Fifth Circuit upholds conservative actuarial assumptions for pension plan contributions.

Vinson & Elkins, a large law firm, established qualified individual defined-benefit pension plans for its partners.

With a defined-benefit plan, 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 must be applied. Internal Revenue Code section 412(c)(3) requires these assumptions to be "reasonable"--either individually or collectively. Further, they must, as a whole, represent the actuary's "best estimate" of anticipated plan experience.

The Vinson & Elkins actuary used conservative estimates to calculate plan contributions. For instance, the actuary assumed a 5% annual return on plan assets and a retirement age of 62 and used conservative mortality tables. As a result, greater funding amounts and deductions were required. For 1986 and 1987, Vinson & Elkins contributed and deducted $10.8 million and $5.1 million, respectively.

The IRS disallowed about 80% of these amounts on audit, arguing Vinson & Elkins's actuarial assumptions were too conservative and therefore unreasonable.

In a big win for the taxpayer, the Tax Court upheld the assumptions as reasonable. The decision was appealed to the Fifth Circuit.

Result: For Vinson & Elkins. The Tax Court was correct in saying the actuarial assumptions were reasonable.

* Vinson & Elkins (5th Cir., 1994).