Comments on revenue ruling 90-105: timing of deduction for section 401(k) contributions December 20, 1990.

Comments on Revenue Ruling 90-105: Timing of Deduction for Section 401(k) Contributions

On behalf of Tax Executives Institute, I am pleased to submit the following comments on Rev. Rul. 90-105, 1990-52 I.R.B. 1, which was issued by the Internal Revenue Service on December 7, 1990.

The Institute's Federal Tax Committee is in the process of analyzing the ruling -- which relates to the timing of deductions for amounts contributed under cash or deferred arrangements under section 401(k) -- and TEI may submit additional substantive comments at a later date. The purpose of this letter is not to focus on the substance of Rev. Rul. 90-105 -- the applicability of section 404(a)(6) to such contributions -- but rather to object to the ruling's effective date. Specifically, assuming Rev. Rul. 90-105 is not withdrawn in its entirety, TEI recommends that the ruling apply only with respect to taxable years beginning after December 7, 1990 -- the release date of Rev. Rul. 90-105.

Background

Rev. Rul. 90-105 holds that contributions to a qualified cash or deferred arrangement within the meaning of section 401(k) or to a defined contribution plan as matching contributions within the meaning of section 401(m) are not deductible by the employer for a taxable year if those contributions are attributable to compensation earned by plan participants after the end of that taxable year; this holding applies, moreover, without regard to whether section 404(a)(6) deems the contributions to have been paid on the last day of that taxable year and without regard to whether the employer uses the cash or accrual method of accounting.

On its face, the holding of Rev. Rul. 90-105 applies on a prospective basis: the requirement that taxpayers change their method of accounting for section 401(k) elective deferrals and section 401(m) matching contributions is effective for contributions that are deducted on returns filed on or after December 7, 1990, the release date of Rev. Rul. 90-105. The revenue ruling provides that the change in method is to be implemented on a "cut-off" basis, without any section 481(a) adjustment.

Prospective treatment under Rev. Rul. 90-105 is conditioned on taxpayers notifying the IRS that they are changing their method of accounting on their first return filed after December 7, 1990. If such a notice is not provided, then the IRS can require the taxpayers to change its method of accounting in the earliest open year on a cut-off basis, without any section 481(a) adjustment. Announcement 90-144A (issued December 14, 1990) provides an amended return "window" in respect of taxpayers filing their first post-December 7, 1990, return before December 18, 1990; those taxpayers may secure the benefit of Rev. Rul. 90-105's nominal prospectivity if they file an amended return (consistent with the ruling) before January 16, 1991.

The Ruling's Retroactive 

and Arbitrary Results

The nominal prospectively of Rev. Rul. 90-105, however, dissipates when the ruling is scrutinized. The ruling's holding applies with respect to contributions actually paid after December 31, 1989, except to the extent that such contributions were deducted on a return filed before December 7, 1990. In other words, the ruling clearly looks backward and applies with respect to timely filed returns for taxable years ending as early as March 31, 1990 -- nearly nine months before its issuance.

More fundamentally, a rule tied to when tax returns are filed can produce arbitrary and inequitable results in respect of similarly situated fiscal-year taxpayers that serendipitiously file their returns on different days. Consider, for example, two taxpayers whose 1989 taxable years both ended on June 30 and whose elective deferals and matching contributions are identical, but which filed their returns respectively on December 6, 1990, and December 7, 1990. The taxpayer that filed its return on December 6 would be permitted to claim a significantly higher tax deduction for its 1989 taxable year than could the taxpayer that filed its return on December 7.

Thus, Rev. Rul. 90-105 will capriciously penalize taxpayers based on when they file their returns. A txpayer that secures an extension of time to file its return pursuant to section 6081 and files by the extended due date (but on or after December 7) will be subjected to a different, harsher substantive result than an identically situated taxpayer that filed its return before December 6. TEI believes it is improper to penalize taxpayers for availing themselves of their statutory right to obtain an extension of time in which to file their returns.

Finally, the requirement that a taxpayer change its method of accounting on its first post-December 7, 1990, return in order to secure the benefit of Rev. Rul. 90-105's nominal prospectivity can unduly penalize a taxpayer that does not become aware of the requirement before that return is filed. Concededly, most large corporate taxpayers have the knowledge and wherewithal to reflect the ruling in their first post-December 7, 1990, return (or to absorb the cost and burden of preparing and filing an amended return in accordance with Announcement 90-144A (1)).

