IRS properly assessed tax and penalties on employer that improperly calculated annual benefit limit

The IRS properly assessed tax deficiencies and penalties on an employer that improperly calculated the annual benefit limitation, resulting in nondeductible contributions, according to the U.S. Court of Appeals in St. Louis (CA-8). The court affirmed the Tax Court’s ruling that the method used by the IRS for determining the annual benefit limit accorded with general actuarial practices.

Incorrect calculation of annual benefit limit

Pizza Pro maintained a defined benefit (DB) pension plan. The IRS determined that from 2002-2006 the company incorrectly calculated the annual benefit limit under Code Sec. 415 and, therefore, made nondeductible contributions to the plan. As a consequence, the IRS assessed a tax equal to 10% of the nondeductible contributions and additional tax for failure to file a return of excise tax and to timely pay the excise tax owed.
The Tax Court affirmed the determination of the IRS. The court also concluded that the company did not make a valid election under Code Sec. 4972(c)(7), which allows a taxpayer to disregard contributions to a DB plan under certain conditions.

IRS determination accorded with actuarial practice

On appeal, the employer maintained that the plan’s annual benefit never exceeded the applicable limitation. Under Code Sec. 415(b)(2)(C), in the event a retirement benefit begins before age 62, the applicable DB limit ($160,000) must be reduced so it is “equivalent” to the annual benefit maximum beginning at age 62.
According to the employer, the Tax Court erred in interpreting the reference in Code Sec. 415(b)(2)(C) to an equivalent benefit as an “actuarially equivalent” benefit. The Tax Court relied on IRS Reg. §1.415-3(e), which states that a plan benefit beginning before normal retirement age must be adjusted to the actuarial equivalent of a benefit beginning at normal retirement age. However, because IRS Reg. §1.415-3(e) does not define actuarial equivalence, the Tax Court looked to general practices within the field of actuarial science to ascertain the proper method for determining the annual benefit limit. Relying on a report prepared by an IRS actuary, the Tax Court concluded that the Agency’s method accorded with actuarial practices.
The Eighth Circuit found the Tax Court’s position to be well reasoned and without clear error. Accordingly, the deficiencies and additions to tax were upheld.

Election to disregard contributions

The appeals court also affirmed the Tax Court’s ruling that the employer failed to make a valid election under Code Sec. 4972(c)(7) to disregard the DB plan contributions. The employer did not make an election, but relied on the recommendation of actuarial advocacy groups that the mere failure to file the required excise tax form should be considered sufficient evidence of an election. The court, however, concluded that because the employer failed to inform the IRS in any manner of its intentions, it actually failed to make an election.

Source: Pizza Pro Equipment Leasing, Inc. v. Commissioner of Internal Revenue (CA-8).
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