[99] It is intended that reasonable conditions may be applied to any extension of time, such as (but not limited to) a requirement that regular payments be made toward funding the deficiency and such as not allowing a plan amendment that increases plan costs until the deficiency is paid off. Correction generally will be made by paying off the principal amount of the funding deficiency plus interest to the date of payment, at the rate used to determine plan costs for the years the deficiency remained unpaid.10

In the usual case, the excise taxes will be owed when a deficiency is showing in the plan's funding standard account. However, as under present law, where the actuarial assumptions used in determining the minimum funding requirements are unreasonable in the aggregate, the Service may on audit retroactively (for open years) require a change in these assumptions. Such a change may result in a change in the plan's funding standard account. If a funding deficiency occurs as a result of such change, an excise tax may be levied. It is expected that retroactive changes of actuarial assumptions would occur only where the initial assumptions used were substantially unreasonable.

The bill provides special rules for applying the excise tax to collectively bargained plans. Generally, the "plan year" for a collectively bargained plan will be considered to be the contract period. If, at the beginning of that contract period, the actuarial assumptions used in setting the plan contributions are reasonable in the aggregate, and the actuarial calculations are correct, then generally no excise tax will be owned by employers who timely pay their appropriate share of the plan contributions during the contract period. However, to the extent that plan contributions are not timely paid, the funding standard account may show a deficiency and an excise tax would be owed. (The excise tax would be owed on the basis of the employer's taxable year and not on the basis of the plan year which runs for the period of the contract.) When a plan has such an accumulated funding deficiency, generally the tax will be imposed only on the employers who do not timely contribute, since the underfunding is the result of their failure to contribute.

At the end of a contract period, even assuming that all contributions were timely made, a collectively bargained plan can have experience losses. In that event, the next contract must provide for the experience loss. This generally will be by higher contributions, though it could also be by amending the plan to decrease benefits. If appropriate adjustments in contributions or benefits do not occur, then the plan will have a funding deficiency and an excise tax will be owed. Liability for this tax is to be determined first on the basis of failure to meet the required employer contributions under the plan, and then on the basis of respective liabilities for contributions under the plan. The bill also provides special rules for applying the excise tax to a controlled group of corporations. Under the bill, if corporations that are members of a controlled group (defined by section 1563 (a) of the Code without regard to section 1563 (e) (e) (C)) adopt a plan, the excise tax on underfunding is to be determined as if all the corporations were a single employer, and the tax is to be allocated to each corportion in accord with regulations prescribed by the Secretary of

10 It is contemplated that if a plan becomes subject to the full funding limitation after It has an accumulated funding deficiency that no correction will be required, but the nondeductible 5 percent first level excise tax will be owed for each year in which there is an accumulated funding deficiency.

[100] the Treasury. It is expected that generally the minimum funding requirements will be allocated proportionately to the relative amount of plan liabilities attributed to the employees of such corporation and any funding tax will be allocated in proportion to failures to make these required minimum contributions.

Maximum deductions for plan contributions.-If an employer wishes to deduct contributions to an employee benefit plan which are greater than the minimum contributions required, the amount deductible will be subject to the maximum deduction limits.

Contributions to a pension plan presently are deductible under three alternative provisions, the "5 percent" method which allows deductions to be taken for contributions not in excess of 5 percent of the annual compensation of the covered employees (sec. 404 (a) (1) (A) of the code), the "level cost" method (sec. 404 (a) (1) (B) of the code), and the "normal cost" method (sec. 404 (a) (1) (C) of the code).

Unlike the "level cost" method and the "normal cost" method, the 5-percent limitation on contributions is often unrelated to the funding needs of the pension plan, for it frequently is not determined by the level of benefits provided by the plan. Consequently, the 5-percent method has allowed employers to contribute and deduct more than is reasonably needed to fund a pension plan.

The bill repeals the 5-percent deduction limitation (present sec. 404 (a) (1) (A) of the code). Thus, deductible contributions under a qualified pension plan generally are to be limited under either the "level cost" or the "normal cost" methods. However, in place of the 5 percent limitation, the bill adds a new sec. 404 (a) (1) (A) (discussed below) relating to contributions needed to meet the minimum funding standard.

