IRS Issues Final Regulations on Minimum Contributions to Single-Employer Pension Plans and Excise Taxes for Failing to Satisfy Minimum Funding Standards | Practical Law

IRS Issues Final Regulations on Minimum Contributions to Single-Employer Pension Plans and Excise Taxes for Failing to Satisfy Minimum Funding Standards | Practical Law

The Internal Revenue Service (IRS) and Department of Treasury issued final regulations providing guidance on the determination of minimum required contributions for single-employer pension plans and excise taxes for failing to satisfy the minimum funding standards for defined benefit pension plans. The regulations apply to plan years beginning after January 1, 2016.

IRS Issues Final Regulations on Minimum Contributions to Single-Employer Pension Plans and Excise Taxes for Failing to Satisfy Minimum Funding Standards

by Practical Law Employee Benefits & Executive Compensation
Published on 08 Sep 2015 • USA (National/Federal)
The Internal Revenue Service (IRS) and Department of Treasury issued final regulations providing guidance on the determination of minimum required contributions for single-employer pension plans and excise taxes for failing to satisfy the minimum funding standards for defined benefit pension plans. The regulations apply to plan years beginning after January 1, 2016.
The Internal Revenue Service and the Department of Treasury (IRS) issued final regulations providing guidance on:
The regulations apply to plan years beginning after January 1, 2016. They finalize proposed regulations under Code Sections 430 and 4971 that were published on April 15, 2008.

Determining MRCs

The MRC is the minimum amount required to be contributed to a pension plan for a plan year. Treasury Regulation Section 1.430(a)-1 provides rules under Code Section 430(a) for determining the MRC for a plan year for a single-employer defined benefit plan. This amount depends on whether the value of plan assets, as reduced to reflect certain funding balances, is less than or at least equal to the plan's present value of accrued benefits at the beginning of the plan year (funding target).
Under Code Section 430, if the plan's assets are equal or less than the plan's funding target, the MRC is equal to the total amount necessary to cover:
  • The benefits to be earned in that plan year, including increases in benefits accrued in previous years because of compensation increases during the current plan year (target normal cost).
  • The shortfall amortization charge for the plan year (if any) (see Shortfall Amortization Charges; Funding Shortfall).
  • The waiver amortization charge for the plan for the plan year (if any) (see Waiver Amortization Charges).
(26 U.S.C. §§ 412, 430; ERISA § 302 (29 U.S.C. § 1082) (all as amended by PPA).)
If the plan's assets exceed the funding target, the MRC is equal to the plan's target normal cost reduced by any of that excess (but not below zero).

Shortfall Amortization Charges; Funding Shortfall

The portion of the shortfall the employer must fund is measured by the shortfall amortization charge in installment payments which are the annual amounts necessary to amortize the shortfall amortization base in level installments over a seven-year period determined:
  • Assuming that installments are paid on the valuation date for each plan year. Installment payments are not redetermined even if the valuation date for a plan changes after the plan year for which the shortfall amortization base was established. In that case:
    • the dates on which the installments are assumed to be paid are changed to the anniversaries of the new valuation date; and
    • the difference in present value due to this change is reflected in any new shortfall amortization base.
  • Using the interest rates under Code Section 430(h)(2)(C) or (D) for the plan year for which the shortfall amortization base is established. The interest rates are not redetermined in subsequent plan years to reflect changes in interest rates under Code Section 430(h)(2) (26 U.S.C. § 430(h)(2)) for the subsequent years.
Under the regulation, in general, a shortfall amortization base is established for a plan year only if the value of plan assets (reduced, but not below zero, by the prefunding balance if an election is made to use any portion of the prefunding balance to offset the MRC for the plan year) is less than the funding target for the plan year. This shortfall amortization base is equal to the funding shortfall for the plan year, minus the sum of any remaining shortfall amortization installments and waiver amortization installments.
For this purpose, the funding shortfall for the plan year is generally the excess, if any, of the funding target for the plan year over the value of plan assets for the year, reduced by certain funding balances as permitted under Treasury Regulation Section 1.430(f)-1(c).

