Rev. Rul. 69-159

Section 1. Purpose

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the positions set forth in PS No. 67, dated April 26, 1951. This ruling deals with the application of the limitations on deductions, under section 404(a)(1) of the Internal Revenue Code of 1954, for contributions under qualified pension or annuity plans established pursuant to union negotiated contracts that terminate upon the expiration of a stated period of time including those plans that use the so-called "terminal funding" method.

Sec. 2. General

.01 An employer's contributions under a qualified pension trust or annuity plan are deductible under section 404(a) of the Code, subject to the conditions and limitations contained in that section. In general, the employer may deduct, under section 404(a)(1)(A) of the Code, an amount not in excess of five percent of the compensation otherwise paid or accrued during the taxable year to all employees under the trust, if that amount is not more than is reasonably necessary to provide the remaining unfunded cost of past and current service credits for the employees. In addition, the employer usually may deduct, under section 404(a)(1)(B) of the Code, any excess over the amount allowable under section 404(a)(1)(A) that is necessary to provide the remaining unfunded cost of the covered employees' past and current service credits distributed as a level amount, or a level percentage of compensation, over the remaining future service of each employee. In lieu of the above amounts, the employer may deduct, under section 404(a)(1)(C) of the Code, an amount equal to the normal cost of the plan plus an amount not in excess of ten percent of the cost necessary to fund any past service or supplementary pension or annuity credits provided for the employees under the plan.

.02 The terminal funding method is a method whereby employer contributions under a plan are based upon the costs of benefits for employees who are actually being retired under the plan. The limitations of section 404(a)(1) of the Code are not affected by the use of the terminal funding method. In all cases, including those using this method, the limitations are, however, dependent upon the non-deferred compensation of employees covered under the plan, or the costs with respect to employees covered under the plan, or both. Therefore, in determining these limitations, there must first be a determination of which employees are considered covered under the plan. In making these determinations the principles set forth in sections 3 through 6 of this ruling, and illustrated in section 7, will generally be applicable.

Sec. 3. Employees Covered Under Plan

The plan may be assumed to be a permanent and continuing program, and all employees who could eventually qualify for benefits in the event of the plan's continuance may be considered covered by the plan (unless the provisions of the plan or union agreement or other collateral document define a narrower group of employees as "covered" or "eligible") if all of the following conditions exist:

.01 There is no provision in the union agreement or in any separate document describing the plan or in any collateral document which requires discontinuance of, or shows intent to discontinue, the plan or employer contributions to it at any stated or definitely determinable time. The general right to discontinue the plan or contributions thereto at any (indefinite) time in the future may be reserved just as in any other type of plan and will not of itself prevent the plan from being considered a permanent program.

.02 There is either (a) a separate document or booklet describing the plan in such form as to indicate a permanent and continuing program, or (b) a board of directors resolution or other action by those empowered to establish the plan, made known to employees generally, setting forth the intention of the employer to establish and continue the plan on a permanent basis. Such resolution or other action may be made subject to a general reservation of right to discontinue as described in subsection .01 above.

.03 There is an explicit provision for liquidation in the event of termination of the plan so that available funds will be applied to contingent as well as actual liabilities under the plan. Available funds may first be applied to the liabilities with respect to retired employees and those eligible to retire at the time of termination, provided this does not result in the discrimination prohibited by section 401(a)(4) of the Code, but any remaining funds must be used in a non-discriminatory manner for the benefits accrued under the plan for other employees who are considered covered thereunder.

Sec. 4. Effect of Termination or Curtailment

Where a plan is considered to be a permanent and continuing program in accordance with the above, a subsequent termination or curtailment of it will make its qualification under section 401(a) of the Code subject to review in accordance with the principles set forth in Revenue Ruling 69-24, page 110, this Bulletin.

Sec. 5. Termination at End of Specified Period

Where the union agreement or separate document describing the plan or other collateral document provides for the termination of the plan or employer contributions thereto at the end of a specified period, or where funds remaining after providing for the pensions of employees who are eligible to retire at the time of termination may revert to the employer or be used for purposes other than benefits accrued under the plan for the employees covered thereunder, the plan will be considered to cover only the employees who can become eligible to retire under its terms during the period for which its continuance is specifically provided. This will apply to determinations under section 401(a) of the Code as well as under section 404(a) of the Code, but does not necessarily mean that the plan will fail to qualify under section 401(a), if the limited duration will not result in prohibited discrimination.

Sec. 6. Termination at Any Time

If a plan provides that it may be terminated at any time and that any funds remaining after the provision for all liabilities for pensioners and for those who satisfy the requirements for retirement at the time of termination may revert to the employer or be used for other purposes, the plan will generally be considered to cover in any taxable year only the employees who could retire under the terms of the plan by the end of the taxable year. If such a plan is actually terminated during a taxable year, however, only those who became eligible for retirement prior to termination will be considered covered.

Sec. 7. Application of Principles

The application of the aforesaid principles is illustrated by the situations and conclusions set forth below.

