January 16, 2020

IRS Allows Employer Debt as Tax-Deductible Pension Plan Contribution

In PLR 201945024, Employer had issued debt that was being traded on an established securities market. The Employer intended to buy back the debt and then contribute the obligation to the Plan. The question posed to the IRS was whether the contribution was tax deductible upon terms similar to a contribution of cash.

Section 404 of the Internal Revenue Code allows a sponsor of a qualified retirement plan to take a tax deduction for cash contributed to the plan in a given year (or within a grace period that ends on the due date of the plan sponsor’s tax return for the year, including extensions).

The IRS confirmed that the contribution of the Employer’s promissory note was tax deductible subject to certain requirements relating to the timing of the deduction. The Employer could not take the deduction for the value of the promissory note immediately in the year that the note was contributed. The IRS cited an “outlay of assets” requirement imposed by the U.S. Supreme Court in Don E. Williams Co. v. Commissioner. Pursuant to Don E. Williams Co., the Employer can take a tax deduction (1) when principal payments are made by Employer under the terms of the note (e.g. annually) and (2) if and when the note is transferred to a third party and value is received by the Plan in consideration for the transfer. In the second instance, the Plan will have received full value for the contribution of the promissory note via payment from a third party, and the Employer is then obligated to an unrelated third party, making the Employer entitled to the deduction.

Although private letter rulings cannot be relied upon by taxpayers other than the recipient of the letter, the PLR offers insight into how the IRS is likely to treat similar transactions, affording another possible method to fund a company pension plan on a tax-deductible basis.

Contact Liam Healy at 313-961-0200 for questions or assistance on these regulatory changes or other business needs.

Liam K. Healy of Kerr Russell practice clients maintain compliance with state and federal tax laws that govern individuals and businessesLiam Healy focuses his practice on helping clients maintain compliance with the myriad of state and federal tax laws and regulations that govern individuals and businesses. He has a broad range of experience in business law and business tax matters including choice and formation of business entities, partnership and shareholder agreements, buy sell agreements, franchise agreements, mergers and acquisitions, business succession planning, real estate, tax free exchanges, non-profit organizations and tax audits. Liam has counseled business owner clients through every stage, from formation to the sale of the business.

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