul. 61-164, 1961-2 CB 99; Treas. Reg. § 1.402(a)-1(e)(1)(i). <a href="#_ftnref3" name="_ftn3">3</a>.  79 FR 26838 (May 12, 2014), amending § 1.401(a)-1(e)). <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.402(a)-1(e)(iii)(2). <a href="#_ftnref5" name="_ftn5">5</a>.  Treas. Reg. § 1.402(a)-1(e)(1)(ii). <a href="#_ftnref6" name="_ftn6">6</a>.  Treas. Reg. § 1.402(a)-1(e)(1)(iii). <a href="#_ftnref7" name="_ftn7">7</a>.  IRC § 414(h)(2). <a href="#_ftnref8" name="_ftn8">8</a>.  Rev. Rul. 77-462, 1977-2 CB 358; Let. Ruls. 201317025; 201143032. <a href="#_ftnref9" name="_ftn9">9</a>.  Foil v. Comm., 92 TC 376 (1989), aff’d, 920 F.2d 1196 (5th Cir. 1990). <a href="#_ftnref10" name="_ftn10">10</a>.  Rev. Rul. 81-35, 1981-1 CB 255; Rev. Rul. 81-36, 1981-1 CB 255; Rev. Rul. 2006-43, 2006-35 IRB 329; Let. Ruls. 201317025; 9441042. <a href="#_ftnref11" name="_ftn11">11</a>.  Rev. Rul. 87-10, 1987-1 CB 136, modified by Rev. Rul. 2006-43, 2006-35 IRB 329; Alderman v. Comm., TC Memo 1988-49. <a href="#_ftnref12" name="_ftn12">12</a>.  Let. Rul. 200035033.g <a href="#_ftnref13" name="_ftn13">13</a>.  Treas. Reg. § 1.401(k)-1(a)(3); Let. Rul. 201509069. </div></div>

March 13, 2024

3938 / Can an employer contribute property other than money to a qualified plan trust?

<div class="Section1"> The U.S. Supreme Court has held that an employer’s transfer of unencumbered property to a defined benefit plan in satisfaction of a funding obligation is a prohibited transaction.<a href="#_ftn1" name="_ftnref1">1</a> The Court left open the question of whether a transfer of unencumbered property that is not in satisfaction of a funding obligation might be permissible without violating prohibited transaction rules. The Department of Labor has expressed the view that a contribution of property other than cash that reduces a sponsor’s funding obligation would be a prohibited transaction in the absence of a statutory or administrative exemption, whether it is made to a defined benefit or a defined contribution plan; a contribution in excess of amounts needed to meet a plan’s funding requirements may be permissible, provided that acceptance of the contribution is consistent with the general standards of fiduciary conduct under ERISA.<a href="#_ftn2" name="_ftnref2">2</a> Certain contributions of employer stock and employer real property are exempt from the prohibited transaction rules ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3980">3980</a>). Furthermore, there is an administrative exemption for the contribution of a life insurance policy to a plan if certain conditions are met ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3974">3974</a>). This exemption also protects self-employed owner-employees and more-than-5-percent shareholder-employees of S corporations from the prohibited transaction rules of Title I of ERISA ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3980">3980</a>).<a href="#_ftn3" name="_ftnref3">3</a> If only a sole proprietor or partners and their spouses participate in the plan, Title I of ERISA does not apply.<a href="#_ftn4" name="_ftnref4">4</a> A contribution of an employer’s promissory note to a trust does not constitute payment and no deduction is allowable until the note is paid.<a href="#_ftn5" name="_ftnref5">5</a> The IRS has taken the position that the contribution of an employer’s own term promissory note is a prohibited transaction.<a href="#_ftn6" name="_ftnref6">6</a> A sale by plan fiduciaries of some of their customers’ promissory notes to a plan was a prohibited transaction, notwithstanding the fact that the notes generated a competitive rate of return.<a href="#_ftn7" name="_ftnref7">7</a> An earlier letter ruling indicated that a contribution of a third party promissory note was payment and that its fair market value could be deducted.<a href="#_ftn8" name="_ftnref8">8</a> Contribution of a check is only conditional payment; if the check is not paid, the deduction will be disallowed.<a href="#_ftn9" name="_ftnref9">9</a> The fair market value of contributed property is considered to be the amount contributed for purposes of calculating annual additions within the overall Section 415 limits ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3868">3868</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3719">3719</a>, and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3728">3728</a>).<a href="#_ftn10" name="_ftnref10">10</a> For special rules applying to the sale of employer securities to a defined contribution plan, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3731">3731</a>. The requirements for a Section 1042 election upon the sale of employer stock to an ESOP are explained at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3820">3820</a>. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Keystone Consol. Indus., Inc. v. Comm., 508 U.S. 152, 113 S. Ct. 2006 (1993). <a href="#_ftnref2" name="_ftn2">2</a>.  DOL Interpretive Bulletin 94-3, 59 Fed. Reg. 66735 (Dec. 28, 1994). <a href="#_ftnref3" name="_ftn3">3</a>.  PTE 92-5, 57 Fed. Reg. 5019, (formerly PTE 77-7, 1977-2 CB 423). <a href="#_ftnref4" name="_ftn4">4</a>.  See Labor Reg. § 2510.3-3. <a href="#_ftnref5" name="_ftn5">5</a>.  Rev. Rul. 55-608, 1955-2 CB 546; Rev. Rul. 80-140, 1980-1 CB 89; Don E. Williams Co. v. U.S., 429 U.S. 569 (1977). <a href="#_ftnref6" name="_ftn6">6</a>.  Rev. Rul. 80-140, 1980-1 CB 89. <a href="#_ftnref7" name="_ftn7">7</a>.  See Westoak Realty & Inv. Co., Inc. v. Comm., 999 F.2d 308, 93-2 USTC ¶ 50,395 (8th Cir. 1993). <a href="#_ftnref8" name="_ftn8">8</a>.  Let. Rul. 7852116. <a href="#_ftnref9" name="_ftn9">9</a>.  Springfield Prod., Inc., v. Comm., TC Memo 1979-23. <a href="#_ftnref10" name="_ftn10">10</a>.  Treas. Reg. § 1.415(c)-1(b)(4). </div></div>

