Rev. Rul. 55-411

Advice has been requested as to the proper method of determining allowable deductions under section 23(p)(1)(A)(iii) of the Internal Revenue Code of 1939 on account of an employer's contributions to its employees' pension plan under a group annuity contract where the cost of past service credits has been increased by a substantial amendment to the plan.

The employer established an employees' pension plan, as of January 1, 1941, with a group annuity contract providing past service benefits of 1 percent of average earnings during the 10 years preceding January 1, 1941, for each year of credited service prior to that date but not including service prior to 1930. The single premium cost to fund such benefits as of December 1, 1941 was 2,000 x dollars. In 1946, the cost of past service benefits was increased by increasing the rate of past service credits from 1 to 1 1/2 percent. Additional amendments made in 1947 further increased the past service costs as of that date by extending the past service credits to include service prior to 1930, and providing certain supplementary annuity credits with respect to service between 1941 and 1947. The single premium cost as of January 1, 1950, to fund the benefits as of that date was calculated actuarially at 5,000 x dollars. The taxpayer had contributed and deducted 600 x dollars of the original past service liability in 1941, and has since deducted up to the maximum limitations in each succeeding year. The question presented is whether the initial cost of 2,000 x dollars may be included in the 10 percent base for purpose of computing limitations on deductions for the year 1950 and subsequent years.

Section 23(p)(1)(A)(iii) of the Internal Revenue Code provides a limitation on deductions with respect to past service and supplementary costs of:

* * * an amount equal to the normal cost of the plan * * * plus, if past service or other supplementary pension or annuity credits are provided by the plan, an amount not in excess of 10 per centum of the cost which would be required to completely fund or purchase such pension or annuity credits as of the date when they are included in the plan, * * * except that in no case shall a deduction be allowed for any amount * * * paid in after such pension or annuity credits are completely funded or purchased . Italics supplied.

It is the position of the Internal Revenue Service that where a plan is amended to provide for a substantial increase in benefits so that the amendment is similar to the establishment of a distinct supplemental plan, deductions with respect to the cost of the additional benefits may thereafter be allowed only to the same extent as deductions would be allowed if the additional benefits were provided under a distinct plan.

Since the employer, in the instant case, contributed and deducted 600 x dollars of the original past service liability in 1941 and has deducted the maximum limitation of 200 x dollars in each succeeding year, it is apparent that the 1941 single premium cost of 2,000 x dollars (plus interest on delayed installments thereof) was completely funded and deducted by 1949. Any remaining 10 percent base after that time should include only costs of past service and supplementary credits provided by the amendments in 1946 and 1947 as of the date they were included in the plan, and such costs should be included in the 10 percent base only until such time as each is completely funded.

Accordingly, it is held that the provisions of section 23(p)(1)(A) of the Code requires that separate treatment be accorded past service costs which are attributable to substantial amendments to an employees' pension or annuity plan, just as though they were provided under distinct supplemental plans. Interest on unfunded portions thereof which tend to increase such costs may not be included in the 10 percent base while, on the other hand, increases in cost due to unfavorable experience or underestimation of the costs or to a change in the insurance company annuity rates should be included in the 10 percent base