Notes for pension deductible when principal paid

Tax Hot Topics newsletter The IRS has issued a private letter ruling (PLR 201945024) holding that an employer is entitled to a deduction for contributing debt securities issued by the employer to its defined benefit (DB) pension plan only when the principal amounts are paid on the debt securities or when the pension plan’s trust sells those instruments.

The employer at issue made contributions of debt, which was composed of various investment-grade securities readily traded on an established securities market, to its DB pension plan. The employer is in the business of providing insurance products and financial services.

Upon review, the IRS stated that the contribution of debt securities only represents the employer’s promise to pay and does not represent the paying out or reduction of the company’s assets (the objective outlay-of-assets test). Accordingly, the contribution of the debt securities themselves is not a contribution paid to the pension plan. However, the payment of principal made pursuant to the terms of the debt instruments would satisfy the objective outlay-of-assets test, and the payment would be deductible by the employer under Section 404(a) as a contribution for the taxable year in which the payment is made.

In addition, the IRS ruled that if the debt instruments are sold or transferred to an unrelated third party and that unrelated third party pays the proceeds to the pension plan’s trust, the trust would obtain the full advantage of the contribution that entitles the employer to a tax benefit. Therefore, any cash (or cash equivalent) proceeds received by the trust from a transfer or sale of the debt to an unrelated third party would be treated as a contribution by the employer to the trust. The contribution amount equal to the amount of the proceeds from the transfer or sale is deductible by the employer for the taxable year in which the transfer is made, or deemed to be made, pursuant to Section 404(a)(6), subject to the applicable limits and other requirements of Section 404 and capitalization requirements of Section 263A.

The debt securities provided for the payment of interest payments before the securities matured, at which time the entire principal would be repaid. The IRS noted that the taxpayer did not request a ruling with respect to the deductibility of the interest payments on the debt, and therefore, the ruling only addresses the deductibility of the principal payments on the debt securities.

Jeff Martin
Partner, Washington National Tax Office
T +1 202 521 1526

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