n-07-28.pdf

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Part III – Administrative, Procedural and Miscellaneous

Certain Deduction Limits under the Pension Protection Act of 2006

Notice 2007-28

This notice provides guidance on certain of the changes made by the Pension
Protection Act of 2006, Pub. L. 109-280 (PPA ’06), to § 404 of the Internal
Revenue Code (Code). Section 404 generally provides rules concerning the
deduction for contributions to plans of deferred compensation. Some of the PPA
‘06 amendments to § 404 are effective for years beginning after December 31,
2005 (the 2006 changes) and others are effective for years beginning after
December 31, 2007 (the 2008 changes). This notice provides guidance with
respect to the 2006 changes and one related issue. Future guidance will be
provided with respect to the 2008 changes.

Q-1. What changes to the rules of § 404 of the Code were made by PPA ’06 for
years beginning after December 31, 2005?

A-1. In general, PPA ’06 amended § 404 to modify the deduction permitted for
defined benefit pension plans under § 404(a)(1). PPA ’06 also modified the
combined limit on deductions for contributions to defined benefit plans and
defined contribution plans with overlapping coverage as set forth in § 404(a)(7).

Q-2. To what years do the 2006 changes apply when the taxable year of the
employer differs from the plan year of the plan?

A-2. The 2006 changes apply to taxable years of the employer beginning after
December 31, 2005.

Under § 1.404(a)-14(c) of the Income Tax Regulations (regulations), if the plan
year of the plan and the taxable year of the employer do not coincide, the
deductible limit for the taxable year of the employer is permitted to be determined
as any one of the following alternatives: (1) the deductible limit determined for
the plan year beginning in the taxable year, (2) the deductible limit determined for
the plan year ending in the taxable year, or (3) a weighted average of alternatives
(1) and (2). A plan year used under any of these alternatives is referred to in this
notice as an associated plan year.

The calculations of the deductible limit for a taxable year are based on the
calculations with respect to an associated plan year or years and must reflect the

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law in effect for the taxable year. For example, with respect to the 2006 calendar
taxable year, any associated plan year (i.e., a plan year beginning in 2006 or
plan year ending in 2006 that is used to determine the deductible limit for the
2006 taxable year) must reflect the 2006 changes. Thus, if the deductible limit is
determined with respect to the plan year ending in 2006 (which begins in 2005),
the calculation of the limit with respect to that plan year must reflect the use of an
interest rate within the permissible corporate rate range (instead of an interest
rate within the permissible 30-year Treasury rate range) (see Q&A-3 below) that
was used for purposes of § 412, and must reflect the limitation based upon 150
percent of current liability (in place of the limitation based on 100 percent of
current liability) under § 404(a)(1)(D). The funding method and other actuarial
assumptions that were used for purposes of § 412 for that plan year must also be
used for the calculations of the deductible limit.

As another example, in the case of a taxable year that is not the calendar year
and that begins in 2005 and ends in 2006, and a plan year that is the calendar
year, the deductible limit for any associated plan year must not reflect the 2006
changes. Thus, if the deductible limit for the taxable year beginning July 1, 2005,
and ending June 30, 2006, is determined based upon the plan year beginning in
the taxable year (the 2006 calendar plan year), the calculations of such limit must
not reflect the limitation based on 150 percent of current liability (i.e., must be
limited to 100 percent of unfunded current liability) and may use the 30-year
Treasury rate in place of the corporate rate.

Q-3. What changes to § 404(a)(1) of the Code were made by PPA ’06 for years
beginning after December 31, 2005?

A-3. In general, PPA ’06 amended § 404(a)(1) of the Code for years beginning
after December 31, 2005, to replace the limitation of § 404(a)(1)(D) based upon
unfunded current liability with a limitation based on 150 percent of current liability
(140 percent in the case of a multiemployer plan). In addition, PPA ’06
eliminated the § 404(a)(1)(F) option to use any interest rate within 90 percent to
110 percent of the weighted average of the rates of interest on 30-year Treasury
securities during the 4-year period ending on the last day before the beginning of
the plan year (the permissible 30-year Treasury rate range) for purposes of
determining current liability in determining the maximum deduction under
§ 404(a)(1) rather than an interest rate within the 90 percent to 100 percent of the
weighted average of the rates of interest on amounts invested conservatively in
long-term investment grade corporate bonds (the permissible corporate rate
range). The current liability is determined pursuant to existing guidance,
including, for example, Notice 90-11, 1990-1 C.B. 319.

Q-4. When determining the deductible limit in accordance with the 2006
changes, is the deductible limit determined as of the valuation date for the plan
year?

