ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in Missouri focused on a plan reversion penalty. The advisor asked: “I’m working with a nonprofit organization with an overfunded defined benefit plan. The sponsor is terminating the plan and wants to know if the overfunding can revert to the nonprofit and, if so, would it be subject to a penalty?”
Highlights of the Discussion
As with any case involving tax issues, the nonprofit organization should seek professional guidance from a tax professional for its unique situation. Generally speaking, based on the Internal Revenue Code (IRC), at least one tax court case and several private letter rulings (PLRs),[1] a nonprofit organization meeting certain criteria that terminates an overfunded defined benefit plan could receive the reversion and would not be subject to the usual penalty tax on reversions from a qualified retirement plan under IRC Sec. 4980. Further, if the nonprofit entity was exempt from tax under IRC Sec. 501(c)(3), never had unrelated business taxable income, and at no time deducted any amounts contributed to the plan from unrelated business taxable income, the reversion would not be includable as income as unrelated business taxable income (PLR 200222035).
A reversion is the amount of cash and property an employer receives, directly or indirectly, from a qualified plan [IRC Sec. 4980(c)(2)(A)]. A tax rate of 50% applies to an employer reversion unless the employer establishes a qualified replacement plan before receiving the reversion, in which case the tax is reduced to 20% [IRC Sec. 4980(d)].
The excise tax is imposed only on employer reversions from "qualified plan[s].” The term qualified plan means any plan meeting the requirements of IRC Sec. 401(a) or 403(a), other than a plan maintained by an employer if such employer has, at all times, been exempt from tax under subtitle A [IRC Sec. 4980(c)(1)(A)].
Conclusion
The nonprofit entity should work with a tax advisor to review its case in particular and document its findings. There is authority for nonprofit entities to avoid the reversion tax associated with the receipt of cash and property from an overfunded defined benefit plan.
Any information provided is for informational purposes only. It cannot be used for the purpose of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.
©2023, Retirement Learning Center, LLC. Used with permission.
