Academic journal article Journal of Accountancy

IRS Wins One Battle in Ongoing War with Small Pension Plans

Academic journal article Journal of Accountancy

IRS Wins One Battle in Ongoing War with Small Pension Plans

Article excerpt

A recent Sixth Circuit Court of Appeals decision held that an employer's actuarial assumptions used in determining deductible contributions to an individual defined benefit plan were unreasonable. The district court's holding that the assumptions were reasonable as a whole was reversed.

This was the third in a series of appellate-level decisions--each dealt with plans maintained by law firms--on individual defined benefit plans. The first was the Fifth Circuit Court of Appeals 1993 decision in Vinson & Elkins (see JofA, Feb.94, page 29); the second was the Second Circuit Court of Appeals 1994 decision in Wachtell, Lipton, Rosen & Katz. Both decisions upheld the employers' conservative actuarial assumptions.

For defined benefit plans, the employer contributes and deducts an amount that, together with accumulated contributions and expected income, will produce the defined retirement benefit.

To compute the proper contribution amount, actuarial assumptions are applied. For instance, assumptions must be made about the retirement age of participants, interest rates before and after retirement and the mortality tables to be used. Naturally, more conservative assumptions require larger contributions to produce the intended benefit.

Internal Revenue Code section 412(c)(3) requires these actuarial assumptions be "reasonable" as a whole. Further, they must represent the actuary's "best estimate" of anticipated plan experience.

In the last few years the Internal Revenue Service has audited small defined benefit plans and denied contribution deductions based on the claimed unreasonableness of conservative actuarial assumptions. Several of these disputes reached the Tax Court. …

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