Code Section 436 Contributions and Funding Shortfalls

The proposed regulations did not count contributions under Code Section 436(b)(2), (c)(2) or (e)(2) (26 U.S.C. § 436(b)(2), (c)(2), e(2)):
  • Toward MRCs for the current year.
  • As plan assets for that year.
Commentators sought to permit these contributions to be reflected in plan assets for purposes of Code Section 430 if the corresponding increase in funding target is required to be reflected, which would have the effect of reducing the funding shortfall for that year.
However, the final regulations adopt the rule as proposed and do not include any special rule that would reduce the funding shortfall for a plan year to take into account Code Section 436 contributions for that year. The IRS reasons that those Code Section 436 contributions will be part of plan assets when measured for the following plan year and, therefore, will reduce any positive shortfall amortization base (or increase any negative shortfall amortization base) that would otherwise be established for that following year.
For more information on Code Section 436, see Practice Note, Benefit Restrictions under Code Section 436.

Waiver Amortization Charges

Under the regulations, the waiver amortization installments for a waiver amortization base established for a plan year are the annual amounts necessary to amortize that waiver amortization base in level annual installments over the five-year period beginning with the following plan year. These installments are determined:
  • Assuming that the installments are paid on the valuation date for each plan year. If a plan uses the segment rates, for example, the installments are determined by applying the first segment rate to the first four installments and the second segment rate to the fifth (and final) installment.
  • Using the interest rates applicable under Code Section 430(h)(2). These are the interest rates:
    • that apply for the plan year for which the waiver is granted (even though the first installment for the waiver amortization base is not due until the subsequent plan year); and
    • are not redetermined in subsequent plan years to reflect changes in interest rates under Code Section 430(h)(2) (26 U.S.C. § 430(h)(2)) for those years.
(Treas. Reg. § 1.430(h)2)-1(f)(2).)

Short Plan Years

The regulations provide rules for determining the MRCs for a short plan year, including that:
  • The amortization installments are prorated.
  • The plan's target normal cost is not prorated. Instead, the plan's target normal cost must reflect benefits that accrue or are expected to accrue during the short plan year. (The final regulations refer practitioners to 29 C.F.R. § 2530.204-2(e) for rules relating to changes in accrual computation periods.)
The regulations also provide rules for the treatment of amortization installments in subsequent plan years to:
  • Take into account the proration of the installments for short plan years.
  • Clarify the treatment of these installments in the event of a change in valuation date.

Terminating Plans

In light of the rules for short plan years in the proposed regulations, commentators questioned how to determine MRCs for a plan year if the plan terminates before the last day of the year.
Under IRS Revenue Ruling 79-237, the minimum funding requirements apply for the year that a plan terminates but not for later years. The final regulations provide that if a plan terminates before the last day of a plan year, then for purposes of Code Section 430, the plan is treated as having a short plan year that ends on the termination date (to determine the termination date, see Determining the Termination Date). As a result, the MRC is determined based on that short plan year (see Short Plan Years). (If a plan terminates before the date that would otherwise have been the valuation date for a plan year, the valuation date must be changed so it falls within the short plan year.)

Determining the Termination Date

The final regulations also provide that the termination date for a plan:
  • Subject to Title IV of ERISA, is the plan's termination date established under ERISA Section 4048 (29 U.S.C. § 1348), rather than the definition of termination date that is provided in the IRS rules for terminated plans in 26 C.F.R. § 601.601(d)(2)(ii)(b).
  • Not subject to Title IV of ERISA, is the plan's termination date established by the plan administrator, so long as the termination date is no earlier than the date on which all actions necessary to effect the plan termination are taken (other than the distribution of plan assets). However, a plan will not be treated as terminated on that date if the plan assets are not distributed "as soon as administratively feasible after that date," based on all relevant facts and circumstances.
Plan assets will not be deemed to have been distributed as soon as administratively feasible after a plan termination date if:
  • The distribution was delayed merely for the purpose of obtaining a higher value than current market value.
  • Plan assets are not distributed within one year following the plan's termination date established by the plan administrator.
However, a plan will not be treated as failing to meet this "administratively feasible" requirement if a delay in distributing plan assets after plan termination is attributable to either:
  • Circumstances beyond the control of the plan administrator.
  • The period of time necessary to obtain a determination letter on the plan's qualified status upon its termination (see Retirement Plan Determination Letters Toolkit), provided that:
    • the request is timely; and
    • the distributions of plan assets are made as soon as administratively feasible after the determination letter is obtained.
For guidance on locating missing participants in terminating plans, see Practice Note, Locating Missing Participants in Terminating Plans.

