Retroactive Plan Amendments Under 412(d)(2)

1 Main 15725 SW Greystone Court, Suite102 Toll Free Beaverton, OR 97006-6016 Fax Retroactive plan Amendments Under 412(d)(2) The law did not change, why did the IRS position change? Or did it? In the hierarchy of statutes, regulations, procedures, notices, and other pronouncements that govern tax qualified retirement plans, the IRS Gray Book1 is somewhere near the bottom. The Gray Book s purpose generally is to provide answers to highly technical and/or fact specific questions; it is not intended to introduce radical changes to established pension law or interpretation. Yet, in the 2011 Gray Book, Question 4 (appended to this article), the IRS introduced a bold new interpretation of Internal Revenue Code (IRC) 412(d)(2) that has the effect of rendering the code section useless. The IRS position has many practitioners wondering how the IRS came to such a conclusion and whether the Gray Book has any real authority.

2 IRC 412(d)(2), which became federal law when ERISA was passed in 19742, states: For purposes of this section, any amendment applying to a plan year which (A) is adopted after the close of such plan year but no later than 2 1/2 months after the close of the plan year (or, in the case of a multiemployer plan , no later than 2 years after the close of such plan year), (B) does not reduce the accrued benefit of any participant determined as of the beginning of the first plan year to which the amendment applies, and (C) does not reduce the accrued benefit of any participant determined as of the time of adoption except to the extent required by the circumstances, shall, at the election of the plan administrator, be deemed to have been made on the first day of such plan year. In other words, 412(d)(2) allows a defined benefit plan sponsor to amend its plan within 2 months of the end of a plan year to increase benefits.

3 For decades, this interpretation has enjoyed real world application and IRS approval. For example, in a prior year a plan sponsor froze benefits in its plan due to difficult financial times. But, in February 2012, after its books are closed and revenues and expenses are tallied, the plan sponsor decides it can afford to provide some level of benefit accruals for its employees for 2011. Until this new position was taken by the IRS, the plan sponsor could have amended its plan as late as March 15, 2012 to create 2011 benefit accruals and recognize the cost as a 2011 1 The Gray Book contains a series of Q &A s that are developed by the employee benefits specialists at the IRS in response to questions suggested in advance by actuaries attending the annual Enrolled Actuary s Meeting.

4 Many of the questions are technical and/or fact specific, but in general they are intended to help actuaries and plan advisors deal with gray areas of the pension laws that need further guidance. 2 IRC 412(d)(2) was initially found Under IRC 412(c)(8). It was moved to 412(d)(2) when the Pension Protection Act of 2006 became law, but the wording remains the same. Main 15725 SW Greystone Court, Suite102 Toll Free Beaverton, OR 97006-6016 Fax expense. In response to Question 4 in the 2011 Gray Book, the IRS now takes the position that this kind of Retroactive application of an amendment is no longer possible. This change of position has not gone unnoticed or unchallenged by the private pension industry. The American Society of Pension Professionals & Actuaries, ASPPA, sent a letter in July of 2011 to the Department of the Treasury to express its concerns3.

5 The ASPPA letter points out the conflict between the position stated in the IRS answer to Question 4 and both the clear reading of the statute and nearly 40 years of statutory interpretation by the IRS. In essence, ASPPA asks the Treasury, Do you know what your guys are doing? By what authority are they rendering meaningless the statutory language in 412(d)(2)? As noted above, Gray Book answers are generally intended to answer highly technical and fact specific questions. A logical question then is how much authority, if any, does an answer to a Gray Book question carry? Should pension plan advisors, attorneys, and actuaries take a Gray Book answer as an official IRS position? Can we be certain the answer has gone through the same chain of review and sign off by the appropriate staff at the IRS and Treasury as other pronouncements?

6 Each Gray Book answer contains the following caveat: The above Response [Answer] is a summary, prepared by representatives of the Program Committee, of the oral responses to the question posed to certain staff members of the Treasury and IRS which represent only personal views of the individuals who provided them. Accordingly, the Response does not necessarily represent the positions of the Treasury or the IRS and cannot be relied upon by any taxpayer for any purpose. Apparently then, each answer or response represents only a personal view of one or more involved individuals at Treasury and/or the IRS and may not be relied upon by any of us. Nonetheless, the IRS takes its Gray Book answers seriously. One of our clients terminated its defined benefit plan and submitted the plan for a determination letter.

7 Initially, the IRS challenged the proposed termination because the employer had elected a 412(d)(2) Retroactive application of a plan amendment to increase benefits as part of the termination. Fortunately, the plan year in question was before the new IRS position took effect, so the agent backed off, but the position he was directed to take was consistent with the answer to Question 4, not the historical application of statutory language in 412(d)(2). This is not the first time that the IRS has introduced something controversial via the Gray Book. Almost every year the Gray Book contains a surprise or two, and occasionally the IRS will adjust its position in response to practitioners comments. However, it has been the author s experience that unless and until the position stated in an answer is changed or revoked, the position does reflect current IRS thinking on a particular matter.

8 So, to the question, Did the IRS position on IRC 412(d)(2) change? the answer appears to be yes, at least for now. Left unanswered is an equally important question: Does their new position correctly apply the law? Stay tuned. 3 The letter can be found at Vault/pdfs/GAC/2011/08312011 Main 15725 SW Greystone Court, Suite102 Toll Free Beaverton, OR 97006-6016 Fax EXCERPT FROM 2011 GRAY BOOK QUESTION 4 Funding: When to Reflect a plan amendment Adopted Within 2 Months After Year End The final 430 regulations provide that a plan amendment is reflected in FT and TNC if adopted no later than the valuation date for the plan year. In the case of an amendment adopted after the valuation date, the amendment is reflected in FT and TNC if the plan administrator makes the election in 412(d)(2).

9 However, in both cases, the amendment is taken into account only if it takes effect on or before the last day of the plan year. Assume a discretionary amendment ( , an amendment that is neither required for qualification nor integral to an amendment that is required for qualification) is adopted within the 412(d)(2) period of 2 months after the end of the prior plan year to increase the benefit formula for prior service for all participants that worked at any time during the prior plan year. If the plan administrator makes the 412(d)(2) election, can the amendment be reflected in FT and TNC? Does the answer depend on whether a 436 contribution is required? On whether plan operations had actually reflected the amendment in the prior year? On whether the amendment is reflected for coverage and nondiscrimination purposes?

10 RESPONSE In this situation the amendment is only reflected if it is adopted and takes effect by the end of the prior plan year. In general, if a discretionary amendment is adopted after the plan year that provides for increases in the prior year, there is no legal right to the increased benefits until adoption. Such an amendment takes effect when adopted (assuming 436 permits), and could be taken into account for the adoption year if a 412(d)(2) election is made for that year. If a discretionary amendment is implemented operationally during a plan year (thus creating a legal right in the plan year) adoption is required by the end of that plan year [see Rev. Proc. 2007 44]. Any corrective amendment that meets the requirements of (a)(4) 11(g) that is adopted after the end of the plan year is treated as being effective in the year preceding the year the amendment is adopted for purposes of coverage and nondiscrimination, but that treatment will not apply for minimum funding (or deductions) as noted above.