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IRS Memo Explains Test for Determining Whether Plan Contributions Are Deductible



IRS Chief Counsel Advice 201935011 (Aug. 15, 2019)

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The IRS has released a Chief Counsel Advice memorandum that explains the test used to determine whether retirement plan contributions have been “paid” and thus may be deducted by the employer. Under Code § 404(a), employer contributions to a tax-qualified retirement plan’s trust are deductible (up to the applicable limit) in the taxable year they are paid into the trust. Contributions for a taxable year that are paid no later than the deadline (including extensions) for that year’s tax return are deemed paid on the last day of the year for which the contribution was paid. Neither the Code nor the applicable regulations set a standard for determining what constitutes payment for this purpose, but the issue was addressed in 1977 by the U.S. Supreme Court in Williams v. Comm’r, 429 U.S. 569. In that case, the employer argued that its contribution of a fully secured promissory note was a deductible payment. The Court, however, characterized the note as only a promise to pay, and concluded that the Code requires a contribution of cash or its equivalent. Also, the policy behind Code § 404 requires that contributions pass an “objective outlay-of-assets test” to ensure the integrity of the receiving plan and give it the “full advantage” of the contribution.

Relying on Williams and a later Tax Court case, the memorandum concludes that, to be deductible under Code § 404(a), any employer contribution to the trust of a tax-qualified retirement plan must be in cash (or its equivalent) or property. Whether such contributions have been paid is determined using the “outlay-of-assets test” established by Williams, which requires an actual “outlay of, or reduction in, [the employer’s] assets.” Also, the trust must obtain the full advantage of the contribution. Thus, the employer must not retain significant control over the contributed asset, and the asset cannot be subject to a significant encumbrance. The memorandum goes on to provide examples illustrating those two elements of the test. The examples conclude, among other things, that contribution of an employer’s promissory note or its publicly traded debt fails the first element because there is no outlay of, or reduction in, the employer’s assets. Other examples discuss the effect of restrictions on a trustee’s ability to access a contributed asset (e.g., if the asset is in escrow or available first to other creditors of the employer), and the effect of put and call options.

EBIA Comment: A 401(k) plan may face this issue if the employer makes noncash discretionary profit-sharing contributions. The deductibility question considered in this memorandum is entirely separate from the question of whether noncash contributions are permitted under ERISA or any other rules. For example, in-kind contributions that reduce the employer’s obligation to make a cash contribution to the plan will constitute prohibited transactions absent a statutory or administrative exemption. While this memorandum represents the IRS’s current view, we note that it may not be used or cited as precedent. For more information, see EBIA’s 401(k) Plans manual at Section X.F (“Limitation on Deductibility of Contributions: Code § 404”).


Contributing Editors: EBIA Staff.

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