Applicable Interest Rates to Determine Present Value (Treas. Reg. §1.430(h)(2)-1)

Code Section 430 describes the interest rates that are used to calculate the MRCs. The interest rates used for this purpose are a set of three segment rates or, alternatively, a full yield curve (see Legal Update, IRS Issues Guidance On Segment Rates for DB Plans Pursuant to MAP-21).
The regulations update the proposed regulations to reflect the modification under the Highway and Transportation Funding Act of 2014 (HATFA) to the five-year period for which the first segment rate applies (see Legal Update, President Obama Signs the Highway and Transportation Funding Act of 2014 with Pension Funding Provisions) and provide that the first segment rate is used to determine the present value of benefits expected to be payable during the five-year period beginning with the valuation date for the plan year.
However, for a plan year beginning before January 1, 2014, if a plan has a valuation date other than the first day of the plan year, the five-year period beginning on the first day of the plan year may be used instead of the five-year period beginning on the valuation date.

Payment of MRCs

The regulations provide rules governing the payment of MRCs, including rules:
Each payment of an MRC:

Designating Unpaid MRCs

If the plan has unpaid MRCs that have not been corrected at the time a contribution is made, the contribution is treated as a contribution for the earliest plan year for which there is an unpaid MRC to the extent necessary to correct that unpaid MRC.
Any excess amount is treated as a contribution for the next earliest plan year for which there is an unpaid MRC. This allocation must be shown on Schedule SB of Form 5500.
If there is no unpaid MRC for prior plan years at the time the contribution is made (or a portion of the contribution corrects all unpaid MRCs), then the contribution made during the current plan year may be designated as a contribution for either that prior plan year or the current plan year. This must also be designated on the Schedule SB of the Form 5500 for the plan year in which the contribution is designated and may not be changed after the actuarial report is completed and filed (if required).

Quarterly Contributions

The regulations provide rules for accelerated quarterly contributions for plans with funding shortfalls. If there is a funding shortfall for the preceding plan year, the employer maintaining the plan must make required quarterly installments for the current plan year equal to 25% of the required annual payment. For this purpose, the required annual payment is equal to the lesser of:
These MRCs are determined as of the valuation date for each year and are not adjusted for interest.
The due dates for the four required quarterly installments for a plan year fall on the 15th day:
  • Of the 4th plan month.
  • Of the 7th plan month.
  • Of the 10th plan month.
  • Following the end of the plan year.
The due dates are different for short plan years (see Short Plan Years).

Using Funding Balances Towards the Quarterly Contribution Requirement

The regulations provide that a plan sponsor can generally use the plan's funding balances to satisfy quarterly contribution requirements, subject to the limitation on the use of funding balances by underfunded plans in Code Section 430(f)(3)(C) (26 U.S.C. § 430(f)(3)(C)). To use these balances:
  • A contribution for a prior plan year in excess of the required MRC must actually have been made.
  • The plan sponsor's election to add the excess to the prefunding balance must have taken effect before it can elect to use the corresponding portion of the prefunding balance to satisfy the quarterly contribution requirements.
The amount of a plan's funding balances available for this election is increased with interest from the beginning of the plan year to the date of the election. However, the election may be made before the plan's effective interest rate for the year has been determined. In this case, a plan sponsor that elects to use these funding balances towards the quarterly contribution requirement must assume that the effective interest rate is equal to the lowest of three segment rates (generally the first segment rate) to ensure the quarterly contribution requirements are satisfied.
The preamble to the proposed regulations noted that the amount of the funding balance used to satisfy the quarterly contribution requirements could not later be added back to the prefunding balance. However, the final regulations provide, consistent with the October 2009 final regulations under Code Section 430(f), that to the extent a quarterly installment is satisfied through the use of a funding balance and the plan sponsor replenishes its funding balances, the amount that may be added to the prefunding balance on account of that subsequent contribution is based on the actual rate of return on plan assets under Treasury Regulation Section 1.430(f)-1(b)(3).
The final regulations agreed to commentators' request to credit interest on an early contribution toward the quarterly contribution requirements on the same basis as interest is credited on an early election to use a funding balance.
The final regulations also provide for any late quarterly installment (and any late election to use the funding balances to satisfy a quarterly installment) to be discounted for interest from the date of the late contribution or election to the due date for the installment using an interest rate equal to the plan's effective interest rate under Code Section 430(h)(2)(A) (26 U.S.C. § 430(h)(2)(A)) for the plan year plus 5 percentage points. This approach is equivalent to the approach suggested in the proposed regulations if compound interest is used.

