Anti-abuse pension regulations.

• Author: Gingerich, Henry F.

Since the beginning of the private pension system in the U.S., many taxpayers, including closely held companies, have spent a great deal of time and effort trying to build significant pensions for deserving highly compensated employees and officers. Sometimes, however, there is an impediment to doing so in the form of cost. The greatest cost to most pension programs is the cost of providing pensions to rank-and-file employees. Just by the sheer number of these employees, the additional costs involved in maintaining a qualified plan can be very significant. While no one questions the desirability of providing qualified plan benefits to all employees, tax law changes throughout the 1980s have made it significantly more expensive and complex, and have caused many private employers to discontinue their pension programs entirely.

Among the techniques used by some employers to reduce the cost of maintaining a qualified plan is to provide pension benefits for only one division or one of several related companies. However, small employers have recently found it extremely difficult to do this because of the myriad of rules on plan qualification, including those in Sec. 401(a)(26) restricting the use of multiple comparable plans in one employer or group of related employers.

For related entities, the basic rule has been that controlled groups of employers are aggregated under Sec. 414(b) or (c) for coverage and other purposes. However, after the tax cases of Kiddie, 69 TC 1055 (1978), and Garland, 73 TC 5 (1979), in which two physicians found a way around the controlled group rules by setting up affiliated service groups to exclude their rank-and-file employees, the rules have been toughened up. Those cases caused the enactment of Sec. 414(m), which combats the affiliated service group and management company practices that many firms used (and still use for good business reasons), but also may result in a perceived discrimination in the pension arena.

Treasury apparently felt that these new rules were still not enough to counter perceived abuses, particularly in the small, closely held arena. As such, in 1987, regulations under Sec. 414(o) were promulgated. Sec. 414(o) is an anti-abuse statute that gives the IRS authority to promulgate regulations to combat abuses not thought of in other Code sections enacted by Congress. These types of general anti-abuse statutes are becoming more and more prevalent in all areas of tax law. The problem with them is...