On February 17, 2004, the Internal Revenue Service (the “IRS”) published Revenue Procedure 2004–15, superseding Revenue Procedure 94–41, which outlines the updated procedures for obtaining a waiver of the minimum funding standards of Section 412(d) of the Internal Revenue Code (the “Code”) or Section 303 of the Employee Retirement Income Security Act of 1974 (“ERISA”). The updated procedures now include a disclosure requirement for executive compensation arrangements for single employers. A new Appendix B provides a checklist for employers to ensure that their applications are complete.
Although market performance has improved over the last few quarters, the prior three years of market performance have not been kind to investors, employee benefit plans included. Employers whose plans were once well funded are now faced with the possibility of having to make substantial contributions to their defined benefit plans at a time when they might have difficulty finding the available cash to make such a contribution.
Section 412 —
Minimum Funding Standards
In general, Section 412 of the Code requires that all defined benefit plans and certain defined contribution plans (money purchase and target benefit plans) meet certain minimum funding requirements. Employers who sponsor defined benefit plans must fund the retirement benefits earned during each year. This involves complex calculations, which include amortizing past funding liabilities and increased liabilities due to changes in actuarial assumptions or experience gains and losses.
Failure to meet the minimum funding standard on a yearly basis subjects the plan sponsor to an excise tax of 10 percent of the amount of the funding deficiency. If the funding deficiency is not corrected, an excise tax of 100 percent of the uncorrected amount is imposed.
An employer faced with an inability to meet the required minimum contribution to the plan may seek IRS approval for a retroactive amendment to the plan that would reduce benefits, for an extension of the amortization period or for a funding waiver. Of these three options, a funding waiver request is the most common approach.
For those single employers who are suffering a temporary business hardship, which must be substantial, Code section 412(d) allows for a waiver of the minimum funding standard for a particular year. The determination of substantial business hardship is based on the facts and circumstances of each individual application.
Timing is critical if an employer is considering obtaining a waiver. An employer has 10 months from the close of the plan year in order to make the required contribution to the plan. However, the IRS waiver procedure requires that the application be filed no later than 31/2 months after the close of the plan year for which a waiver is sought. Therefore, it is important for plan sponsors to consider the funding needs of their plans well before the expiration of the period in which to apply for a funding waiver.
Request for Waiver:
The Procedure (Defined Benefit Plans)
The information required by Revenue Procedure 2004–15 includes:
- an overview of the employer;
- the employer’s financial records and the nature of the hardship;
- a description of the plan and the plan’s financial records; and
- whether the employer has ever filed for a waiver in prior years.
The IRS looks at the employer’s and plan’s current financial situation to help evaluate what the prospects for recovery from the hardship are and when contributions to the plan can reasonably be expected to resume.
Request for Waiver:
The Procedure (Defined Contribution Plans)
In general, single employers who sponsor defined contributions plans subject to the minimum funding standards of Code section 412 may also apply for a waiver using the same procedures for defined benefit plans. In addition, a defined contribution plan waiver must also comply with Revenue Ruling 78–223. Section 3 of Rev. Rul. 78–223 requires that a defined contribution plan contain certain provisions in order for a waiver to be granted. In order to provide flexibility, a defined contribution plan applicant may file one of three requests:
- waiver without submission of a plan amendment (the IRS will provide sample language to comply);
- waiver ruling with plan amendment (drafted by the plan sponsor); or
- waiver ruling and determination letter request.
The third option requires that the applicant also satisfy the procedures for requesting a determination letter (including appropriate user fees).
Disclosure of Executive Compensation Arrangements
In addition to the criteria described above, Revenue Procedure 2004–15 added a new requirement: employers seeking a minimum funding waiver must now disclose executive compensation arrangements. This rule is not applicable to multiemployer plans. An “executive” is a person who is an officer within the meaning of Section 1.416–1 of the regulations (top heavy provisions) or a director of the applicant employer (or any other aggregated entity).
What must be disclosed? A detailed statement concerning all amounts that have been paid or will be paid to or for the executive’s benefit during the plan year for which the request is made and the immediately preceding two years. Based on the size of the plan population, up to 10 employees will be treated as executives. The employer does not get to choose which 10 employees will be the “executives” for purposes of obtaining the waiver. Those executives with the highest payments (actual or future) during the testing period must be considered. In addition, information must be provided for up to 5 former “executives” if they would be placed in the group of 10 had they still been employed.
The disclosure statement should include all amounts paid as salary, non-qualified deferred compensation, fringe benefits, perquisites and other personal benefits, bonuses and incentive compensation, and equity compensation (stock options, restricted stock). In addition, if any money or property (i.e., company stock) has been set aside in a trust, escrow, insurance or other funding vehicle, then that must also be included, regardless of whether it was included in income. Also included are change in control payments, severance plans, long-term incentive plans, and any other compensation not listed that affects the cash flow of the employer/applicant. This does not include contributions to qualified retirement and health and welfare plans, as long as they do not discriminate in favor of these “executives.”
In addition to submitting the above information to the IRS, the employer/applicant must give advance notice of the waiver application to each participant, alternate payee and beneficiary under the plan. The notice must be hand delivered or mailed within 14 days prior to the date of the application and must include a description of the present value of vested benefits, the present value of benefits calculated as though the plan terminated, the fair market value of plan assets and the interest rate used to calculate such values. The IRS has provided a Model Notice that satisfies the notice content requirements.
The current user fee is $5,415 for a waiver of $1 million or more and $2,290 for a waiver of less than $1 million (Revenue Procedure 2004–8).
The request must:
- be signed by the employer maintaining the plan, or an authorized representative (include a Form 2848 — Power of Attorney, if signed by a representative);
- include a declaration that the statements are true and correct which must be signed by the applicant/employer and cannot be signed by an authorized representative; and
- comply with the public inspection requirements of Section 6110 (a) of the Code.
Rev. Proc. 2004–15 became effective for all ruling requests received after February 17, 2004, the date of publication in the Internal Revenue Bulletin.