The "normal cost" method (sec. 404 (a) (1) (C) of the Code) presently allows a maximum deduction of normal cost plus 10 percent of unfunded past service costs. The 10 percent figure includes interest as well as principal, and therefore this method is not the same as 10-year amortization."

11

To put the minimum contribution requirements and maximum deduction limitations on a comparable basis, the bill amends the "normal cost" deduction limitation rules to allow a maximum deduction of normal cost plus amounts needed to amortize past service costs in ten equal annual payments (including principal and interest). Under this provision, initial past service costs could be amortized over ten years from the date established (past service cost established by plan amendment could be amortized over ten years from the amendment, and experience losses could be amortized over ten years from the date they are determined). The maximum deduction for any year would be the amount determined under ten-year amortization and no more than this amount could be deducted in any year even though less than this amount were contributed in a prior year.

Your committee recognizes that under the minimum funding rules an employer might have to contribute more than the maximum allowed

11 Since the 10 percent figure includes interest as well as principal, it is estimated that, depending upon the interest rate, an employer usually may deduct amounts needed to fund accrued past service costs over 12-14 years.

[101] for deduction under the "level cost" or "normal cost" limits. For example, this could occur if the employer corrected a substantial funding deficiency for a prior year. Consequently, the bill provides that in such cases if the minimum funding standard requires a contribution to a tax-qualified pension trust which is greater than the maximum amount otherwise deductible, the amount contributed to satisfy the minimum standard is to be deductible. However, this rule does not apply to contributions to plans that are subject to the minimum funding standard but are not tax-qualified. Additionally, contributions must meet the requirements of sec. 162 before being deductible under sec. 404. In order to put the minimum funding requirements and maximum deduction limits on a compatible basis, the bill also provides that the funding method and actuarial assumptions used to determine the amount deductible are to be the same as the method and assumptions used to determine the minimum funding required. In addition, the maximum amount deductible generally cannot be more than full funding limitation of the minimum funding standard; otherwise, deductions would be allowed for contributions greater than needed to fund the plan.

Present law generally allows deductions for contributions to overlapping combinations of pension, profit-sharing, and stock bonus plans of up to 25 percent of compensation paid or accrued to all the employees who are beneficiaries under the plans. In some cases, where there has been a previous contribution greater than the deductible limits, the deduction can be up to 30 percent of aggregate compensation. In accordance with the decision to limit contributions to defined contribution plans to 25 percent of employee compensation, the bill provides that maximum deductions for contributions to overlapping plans are to be 25 percent of aggregate compensation, and the provision for an additional 5 percent for carryovers is to be eliminated. Under present law, contributions by an accrual basis taxpayer made by the time for filing his tax returns may be treated as paid in the year for which the return is due. This allows taxpayers time after the close of their taxable year to determine the amount of their contributions to be made to a plan. The bill extends this rule to cash basis taxpayers. With regard to collectively bargained plans, the bill (as present law) provides that the maximum deduction limits are to be determined as if all participants in the plan were employed by one employer. Further, the bill provides that the amount contributed by each employer under a collectively bargained plan will not exceed the maximum deduction limitation if the anticipated employer contributions for the plan year are no greater than the limitation. With respect to a plan adopted by several corporations that are members of a controlled group, the maximum deduction limitations are to be determined as if all employers were a single employer, and deductible amounts are to be allocated in accordance with regulations to be prescribed by the Secretary of the Treasury.

Effective dates

The new minimum funding requirements and the new rules with respect to deductions generally are to apply to plan years beginning after the date of enactment of the bill. However, with respect to

[102] plans in existence on January 1, 1974, the new funding standards and deduction rules are to apply to plan years beginning after December 31, 1975. If a plan existing on January 1, 1974, is maintained by a labor organization exempt under section 501 (c) (5) of the Code exclusively for the benefit of the employees of the organization, the new funding rules are to apply to this plan for plan years beginning after the later of (1) the last day of the second convention of the labor organization occurring after enactment of the bill (but not later than December 31, 1980) or (2) December 31, 1976.

