Employers hoping to get IRS rulings on certain transactions that involve reversions from terminating defined benefit (DB) plans are now out of luck. Rev. Proc. 2022-28 announces that the agency will no longer issue private letter rulings on whether a reversion has occurred when a plan has excess assets after a spinoff/termination (“spin-term”) transaction. The announcement applies to all letter-ruling requests received or pending on or after June 21, 2022, and appears to formalize a policy that has been in place even prior to that date.

Strategic uses for spin-terms

Spin-terms are a popular strategy for employers to reduce the size of their DB plans. The approach involves spinning off a portion of an existing plan into a different plan and then terminating one of the plans, leaving behind a smaller ongoing plan. An employer may initiate a spin-term for many reasons, such as to be able to pay benefits to active participants with frozen benefits, to reflect a corporate reorganization, to reduce balance sheet volatility, or to lower administrative costs and insurance premiums paid to the Pension Benefit Guaranty Corp. However, employers may also use spin-terms as a workaround for two burdensome restrictions on DB and defined contribution (DC) plans.
 

Recovering trapped DB plan surplus. A spin-term gives an employer a means of retrieving surplus assets in its DB plan while still maintaining a plan. Employers generally can’t withdraw money from an ongoing DB plan even when it has a significant surplus (except when contributions are attributable to a “mistake of fact”). However, employers can take back surplus assets remaining after terminating a DB plan. In a spin-term, the employer can transfer a portion of the surplus to the terminating plan and retrieve the surplus after all of that plan’s benefit liabilities and expenses have been paid.
 

The reversion is subject to a steep excise tax of up to 50%. However, employers can reduce or eliminate the excise tax by using the funds to increase benefits under the terminating plan or transferring a portion to a qualified replacement plan (QRP). Even with the excise tax, some sponsors may still find this approach attractive since it provides immediate access to otherwise unavailable funds.
 

Prefunding DC plan benefits. Employers generally may only make DC-plan contributions in the year they are allocated to participants’ accounts (unlike contributions to DB plans, which may be prefunded). However, an exception applies to surplus assets transferred from a terminating DB plan to a QRP (which can be a DB or DC plan). Subject to several restrictions and limitations beyond the scope of this article, funds transferred to a DC QRP may be held in a suspense account and used to fund nonelective (but not matching) contributions for up to seven years. Surplus assets transferred to the QRP aren’t subject to the excise tax on reversions, and a reduced excise tax applies to any remaining surplus that reverts to the employer.
 

No ruling on spin-terms involving excess assets

IRS will no longer issue letter rulings on whether a DB plan termination results in a reversion if the transaction meets the following conditions:
 

• An ongoing plan spins off less than 100% of its assets to another DB plan sponsored by the same employer (or certain related employers).
• The receiving plan is terminated “a short period of time” after receiving the assets.
• Assets remaining in the receiving plan’s trust after all benefits are distributed to the plan’s participants and beneficiaries.

Although the revenue procedure seems to focus only on transactions where the spunoff plan is terminated, nothing in the announcement suggests IRS would be any more receptive to ruling on a transaction where the original plan is the one terminated immediately after the spinoff.
 

IRS doesn’t explain exactly why it will no longer issue letter rulings under these circumstances. The agency may hope to discourage transactions specifically designed to circumvent restrictions on DB and DC plans, and instead limit rulings to reversions after complete termination of a DB plan. However, employers undertaking a spin-term don’t need IRS approval and may still feel comfortable pursuing strategies such as those discussed above without a letter ruling. These employers may want to consult legal counsel.
 

Scope of guidance unclear

Rev. Proc. 2022-28 specifically states that IRS will not rule on whether a reversion has occurred after a spin-term under a single set of circumstances. However, the guidance does not address whether IRS will also decline to rule on related issues, such as the allocation of assets between plans and the disposition of any surplus assets from the terminated plan (such as whether a DC plan that receives those surplus assets constitutes a QRP).
 

Related resource

Non-Mercer resource

Rev. Proc. 2022-28 (IRS, June 21, 2022)