Rev. Rul. 57-89

Advice has been requested whether an employer may deduct contributions to a qualified employees' pension plan, to the extent of the applicable limitation under subparagraph (A) of section 404(a)(1) of the Internal Revenue Code of 1954, even though it would result in allowable deductions greater than the limitation under subparagraph (C) of that section.

Subparagraph (A) of section 404(a)(1) of the Code provides, in part, that an employer may deduct contributions paid to a pension plan in an amount not in excess of five percent of the compensation paid or accrued during the taxable year to all the employees under the trust. However, the amount deductible is subject to reduction upon specific findings by the Commissioner.

Alternatively, subparagraph (C) of section 404(a)(1) of the Code provides, in part, that the amount deductible shall be limited to the sum of the normal cost of the plan plus an amount not in excess of ten percent of the cost which would be required to completely fund or purchase the past service pension or annuity credits as of the date when they are included in the plan.

Section 1.404(a)-4 of the Income Tax Regulations states that the five percent limitation, provided by section 404(a)(1)(A) of the Code, applies to the initial year and to each subsequent year for which the five percent figure is not reduced as provided below. For years to which the initial five percent limitation applies, no adjustment on account of prior experience is required. If the contributions do not exceed the initial five percent limitation in the first taxable year to which this limitation applies, the taxpayer need not submit actuarial data for such year. For the first taxable year following the first year to which the initial five percent limitation applies, and for every fifth year thereafter, or more frequently where preferable to the taxpayer, the taxpayer shall submit with his return an actuarial certification of the amount reasonably necessary to provide the remaining unfunded cost of past and current service credits of all employees under the plan with a statement explaining all the methods, factors, and assumptions used in determining such amount. The District Director of Internal Revenue will make periodical examinations of such data at not less than five year intervals. Based upon such examinations, the Commissioner will reduce the limitation under section 404(a)(1)(A) of the Code below the five percent limitation for the years with respect to which he finds that the five percent limitation exceeds the amount reasonably necessary to provide the remaining unfunded cost of past and current service credits of all employees under the plan. It is also stated that deductions are allowable to the extent of the applicable limitations under section 404(a)(1)(A) of the Code even where these are greater than the applicable limitations under section 404(a)(1)(B) or section 404(a)(1)(C) of the Code.

Accordingly, the limitation of deductions under subparagraph (A) of section 404(a)(1) of the Code to five percent of the nondeferred compensation of all employees, who are under the trust in the taxable year, may be applied even where it may exceed the limitation under subparagraph (C) of that section, provided it does not exceed the unfunded past service cost as of the beginning of the year plus the normal cost of the plan for the year. In applying this limitation, the compensation of any employee who is not a potential beneficiary of the plan may not be included. Thus, if the effect of offset provisions in the benefit formula would, on the basis of projecting the employee's earning rate to his retirement date, eliminate any net benefits under the plan for him, or if, because of the circumstances of his age and service, it would be impossible for him to qualify for benefits under the plan, his compensation cannot be included for the purpose of applying the limitation. In no event are deductions allowable for contributions to the extent that they, together with other assets of the fund, result in overfunding the cost of service credits up to the end of the taxable year, since to such extent they do not constitute ordinary and necessary expenses under section 162 of the Code.

It is also held that the application of the limitation under subparagraph (A) of section 404(a)(1) of the Code, where the subparagraph (C) limitation of that section has been used in prior years, is acceptable. This ruling shall not be construed as authorizing or approving increased deductions under the limitation of subparagraph (A) for any year for which the employer's income tax return has been filed and for which the deduction has been computed under the limitation of subparagraph (C). See section 1.404(a)-3(c) of the regulations.