.01 An employer is committed, under a union negotiated contract that is to terminate at the end of five years, to establish a pension plan and to provide fixed benefits, commencing upon retirement at age 65 or thereafter, for all employees who are union members and have at least 15 years of service. The contract does not limit the duration of the plan. The document setting forth the plan recites that it is established as a continuing and permanent program and the plan has been found to meet the requirements of section 401(a) of the Code. The annual compensation of all union members under the plan is $1,000,000 and the annual compensation of those who may retire within the term of the contract is $100,000. The annual contribution is $40,000. Held, the $40,000 does not exceed the limit under section 404(a)(1)(A) of the Code, as applied to the compensation of $1,000,000, and is deductible in full.

.02 The facts are similar to those in subsection .01 above, except that provision is made for termination of the plan upon expiration of the union contract and for a reversion to the employer of any funds then remaining after providing for all liabilities to pensioners and those who may satisfy the requirements for pensions at such time. Held, no more than $5,000 would be deductible under section 404(a)(1)(A) of the Code. The deduction, however, is not limited to a determination under section 404(a)(1)(A). If, for example, the past service liability with respect to employees who may retire within the contract period is $200,000 and the normal cost for such employees is $5,000, the deduction under section 404(a)(1)(C) would be $25,000, that is, 10 percent of $200,000 plus $5,000.

.03 An employer's contract requires him to contribute 10 cents per hour worked by all employees within a bargaining unit represented by the union. The contributions must be used for the benefit of such employees and under no circumstances can there be any reversion to the employer. The contract is for a five year period and the plan is established to run concurrently therewith and indefinitely thereafter, as indicated by the separate plan document. Fixed benefits are provided upon retirement after a stated period of service. The plan has been found to meet the requirements of section 401(a) of the Code. The employer certifies that actuarial computations show that (a) the contributions are sufficient to provide the full costs of the prospective pensions for employees expected to retire under the plan during the five year period, and (b) such contributions are also sufficient to meet the normal costs and interest accruing on the unfunded past service liability for all employees in the bargaining unit. The employer also certifies that he accepts as reasonable the methods and assumptions used in such computations and the results thereof. The past service liability under section 404(a)(1)(C) of the Code for all employees in the bargaining unit is $1,000,000 and $400,000 for those who may retire within the five year period. The normal cost is $50,000 for all and $10,000 for those in the five year group. Held, the deduction under section 404(a)(1)(C) is limited to $150,000, that is, 10 percent of $1,000,000 plus $50,000 for normal cost.

.04 A pension plan was established pursuant to a union contract that is to terminate at the end of five years. The employer is required to contribute during each of the five years an amount equal to at least 20 percent of the cost of life annuities of stated amounts for all retiring employees during the particular year who reach age 65 and have 25 years of service and proportionate annuities for those who have at least 15 years of service but less than 25. No cut-off period is mentioned in the plan and all communications pertaining thereto recite that it is established on a continuing and permanent basis. The plan has been found to meet the requirements of section 401(a) of the Code. Under the method of funding adopted by the employer annual contributions are made equal to the normal cost and amortization of the total past service liability on a 30-year basis for all union employees regardless of age. For the first year of operations, the normal cost and applicable portion of the past service cost, computed on such basis, amounted to $75,000. Such amount was contributed by the employer although no employee reached the retirement age and retired during that year. Held, the full amount of $75,000 is within the limits of section 404(a)(1)(C) of the Code as applied to all union employees and is deductible.

.05 The facts are similar to those in subsection .04 above except provision is made that, after taking care of all liabilities to pensioners upon the expiration of the contract period, any remaining funds are to revert to the employer. The payroll of union employees who are 60 years of age and older and will have at least 15 years of service at the expiration of the contract period is $100,000. The past service liability with respect to such employees is $200,000 and the normal cost is $5,000. Held, the maximum allowable deduction is $25,000, that is, 10 percent of $200,000 plus $5,000, notwithstanding the fact that $75,000 was contributed.

.06 A plan established pursuant to a union contract requires the employer to continue contributions to the plan on a specified minimum basis for the period of the contract, five years. The plan provides that the employer may discontinue contributions at any time after the expiration of the contract and, in the event of such discontinuance, no employee who has not already become eligible for a pension by that time may thereafter become eligible for any benefits under the plan. The plan is funded through a trust that also holds the funds of another plan of the employer. The other plan covers only employees who are not covered by the union plan. Any funds remaining from contributions to the union plan after providing for the pensions of union employees who become eligible for retirement thereunder prior to discontinuance will remain in the trust to meet liabilities under the other plan and may revert to the employer after the satisfaction of all such liabilities. Held, only the employees who can become eligible for retirement under the union plan during the five-year period for which the employer is committed to continue it will be considered covered by such plan for the purpose of determining the costs thereof and the limitations under section 404(a) of the Code during the first five years. Held further, if the union plan is continued beyond the five-year period, the only employees who may be considered covered thereunder after the end of the five-year period are those who could become eligible for retirement under its terms by the end of the taxable year involved, unless the plan is terminated sooner in which case only those who became eligible before termination will be considered covered.

Sec. 8. Effect on Other Documents

PS No. 67 is hereby superseded since the positions set forth therein are incorporated in this Revenue Ruling.

¹ Prepared pursuant to Revenue Procedure 67-6, C.B. 1967-1, 576.