Two new IRS issue snapshots review issues for terminating, underfunded single-employer defined benefit (DB) plans. One snapshot addresses plan-termination concerns for plans covered by the Pension Benefit Guaranty Corporation (PBGC) under ERISA Title IV’s plan termination insurance program, while the other snapshot addresses plans not covered by PBGC. Although the snapshots don’t provide new guidance or information, they highlight the issues IRS agents may review during plan audits.
The two types of plans are subject to similar rules on plan termination. Both have to make up any accumulated funding deficiencies under the applicable IRS funding rules. Plans that don’t distribute assets in a reasonable period of time after the termination date are not considered terminated by the IRS, and therefore remain subject to minimum funding rules — and could be subject to an excise tax if a funding deficiency arises after the termination date. IRS will check to see if the final distribution was timely. If not, the agency will assess if the plan had a funding deficiency, and if so, whether any excise taxes owed have been paid.
Even after meeting minimum funding requirements, a plan might still be underfunded on a plan termination basis under PBGC’s rules, due to different assumptions and methodologies for the two calculations. For plans subject to PBGC’s termination insurance program, the sponsor must make the plan fully funded on a termination basis to avoid a distress termination. Sponsors can make additional contributions to fully fund the plan. In addition, the majority owner can forgo all or a portion of their distribution, subject to certain requirements — including spousal consent if necessary. IRS will check if the majority owner decided to forgo all or a part of their benefit distribution, and if so, how that decision was made — these decisions can’t be made by plan amendment or by waiving the benefit, since that would violate IRS anti-cutback rules.
For plans not covered by the PBGC, final distribution of assets must follow the allocation rules of ERISA Section 4044. For these plans, the snapshot says IRS will look to see if assets were allocated to participants in a nondiscriminatory manner.