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A-4. Yes, the deductible limit is determined as of the valuation date for the plan
year and is adjusted for interest to the earlier of the end of the plan year or the
end of the taxable year of the employer (the “relevant date”). See, for example,
§ 1.404(a)-14(f)(3) of the regulations.

Q-5. What does § 404(a)(1)(D)(ii) provide and is the adoption of a new plan
treated as a plan amendment for purposes of § 404(a)(1)(D)(ii)?

A-5. Section 404(a)(1)(D)(ii) provides that, in the case of a plan which has 100 or
fewer participants for the plan year, unfunded current liability shall not include the
liability attributable to benefit increases for highly compensated employees (as
defined in § 414(q), “HCEs”) resulting from a plan amendment which is made or
becomes effective, whichever is later, within the last two years. For purposes of
§ 404(a)(1)(D)(ii), the adoption of a new plan will not be treated as a plan
amendment only if the employer did not maintain a defined benefit plan covering
any HCE covered by the new plan during the past 2 years. Thus, for an
employer with a taxable year that is the calendar year, if an HCE was covered by
a defined benefit plan of the employer at any time during 2004 or 2005, a new
plan established during the 2006 taxable year that covers that HCE would be
considered a plan amendment for purposes of § 404(a)(1)(D)(ii).

Q-6. What changes to § 404(a)(7) were made by PPA ’06 for years beginning
after December 31, 2005?

A-6. In general, PPA ’06 amended § 404(a)(7) of the Code for years beginning
after December 31, 2005, to exclude multiemployer plans from consideration and
to provide that the combined limit of § 404(a)(7) only applies in the case of
employer contributions to one or more defined contribution plans to the extent
that such contributions exceed 6 percent of the compensation otherwise paid or
accrued during the taxable year to the beneficiaries under the plan.

Q-7. Is a plan that contains a qualified cash or deferred arrangement described
in § 401(k) taken into account for purposes of the combined limit of § 404(a)(7)?

A-7. Yes, a plan that contains a qualified cash or deferred arrangement
described in § 401(k) is taken into account for purposes of the combined limit of
§ 404(a)(7). However, pursuant to § 404(n), elective deferrals as defined in
§ 402(g)(3) are not taken into account. Thus, matching contributions and
nonelective employer contributions are taken into account in applying the limits of
§ 404(a), including the combined limit of § 404(a)(7). If elective deferrals are the
only contributions under a defined contribution plan, then the plan is not taken
into account in applying the limits of § 404(a)(7).

Q-8. How does the combined limit of § 404(a)(7) apply when employer
contributions to defined contribution plans (other than elective deferrals) exceed
6 percent of compensation of participants in those plans?

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A-8. When employer contributions to defined contribution plans (other than
elective deferrals) exceed 6 percent of compensation of participants in those
plans, the amount of employer contributions to defined contribution plans to
which the combined limit of § 404(a)(7) applies is equal to the amount of
employer contributions for the plan year less 6 percent of compensation of
participants in those plans. Thus, the combined limit of § 404(a)(7) (i.e., the
greater of 25 percent of compensation, or the contributions to the defined benefit
plan or plans to the extent such contributions do not exceed the amount
necessary to satisfy the minimum funding standard for the defined benefit plans,
treating a contribution that does not exceed the unfunded current liability as an
amount necessary to satisfy the minimum funding standard for each defined
benefit plan) applies to the total of employer contributions to defined benefit plans
and employer contributions to defined contribution plans (other than elective
deferrals), less 6 percent of compensation of participants in the defined
contribution plans.

Q-9. How does the combined limit of § 404(a)(7) apply when employer
contributions to defined contribution plans (other than elective deferrals) do not
exceed 6 percent of compensation of participants in those plans?

A-9. When employer contributions to defined contribution plans (other than
elective deferrals) do not exceed 6 percent of compensation of participants in
those plans, the combined limit of § 404(a)(7) does not apply to any employer
contributions to defined contribution plans. In such a case, the combined limit of
§ 404(a)(7) (i.e., the greater of 25 percent of compensation, or the contributions
to the defined benefit plan or plans to the extent such contributions do not
exceed the amount necessary to satisfy the minimum funding standard for the
defined benefit plans, treating a contribution that does not exceed the unfunded
current liability as an amount necessary to satisfy the minimum funding standard
for each defined benefit plan) applies only to contributions to the defined benefit
plans.

Drafting Information

The principal author of this notice is James E. Holland, Jr. of the Employee
Plans, Tax Exempt and Government Entities Division. For further information
regarding this notice, contact Mr. Holland at (202) 283-9699 (not a toll-free
number).