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Score one for small pension plans.

A Ninth Circuit Court of Appeals decision has held that an employer's conservative actuarial assumptions used in determining the amount of deductible contributions to an individual defined benefit plan were reasonable.

This is the fourth in a series of appellate-level decisions on individual defined benefit plans. Unlike the previous decisions, this one does not deal with plans maintained by law firms. Instead, the case was a consolidation of 12 businesses' petitions to the Tax Court seeking reversal of Internal Revenue Service audit findings.

Before this case, the Fifth Circuit Court of Appeals 1993 decision in Vinson & Elkins (see JofA, Feb.94, page 29) and the Second Circuit Court of Appeals 1994 decision in Wachtell, Lipton, Rosen & Katz both upheld conservative actuarial assumptions used by law firms in contributing to individual defined benefit plans. Both of the cases were appeals from Tax Court decisions.

The Sixth Circuit Court of Appeals decision in Rhoades, McKee & Boer (see JofA, Apr.95, page 23) was in the IRS's favor. The Court decided that two of the actuarial assumptions used by the law firm in determining contributions to individual defined benefit plans were in fact unreasonable. The Sixth Circuit also found that the "substantially unreasonable" test - the standard developed by the Tax Court and used by the district court in Rhoades, McKee to uphold conservative actuarial assumptions - was wrong because it granted more deference to actuarial assumptions than was intended under the statute.

For a defined benefit plan, an 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 made about the participants' retirement age, interest rates before and after retirement and the mortality tables to be used, for example. Naturally, more conservative assumptions will require larger contributions to produce the intended benefit.

Internal Revenue Code section 412(c)(3) requires these actuarial assumptions be "reasonable" as a whole. Further, the assumptions must represent the actuary's "best estimate" of anticipated plan experience.

In the past few years, the IRS has audited small defined benefit plans and denied contribution deductions based on the claimed unreasonableness of conservative actuarial assumptions. Three of these disputes were heard by the Tax Court as test cases.

In the most recent case, the IRS audited the individual defined benefit plans of 12 businesses and challenged the conservative actuarial assumptions used to compute deductible contributions. The IRS claimed the assumptions did not meet the reasonable standard of section 412(c)(3). The 12 businesses petitioned the Tax Court and the cases were consolidated. The Tax Court ruled in the businesses' favor saying the assumptions were reasonable. The IRS appealed to the Ninth Circuit.

Result: For the taxpayers. The Ninth Circuit affirmed the Tax Court decision, with a few minor exceptions. The assumptions made by the actuaries satisfied the standards of the code. * (9th Cir., 1995).
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Author:Wagenbrenner, Anne
Publication:Journal of Accountancy
Date:May 1, 1995
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