If an existing plan is maintained under a collective bargaining agreement, then the new funding standard and deduction rules are to apply to plan years beginning after December 31, 1980, or the date on which the agreement terminates, whichever is earlier (but in no event sooner than plan years beginning after December 31, 1976). The date of termination is to be determined without regard to any extension agreed to after the date of enactment on the bill.12

Plans in effect on January 1, 1974, may elect to have the Internal Revenue Code provisions relating to participation, vesting, funding, and form of benefit apply to plan years beginning before the otherwise applicable effective date and all plan years thereafter. The election is to be made by the plan administrator and is to be irrevocable.

The provisions of the bill defining governmental plan, church plan, multiemployer plan, and plan administrator are to be effective on the date of enactment.

The provision of the bill establishing enrollment procedures for actuaries is to become effective upon enactment. The provisions relating to filing actuarial reports are to become effective at the same time as the general provisions relating to the new minimum funding rules. Revenue effect

It appears clear that the new funding provisions will give rise to additional income tax deductions by employers in the immediate years ahead. However, the statistical data available do not provide any method for determining the size of this revenue effect. It is believed, however, that it will not represent a large revenue loss. In the longer run, it appears unlikely that the greater immediate funding expected under this bill will have any appreciable effect on revenues. Although funding occurs earlier under the bill than under present law, the income tax deductions taken by employers under the bill would for the most part ultimately be taken under the present funding rules.

D. ADMINISTRATION AND ENFORCEMENT

(Secs. 1041, 1051, and 1052 of the bill, and secs. 7476 and 7802 of the Code)

Your committee's bill relies heavily on the tax laws in order to secure compliance with the new requirements that it imposes on employee pension, profit-sharing and stock bonus plans. The bill, in providing new standards of coverage, vesting, and funding continues the administration of these provisions in the Internal Revenue Service.

Many aspects of compliance have been discussed in conjunction with the various substantative provisions described in the bill. This includes,

12 For statement relative to the termination of a collective bargaining agreement, see the discussion under the effective date with respect to "A. Participation" above.

[103] for example, the new excise taxes imposed with respect to under-. funding.

In a number of other ways, however, efforts have been made to improve the provisions of existing law. The provisions of this type discussed here are the new office set up in the Internal Revenue Service to administer the new standards in this bill as well as the authorization of funds to provide for this administration. In addition, the bill deals with the problem raised as to the absence under existing law of a judicial review for letters of determination as to the qualification status of plans. Procedures are also set out whereby employees can question the qualification of plans.

1. INTERNAL REVENUE SERVICE

Present law

Under present law, the national office of the Internal Revenue Service is organized on a general activity basis rather than a tax or subject basis. At the present time, there are six Assistant Commissioners of Internal Revenue in the national office whose activities are broken into the following categories: collection and taxpayer service, compliance (including auditing), inspection (internal security), planning and research, technical (rulings) and administration (housekeeping). Similarly, the field offices of the Service are organized on a similar line. Within each of these broad categories there are Service units whose jurisdictional breakdown is by subject matter under examination. For example, the Miscellaneous and Special Provisions Tax Division under the Office of Assistant Commissioner (Technical) contains an Actuarial Branch, a Pension Trust Branch and an Exempt Organization's Branch. However, various other aspects of national office employee benefit plan and tax exempt organization administration are under the Office of Assistant Commissioner, Accounts Collection and Taxpayer Service and the Office of Assistant Commissioner, Compliance.

General reasons for change

Concern has been expressed in the case of the administration of employee benefit plans (and also tax exempt organizations) as to whether the Internal Revenue Service with its primary concern with the collection of revenues is giving sufficient consideration to the purposes for which these organizations are exempt. Many believe that the present organization of the Service causes it to subordinate concern for the protection of the interests of plan participants (or the educational, charitable, etc., purposes for which the exemptions are provided).

On the other hand, the enormous growth in retirement plans during the last third of a century has proceeded largely under the tax regulations of the Internal Revenue Service. Moreover, clearly the greatest single protection for rank and file employees during this time has been the Internal Revenue Service's administration of the provision denying any special tax treatment for contributions or benefits discriminating in favor of employees who are officers, shareholders, supervisors, or highly compensated employees. The thrust of this provision is to re

1 Reorganization Plan No. 1 of 1952 which went into effect on March 15, 1952. For a description of the present organization of the Internal Revenue Service, see Statement of Organization and Functions (C.B. 1970-1, 442).