Tax Court Approves Post-Retirement Benefits Funding

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The Tax Court recently held in Wells Fargo & Co. v. Comm., that the present value of projected post-retirement medical benefits, for employees who are retired at the time the reserve is created, may be deducted in the year the reserve is created.

In 1991, Norwest Corp. (a multi-bank holding company now known as Wells Fargo) established and funded a trust to provide post-retirement medical benefits for active and retired employees. Norwests contribution to the trust was based on actuarial calculations of the present value of future post-retirement medical benefits for active ($14,096,473) and retired ($27,759,057) employees.

The companys actuaries also determined that the amount for retired employees was fully deductible in 1991. Norwest contributed $30,689,717 to the post-retirement medical trust in 1991 and claimed a deduction for the contribution on its consolidated return as an addition to a “qualified asset account” under IRC Section 419A(b).

The Service determined that Norwests method of computing the contribution for post-retirement benefits was improper because it purportedly resulted in a contribution that exceeded the account limit for a post-retirement reserve under IRC Section 419A(c)(2).

The account limit includes the amount of an additional reserve funded over the working lives of the covered employees and actuarially determined on a level basis (using assumptions that are reasonable in the aggregate) as necessary for post-retirement medical and life insurance benefits.

The Service argued that the cost of the post-retirement benefit must be spread over the remaining working lives of the covered employees and since retirees have no remaining working lives, the cost must be spread over the remaining working lives of the active employees (under the aggregate cost method).

On the other hand, Norwest contended that the “reserve” under IRC Section 419A(c)(2) refers to the employers accrued, separate liability to provide post-retirement benefits; furthermore, the cost must be calculated by allocating the present value of an employees future benefit over the employees entire working life.

According to the Tax Court: “The actuarial present value of the projected benefit of each covered employee should be allocated on a level basis to each year commencing with the year in which the allocation is first recognized and ending with the year the employee is expected to retire. The funding of a reserve funded over the working lives of the covered employees cannot begin until the reserve is created. Thus, the allocation is first recognized on the later of (1) the date when the reserve is created and (2) the date the employee becomes a covered employee. Essentially, this is the “individual level premium cost method” with the date of the creation of the reserve substituted for the date the plan is instituted. When the year in which the allocation is first recognized is after the employee has retired, there are no future years to which the benefits may be allocated. Since there are no future years to which the benefits may be allocated, there are no future normal costs, and the entire present value of the projected benefit is properly allocated to the first year. This is the method that [Norwests actuaries] used in computing Norwests contribution for 1991, the year the reserve was created.”

The court further reasoned: “The individual level premium cost method comports with our holding that the amount of the liability that may be satisfied by the reserve is the amount at the time the reserve is computed that, together with future normal costs and interest, will be sufficient upon retirement of an employee to pay future medical claims of the employee when they become due.”

Accordingly, the Tax Court held that with respect to an employee who is retired when the reserve is created, the present value of that employees projected benefit may be allocated to the year the reserve is created.

Furthermore, Norwests contribution to the post-retirement medical benefits trust to fund a reserve for post-retirement medical benefits for 1991 did not cause the qualified asset account to exceed the account limit (under IRC Section 419A(b)) with respect to the reserve for post-retirement medical benefits (under IRC Section 419A(c)(2)).

Thus, in computing Wells Fargos consolidated income tax for 1991, Wells Fargo was entitled to a deduction for post-retirement medical benefit contributions of $30,689,717 in 1991. [Wells Fargo & Co. v. Comm., 120 TC No. 5 (2003)]

In another development, the Service has released final regulations requiring taxpayers to disclose their participation in potentially abusive transactions (including certain 10 or more employer plans under IRC 419A(f)(6)), promoters to register certain abusive transactions and advisors to maintain lists of clients who have entered into potentially abusive tax avoidance transactions. The final tax shelter regulations conform the taxpayer disclosure regulations and the promoter list maintenance regulations so that the rules are easier to apply and administer. In addition, the final regulations reflect a number of changes intended to reduce unnecessary disclosure.

Sonya E. King, J.D., LL.M., is an assistant editor of Tax Facts, a National Underwriter Company publication.


Reproduced from National Underwriter Edition, April 7, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.