March 13, 2024

3942 / How much may an employer deduct if it contributes to more than one kind of qualified plan?

<div class="Section1"> An employer that sponsors both a defined benefit and defined contribution plan covering any common participants may deduct no more than the greater of 25 percent of participant payroll paid in the employer’s tax year or the contribution necessary to satisfy the minimum funding requirements for the plan year for any of the defined benefit plans.<a href="#_ftn1" name="_ftnref1">1</a> In the case of employer contributions to one or more defined contribution plans, this limitation applies only to the extent contributions exceed 6 percent of the compensation paid or accrued during the taxable year.<a href="#_ftn2" name="_ftnref2">2</a> This combined limit does not apply if the only amounts contributed to the defined contribution plan are elective deferrals ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3752">3752</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3753">3753</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3760">3760</a>).<a href="#_ftn3" name="_ftnref3">3</a> Nonetheless, contributions or benefits may not be deducted in the year of contribution to the extent that they exceed the Section 415 limits ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3719">3719</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3728">3728</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3868">3868</a>), even if they are required by the minimum funding requirements.<a href="#_ftn4" name="_ftnref4">4</a> The excess may be deducted in succeeding years as a contribution carry-over, but see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3943">3943</a> for an excise tax on nondeductible contributions. The deduction for current contributions and carryovers in a tax year cannot exceed 25 percent of aggregate compensation ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3750">3750</a>).<a href="#_ftn5" name="_ftnref5">5</a> For purposes of the deduction limitations, a Section 412(e)(3) (formerly 412(i)) fully insured plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3812">3812</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3813">3813</a>) is treated as a defined benefit plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3735">3735</a>).<a href="#_ftn6" name="_ftnref6">6</a> In plan years beginning after December 31, 2007, contributions to defined benefit plans insured by the PBGC are excluded from the combined plan limit.<a href="#_ftn7" name="_ftnref7">7</a> If no employee or former employee benefits under both plans, then the limits that would apply to such plans separately ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3735">3735</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3750">3750</a>) are not reduced by this overall limit.<a href="#_ftn8" name="_ftnref8">8</a> Under earlier provisions, a simplified employee pension plan was treated as if it were a separate profit sharing or stock bonus plan for purposes of the overall 25 percent limit.<a href="#_ftn9" name="_ftnref9">9</a> If an employer maintains both a simplified employee pension plan and a profit sharing or stock bonus plan, the 25 percent deductible limit applicable to qualified profit sharing and stock bonus plans must be reduced by the amount of any employer deduction for contributions to the simplified employee pension plan on behalf of a participant also covered under the profit sharing or stock bonus plan.<a href="#_ftn10" name="_ftnref10">10</a> An employer sponsoring both a stock bonus and a profit sharing plan is considered to have a single plan.<a href="#_ftn11" name="_ftnref11">11</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 404(a)(7)(A). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 404(a)(7)(C)(iii). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 404(a)(7)(C)(ii). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 404(j); Notice 83-10, 1983-1 CB 536, F-3. <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 404(a)(7)(B). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 404(a)(7)(D). <a href="#_ftnref7" name="_ftn7">7</a>.  IRC § 404(a)(7)(C)(iv). <a href="#_ftnref8" name="_ftn8">8</a>.  IRC § 404(a)(7)(C). <a href="#_ftnref9" name="_ftn9">9</a>.  IRC § 404(h)(3). <a href="#_ftnref10" name="_ftn10">10</a>.  IRC § 404(h)(2). <a href="#_ftnref11" name="_ftn11">11</a>.  Let. Rul. 7916102. </div></div>

March 13, 2024

3940 / What other specific rules affect an employer’s deduction for its contributions to a qualified plan?

