Reversion of Qualified Plan Assets to Employer

[KBTS]

Client called yesterday and said they had just received a large check from their pension plan administrator because they had closed out their pension plan. The corporation was sold a while back and they were wrapping everything up in 2007 and would file a final return this year. They faxed over a Form 5330 Return of Excise Taxes Related to Employee Benefits Plans showing the 50% excise tax due and some other paperwork.

I have no experience in something like this and of course I had no idea my client was planning this until the phone call. Client wants to know if there will be any additional tax on the distribution - I am having a hard time finding much information except for the 50% penalty which applies. I did find one article which seems to indicate the entire distribution will also have to be reported on the corporate tax return subject to income tax - but cannot find anything in the 1120 instructions about this.

Any help is appreciated.

[Bees Knees]

Instructions for Form 5330 give a list of who must file the form.

Number 12 says:

12. Any employer who receives an
employer reversion from a deferred
compensation plan that is taxable under
section 4980.

To read code section 4980, click on the link below:

http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=browse_usc&docid=Cite:+26USC4980

[veritas]

Good grief

Why did they not roll their retirement over to an IRA?

[sea-tax]

I think but am not sure that in either 2005 or 2006 there was a tax law change or ERISA law change which allows for 401k's and the like to distribute a employees plan if the account balance is less than 5k. Usually the employee is provided with the paperwork and ample time to request a direct rollover. If they choose not to act then the plan administrator will distribute the money. This was passed I think in order to help employers cut down on administrative cost and fees of retirement plans.

[KBTS]

Clarification

Sorry, I should have made this more clear. My client is the owner of the corporation and the corporation received the distribution from closing out the pension. Client needs to know if the distribution is taxable income to the corp in addition to having to pay the 50% excise penalty.

[veritas]

What kind of pension plan?

Our company had a profit sharing plan which we terminated. The money was in a local mutual fund which I had them cash out and send to our corporation. I then in turn wrote checks to each employees IRA which I setup to rollover the pension proceeds. At year end we did 1099Rs showing the distributions.

We didn't pay any excise tax.

[JON]

Over our heads,

but you better make sure that it is the corporation's money. Most defined contribution plans will always be due to participants and administrator should know it unless they just handled investments and accounting is done by someone else. Defined benefit plans can have exces contributions on termination. It can happen for refunds. I think the switch to cash plans were generating that when it was going on in the 90s and early 2000. You need to get some better minds than ours. Make sure it was not a brokerage firm closing out the account because your client asked them to..??? Does not sound like it if you got 5330. If so I think for sure it is taxable and penalties seem logical, unless you have an exception.

[Bees Knees]

The employer is subject to tax under Section 4980 when pension plan assets revert back to the employer upon termination of a pension plan.

For example, say you have a defined contribution plan that is made up of both employee and employer contributions. The employee is not vested in any employer contributions until after three years. The employee is always 100% vested in his or her own contributions.

Lets say that out of $100,000 of total assets in the employer’s defined contribution plan, only $60,000 represents vested employee benefits. That means only $60,000 can be allocated to the employees (who can then take their distribution and roll their money over into an IRA to avoid paying tax), while the other $40,000 reverts back to the employer (called a reversion of qualified plan assets to the employer).

It’s the $40,000 that is subject to tax under Section 4980 because the employer is not giving that portion of the pension assets to the employees. The employer deducted the contributions when made to the plan. Now the employer has to pay tax on it when the employer gets the money back.

[veritas]

?

When we ternminated out plan the employees became 100% vested immediatelty.

[KBTS]

The employer is subject to tax under Section 4980 when pension plan assets revert back to the employer upon termination of a pension plan.

For example, say you have a defined contribution plan that is made up of both employee and employer contributions. The employee is not vested in any employer contributions until after three years. The employee is always 100% vested in his or her own contributions.

Lets say that out of $100,000 of total assets in the employer’s defined contribution plan, only $60,000 represents vested employee benefits. That means only $60,000 can be allocated to the employees (who can then take their distribution and roll their money over into an IRA to avoid paying tax), while the other $40,000 reverts back to the employer (called a reversion of qualified plan assets to the employer).

It’s the $40,000 that is subject to tax under Section 4980 because the employer is not giving that portion of the pension assets to the employees. The employer deducted the contributions when made to the plan. Now the employer has to pay tax on it when the employer gets the money back.

So they will pay the 50% excise tax under Section 4980 on the distribution and also include it as income on the corporate return. Which means they will pay out at least another 15% in income tax on the distribution - meaning they will see little of the payout once all the taxes are paid!

[Bees Knees]

When we ternminated out plan the employees became 100% vested immediatelty.

Good for your employees.

Not all terminations result in 100% vesting. That is the purpose of Section 4980.

[Bees Knees]

So they will pay the 50% excise tax under Section 4980 on the distribution and also include it as income on the corporate return. Which means they will pay out at least another 15% in income tax on the distribution - meaning they will see little of the payout once all the taxes are paid!

A good incentive not to terminate a plan. The government doesn't like it when employers renege on their promise to provide retirement plan benefits for employees.

[veritas]

Amend the plan?

Good for your employees.

Not all terminations result in 100% vesting. That is the purpose of Section 4980.

Maybe this company should have done a plan amendment. It would be insane to pay the tax and penalty this section would require.

[Bees Knees]

Maybe this company should have done a plan amendment. It would be insane to pay the tax and penalty this section would require.

Well, I agree. I think it is jerky to not let your employees have all the money. I think that was the point of imposing such a stiff tax on employers when they terminate their plan and take some of the money back.

[KBTS]

Tax Return Question

I am now in the process of doing the 1120 return. Since the entire distribution is taxed as ordinary income and there is no other line that fits, I was planning to put it on line 10 "Other Income" and provide and explanation. Does that sound right?

Also, I assume the 50% excise tax client paid is not deductible on line 17 "Taxes and Licenses" - correct?

Wish the client had discussed this before all this happened!