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IRS penalty tax ruling may provide trap for unwary tax-exempt employers.

The IRS recently addressed the application of the 10% excise tax imposed by Sec. 4972 on nondeductible contributions made by an employer to a qualified plan. In Letter Ruling 9236026, a controlled group, comprised of both tax-exempt and nonexempt companies, maintained a qualified pension plan. Because the controlled group contained at least one nonexempt employer, the entire controlled group was considered a nonexempt organization for purposes of Secs. 404 and 4972. Therefore, contributions that exceeded the Sec. 404 deduction limit and were made by a tax-exempt member of the controlled group were subject to the Sec. 4972 excise tax.

Sec. 4972 imposes a 10% excise tax on the amount of nondeductible contributions made to a "qualified employer plan."An exemption from this tax is provided at Sec. 4972(d)(1)(B) for "always exempt" employers. However, the legislative history indicates that even plans that have been exempt at all times may not qualify for the exemption from the excise tax if the employer has unrelated business taxable income (UBTI) or has otherwise derived a tax benefit from the qualified plan. Although plan administrators and employers were aware of this exception for UBTI, many may be surprised to find the IRS extending the exception to a controlled group with nonexempt members.

Sec. 414(b)provides that employees of all corporations that are members of a controlled group will be treated as employed by a single employer. Sec. 414(b) further provides that, for a plan adopted by more than one such corporation, the applicable limitations provided by Sec. 404(a) (i.e., the limitations on deductions for contributions to employer plans) are determined as if all such employers were a single employer. Therefore, in order for the controlled group to be considered an exempt organization, each and every member of the controlled group must be an exempt employer.

The facts in the letter ruling involved a nonexempt company and three related tax-exempt corporations that formed a controlled group within the meaning of Sec. 414(b). The plan, which had reached its full funding limitation, was maintained by all members of the controlled group, all of which had employees who were covered under the plan. Because the controlled group contained at least one nonexempt employer, the entire controlled group was considered to be a nonexempt organization for Secs. 404 and 4972 purposes. Because the controlled group was a nonexempt organization, the plan to which members of the controlled group contributed was not entitled to the exemption under Sec. 4972. Therefore, although there is no prohibition against a tax-exempt employer making contributions to the plan in these circumstances, the Service held that any such contribution would be nondeductible and subject to the excise tax of Sec. 4972, whether or not the employer generated UBTI.

IRS personnel involved in this ruling have indicated informally that, although it is far from clear in the ruling, the Service would not apply the same analysis to a controlled group situation in which the employees of the taxable entity were not covered by the plan. Apparently, the IRS feels that there is no opportunity to "derive a tax benefit" in that circumstance.

Another point left open by the ruling is whether the Service would reach the same conclusion as to the Sec. 4980 reversion excise tax. In reaching its conclusion on the Sec. 4972 excise tax, the IRS relied on the language in Sec. 414(b) that applies the Sec. 404 limits on a controlled group basis when a plan is adopted by all employers in the controlled group. No .such controlled group rule is specifically provided in either Sec. 414(b) or 4980 with respect to the reversion excise tax. Nonetheless, the Service has reached the conclusion that the reversion tax would also apply to the controlled group. From Ruth M. Wimer, CPA, Elizabeth N. Buchbinder, Esq., and Lorraine Bell, CPA, Washington, D.C.
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Author:Bell, Lorraine
Publication:The Tax Adviser
Date:Jan 1, 1993
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