Standing Elections to Satisfy Quarterly Installments Through Funding Balances

Commentators uniformly favored permitting the use of standing elections to pay quarterly installments. The final regulations includes rules that permit these standing elections, including that:
  • A plan sponsor may provide a standing election in writing to the plan's enrolled actuary to use funding balances to satisfy any otherwise unpaid portion of a required installment under Code Section 430(j)(3) (26 U.S.C. § 430(j)(3)).
  • The otherwise unpaid portion of a required installment is the amount necessary to satisfy the required installment rules under Code Section 430(j)(3) based on quarterly installment amounts equal to 25% of the MRC for the preceding plan year.
  • If the amount of the funding balances is less than the amount needed to satisfy a quarterly installment, then the entire amount available will be used under the standing election.
  • Any election made by a standing election is deemed to occur on the later of:
    • the last date for making the required installment under Code Section 430(j)(3); and
    • the date the standing election is provided to the actuary.
  • Any standing election will remain in effect for the actuary named in the election, unless the standing election is revoked or the plan's actuary is changed.
  • A plan may suspend the operation of a standing election for the remainder of a plan year by providing written notice to the actuary.
  • If the plan's actuary determines the current year's MRC, a plan may replace the standing election for the remainder of the plan year with a formula election to use (to the extent available) the funding balances as necessary so that the remaining required installments satisfy the rules under Code Section 430(j) taking into account the actuary's determination of the current year's MRC.

Liquidity Shortfalls

The regulations provide rules for the liquidity requirements that generally apply to plans for which quarterly contributions are required. To satisfy the quarterly contribution requirement, liquid assets in the amount of the liquidity shortfall (as defined in Code Section 430(j)(4)(E)) must be contributed:
  • After the end of that quarter.
  • On or before the due date for the installment.
If the amount of a required quarterly installment is increased because of this rule, the increase is generally limited to the amount which, when added to the current installment, and prior installments for the plan year, is necessary to increase the funding target attainment percentage for the plan year to 100%. The use of funding balances or the contribution of illiquid assets cannot remedy a liquidity shortfall.
In response to comments, the regulations provide special rules for applying the liquidity requirements to a multiple employer plan to which Code Section 413(c)(4)(A) applies.
The final regulations agreed with commentators' request that unpaid liquidity amounts under Code Section 430(j)(4)(C) be treated as paid at the end of the quarter for all purposes. Accordingly, any portion of a required quarterly installment that is treated as unpaid due to the liquidity rules is treated as unpaid until the close of the quarter in which the due date for the installment occurs (without regard to any contribution of liquid assets that is made after the due date). However, to the extent that a portion of the unpaid liquidity amount is no longer treated as unpaid after the close of the quarter, the regulations provide a special rule that imposes an interest charge that increases the MRC. This prevents plan sponsors from merely deferring a contribution until after the close of the quarter in which a liquidity amount is due to avoid an additional interest adjustment.

Excise Taxes Under Code Section 4971

Code Section 4971 (26 U.S.C. § 4971), as amended by the PPA, imposes an excise tax on unpaid MRCs for all years until corrected. In contrast to the pre-PPA rule, an unpaid MRC may only be corrected by making the contribution described in the regulations. The final regulations do not reflect requests by commentators for a special rule to preserve the pre-PPA "full-funding" rule for pre-PPA funding deficiencies.
The regulations provide the definitions that were modified by the PPA that apply under Code Section 4971. These definitions are substantially the same as the definitions in the proposed regulations, and include:
  • Accumulated Funding Deficiency (AFD). A single-employer plan's AFD has the meaning in Code Section 431 (for multiemployer plans) or Code Section 433 (for plans of charities and cooperative association as defined in Code Section 414(y) (26 U.S.C.§ 414(y)). A plan's AFD takes into account all charges and credits to the funding standard account under Code Section 412 for plan years before the first plan year for which Code Section 431 or 433 applies to the plan.
  • Unpaid MRC. For any plan year, an unpaid MRC is the portion of the MRC for which contributions have not been made on or before the due date for the plan year under Code Section 430(j)(1), after taking into account interest adjustments and offsets of funding balances. A plan's AFD for the pre-effective plan year is treated as an unpaid MRC for that plan year until a correction is made. Unlike the treatment of AFDs pre-PPA, the total amount of unpaid MRCs subject to excise taxes under Code Section 4971 is not adjusted with interest.
  • Correct. The regulations define the term "correct" as applies to an AFD or an unpaid MRC. The correction of an unpaid MRC requires the contribution, to or under the plan, of the amount that, when discounted to the valuation date for the plan year for which the unpaid MRC is due at the appropriate rate of interest, equals or exceeds the unpaid MRC.
  • Single-employer plan. The regulations define the term single-employer plan to mean a plan to which the minimum funding requirements of Code Section 412 apply that is not a multiemployer plan described in Code Section 414(f). (Therefore, this term includes a multiple employer plan.)