Rev. Rul. 67-116

Advice has been requested concerning a method of determining the limit on deductions provided by section 404(a)(1)(C) of the Internal Revenue Code of 1954 for contributions to an employees' exempt pension trust. Such method automatically adjusts the limit on deductions to reflect "gains" or "losses" on a cumulative basis.

An employer established an employees' pension plan and trust which meets the requirements of section 401(a) of the Code and is exempt under section 501(a) of the Code. The employer used the "entry age normal" method to compute the normal cost and past service cost (accrued liability). Under this method, annual (or normal) costs are determined as a level percentage of payroll as indicated in section 1.404(a)-6 of the Income Tax Regulations. The excess of the present value of projected benefits over the present value of current and future normal costs is treated as past service cost. Deductible limits under the plan are determined under section 404(a)(1)(C) of the Code.

As noted in Revenue Ruling 59-153, C.B. 1959-1, 89, section 1.404(a)-3(b) of the Income Tax Regulations states in part, that, in any case, in determining the costs and limitations, an adjustment shall be made on account of any experience more favorable than that assumed in the basis of limitations for prior years. Unless such adjustments are consistently made every year by reducing the limitations otherwise determined by any decrease in liability or cost arising from experience in the next preceding taxable year which was more favorable than the assumptions on which the costs and limitations were based, the adjustment shall be made by some other method approved by the Commissioner. Such decreases in liability or cost are generally referred to as "gains." The occurrence of "gains" indicates that previous costs were overestimated. If the factors and assumptions used as a basis for determining costs and deductible limits in prior years are acceptable, the adjustment for "gains" required by the regulations takes the place of a retroactive revision of costs and deductions for prior years, which would otherwise be required when "gains" arise. However, an adjustment for gains is satisfactory for this purpose only when the costs are based upon acceptable factors and assumptions. An adjustment for gains would not be sufficient to correct for overestimation of costs where the factors and assumptions are not acceptable, and would not meet the requirement of section 1.404(a)-3(b) of the regulations that costs for the purpose of section 404(a)(1) of the Code shall in no event exceed costs based on reasonable assumptions and methods.

Revenue Ruling 59-153, above, sets forth an acceptable method of adjusting for gains under a pension plan where costs are determined under the entry age normal method, as in the present case. (Except where noted, the terminology used herein has the same meaning as in Revenue Ruling 59-153.)

In lieu of the method of adjusting for gains outlined in Revenue Ruling 59-153, the method outlined below may, in appropriate cases, be used to compute the deductible limit, as adjusted for gains on a cumulative basis. Under this method, so long as the assumptions used to determine the plan costs are reasonable, gains need not be separately determined, but are reflected in the special 10-percent base. The special 10-percent base automatically decreases (increases) each year by the amount of the discounted value of the current gain (loss). The method of computing the special 10-percent base is set forth in Revenue Ruling 59-153.

The deductible limit, after adjusting for gains, is computed as follows:

(1) Special 10-percent base.

(2) Number of years plan has been in effect as of valuation date.

(3) Sum of all prior deductible contributions toward past service cost including interest on unfunded past service cost (item (10), below, of prior year).

(4) Special limit (10 percent of item (1) times item (2), less item (3)).

(5) Unfunded past service cost at valuation date, plus interest on such cost while unfunded within the year.

(6) Normal cost, including interest on any unfunded portion of such cost within the year.

(7) Smaller of 10 percent of item (1), and item (4).

(8) Deductible limit (item (6) plus item (7), but not more than item (5) plus item (6)).

(9) Currently deductible contribution toward past service cost including interest on unfunded past service cost (smaller of current contribution and item (8), less item (6)).

(10) Sum of all deductible contributions toward past service cost including interest on unfunded past service cost (item (3) plus item (9)).

The use of this method of computing the deductible limit, including the adjustment for gains, is reasonable in plans where the employer's liability has not been substantially increased. Where the employer's liability has been substantially increased, as, for example, by plan amendment, a further adjustment will generally be required in applying the method outlined above. If, in a given year, assets include any prior contributions which have not yet been deducted, that fact would require an appropriate modification of the foregoing method.

Accordingly, where plan costs are determined by the entry age normal method, the foregoing constitutes an acceptable method of computing deductible limits, including the adjustment for gains, under section 404(a)(1)(C) of the Code, if used consistently and if, as noted above, the employer's liability has not been substantially increased.