In tying the effective date of the ruling to its release date, however, the IRS erroneously assumed that all taxpayers can and will almost instantaneously become aware of, and be able to act upon, the ruling. (The ruling will not even be published in the Internal Revenue Bulletin until December 24, 1990). Thus, under the ruling, the IRS could require a small or medium-sized corporation whose 1989 fiscal year ended September 30, 1990, and that obtains a six-month extension but nevertheless files its return on December 18, 1990 -- only one day after the original due date -- to change its method of accounting in the earliest open year (at least three and possibly more years in the past). Had the taxpayer filed its return on or before the original due date, however, the year of change would be 1990 (for the return filed in 1991). To our mind's eye, such a harsh and incongruous result cannot be justified on tax policy or tax administration grounds.

Recommendation

A more equitable approach would be to make the ruling effective for taxable years beginning after December 7, 1990. Such an approach would be consistent with the principle that, absent a compelling reason, rulings unfavorable to taxpayers should generally be applied on a prospective-only basis. Prospectivity is especially proper in light of the IRS's issuance of Rev. Rul. 76-28, 1976-1 C.B. 106, and a subsequent private letter ruling -- Letter Ruling No. 8822104 (March 14, 1988) -- which led taxpayers to deduct section 401(k) elective deferrals and section 401(m) matching contributions attributable to compensation earned after the end of the year. Taxpayers relied on the rationale set forth in the published and private rulings, made plans based on that rationale, and should not be penalized by the IRS's change of position. (2)

A truly prospective application of Rev. Rul. 90-105 would have obviated the need for Announcement 90-144, and the Supplement to Announcement 90-144, and Announcement 90-144A (which superseded the Supplement), which relate to the estimated tax and late payment penalties. Indeed, we submit that the impropriety of the December 7 "returns filed" rule is underscored by the slap-dash nature in which the IRS issued the revenue ruling and then rushed to issue three clarifications/modifications/explanations in less than a week.

For the foregoing reasons, TEI recommends that the IRS revise Rev. Rul. 90-105 to shift from a "returns filed" to a "taxable years" effective date provisions. Such a change would not only treat taxpayers evenhandedly, but would also more effectively encourage taxpayers to come "on side" in respect of the substantive rule set forth in the ruling. (3)

Conclusion

TEI appreciates this opportunity to present its views on the effective date of Rev. Rul. 90-105. If you should have any questions about our position, please do not hesitate to call either Lester D. Ezrati, chair of the Institute's Federal Tax Committee, at [phone] or TEI's professional staff (Timothy J. McCormally or Mary L. Fahey) at (20) 638-56011990.

(1) The preparation and filing of an amended return, however, is not a simple or inexpensive task. The taxpayer must attest that all the facts reflected in the return remain correct, including those completely unrelated to the item triggering the filing of the amended return. Even if the period between the filing of the original and amended returns is only 39 days (the longest such interregnum sanctioned by Announcement 90-144A), the responsibility is not one the taxpayer can lightly shirk. The burden could be substantially reduced by the IRS's developing a "short-cut" procedure, perhaps along the lines of the "qualified amended return" procedure set forth in Rev. Proc. 85-26, 1985-1 C.B. 580, in respect of taxpayers that are subject to the Coordinated Examination Program.

(2) TEI recognizes that taxpayers have no statutory right to rely on private letter rulings issued to other taxpayers. Having recognized the need for some prospectivity (presumably on the ground that taxpayer had some justification -- by virtue of the private ruling's interpretation of Rev. Rul. 76-28 or otherwise -- for taking the position they did), however, the IRS should not deny the full measure of relief to some taxpayers based on when they file their returns.

(3) In choosing to issue guidance in the form of a revenue ruling instead of a proposed regulation, the IRS avoided the question whether the position could be made effective before the expiration of a 30-day notice-and-comment period. (Administrative Procedure Act, 5 U.S.C. [section] 553.) Regardless of the form the guidance takes, however, policy concerns under section 7805(b) should lead the IRS to develop a truly prospective rule. Moreover, inasmuch as Rev. Rul. 90-105 will not appear in an official publication until December 24, 1990 (when the 1990-50 issue of the Internal Revenue Bulletin is released), we question whether December 7 should properly be considered the ruling's release date. (The effective date of regulations is generally keyed to their publication in the Federal Register.)