<div class="Section1"> If a plan is qualified, an employer may deduct its contributions currently, regardless of whether the rights of the individual participants are forfeitable or nonforfeitable.<a href="#_ftn1" name="_ftnref1">1</a> To be deductible, a contribution on behalf of a participant must qualify as reasonable compensation for services actually rendered to the contributing employer by the participant as an employee.<a href="#_ftn2" name="_ftnref2">2</a> The IRS has discussed the limitations on deductions and carryovers for contributions to a qualified profit sharing plan when an employee’s total compensation is unreasonable.<a href="#_ftn3" name="_ftnref3">3</a> Where reasonableness of compensation was not in question, the Tax Court ruled that a newly formed corporation could deduct its full contribution to a defined benefit plan for the plan year that began in the corporation’s short first tax year and it rejected the IRS argument that only 4.5/12 of the contribution should be deductible because the short year was only 4.5 months long.<a href="#_ftn4" name="_ftnref4">4</a> Deductions with respect to a multiemployer plan maintained pursuant to a collective bargaining agreement are determined as if all participants were employed by a single employer.<a href="#_ftn5" name="_ftnref5">5</a> In the case of a multiple employer plan, the deduction limit generally is applied as if each employer maintained a separate plan.<a href="#_ftn6" name="_ftnref6">6</a> Different rules apply to a plan adopted by two or more corporations that are members of the same controlled group ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8964">8964</a>); in that case, the deduction limits are determined as if all such employers were a single employer.<a href="#_ftn7" name="_ftnref7">7</a> Deductions with respect to a CSEC (Cooperative and Small Employer Charity) plan are determined as if all participants were employed by a single employer.<a href="#_ftn8" name="_ftnref8">8</a> Certain employer liability to the Pension Benefit Guaranty Corporation (“PBGC”) as a result of plan termination or withdrawal from a multiemployer plan will be treated as a contribution to be deducted when paid without regard to the usual limits on the deduction of employer contributions to qualified plans.<a href="#_ftn9" name="_ftnref9">9</a> Contributions to fund post-retirement medical benefits under IRC Section 401(h) for common law employees may be deducted currently by an employer if they are reasonable, ascertainable, and distinct from contributions to fund retirement benefits, provided the benefits are subordinate to the retirement benefits provided by the plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3830">3830</a>).<a href="#_ftn10" name="_ftnref10">10</a> Contributions to fund postretirement medical benefits are not taken into account in determining the amount deductible with respect to contributions for retirement benefits. The amount of any excess pension assets transferred in a “qualified transfer” ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3836">3836</a>) to an IRC Section 401(h) account is not deductible.<a href="#_ftn11" name="_ftnref11">11</a> Any allocable portion of past service and current pension costs that must be included in the basis of property produced by an employer or held for resale by the employer under the uniform capitalization rules is not deductible by the employer.<a href="#_ftn12" name="_ftnref12">12</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 404. <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 404(a); Thousand Oaks Residential Care Home I, Inc. v. Comm., TC Memo 2013-10; Bianchi v. Comm., 66 TC 324 (1976), aff’d, 553 F.2d 93 (2d Cir. 1977); La Mastro v. Comm., 72 TC 377 (1979); Edwin’s Inc. v. U.S., 501 F.2d 675 (7th Cir. 1974); Chas. E. Smith & Sons Co. v. Comm., 184 F.2d 1011 (6th Cir. 1950); Bardahl Mfg. Co. v. Comm., TC Memo 1960-223; Acme Pie Co. v. Comm., 10 TCM (CCH) 97 (1951). <a href="#_ftnref3" name="_ftn3">3</a>.  Rev. Rul. 67-341, 1967-2 CB 156. <a href="#_ftnref4" name="_ftn4">4</a>.  Plastic Eng’g & Mfg. Co. v. Comm., 78 TC 1187 (1982). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 413(b)(7); see Let. Rul. 8743077. <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 413(c)(6). <a href="#_ftnref7" name="_ftn7">7</a>.  IRC § 414(b). <a href="#_ftnref8" name="_ftn8">8</a>.  IRC § 413(d)(2). <a href="#_ftnref9" name="_ftn9">9</a>.  IRC § 404(g). <a href="#_ftnref10" name="_ftn10">10</a>.  IRC § 404(a)(2); Treas. Reg. § 1.404(a)-3(f). <a href="#_ftnref11" name="_ftn11">11</a>.  IRC § 420(d)(1)(A). <a href="#_ftnref12" name="_ftn12">12</a>.  OBRA ’87, § 10204. See Notice 88-86, 1988-2 CB 401, obsoleted by TD 8897, 2000-2 CB 234. </div></div>