FSA 200107012: new standard for deducting qualified plan contributions?

• Author: Zarzar, Robert
• Position: IRS Field Service Advice

Under Sec. 404, employer contributions to a qualified plan that are "otherwise deductible" under Chapter 1 of the Code are deductible in the tax year paid. Field Service Advice (FSA) 200107012 sets forth a curious interpretation of the "otherwise deductible" requirement.

In the FSA, the IRS denied deductions taken by an accrual-basis taxpayer for contributions to a Sec. 401(k) plan, because the contributions were allocable based on compensation earned after the close of the tax year in which the deduction was claimed. The Service reasoned that, for a qualified plan contribution to be "otherwise deductible" under Sec. 162 or 212, the contribution must satisfy the Sec. 461 deduction-timing rules. Under the provision, an accrual-basis taxpayer cannot take a deduction until all events have occurred that fix the liability. When an expense (such as compensation) relates to the performance of services, the all-events test is not satisfied until economic performance occurs. Because the contribution at issue was allocable to services performed after the close of the tax year in which the deduction was sought, the IRS held that the all-events test was not met.

Defining "Otherwise Deductible"

The result reached in FSA 200107012 seems curious for two reasons. First, it appears questionable whether the "otherwise deductible" language of Sec. 404(a) is intended to incorporate the Sec. 461 timing rules. A better reading of the statute may be that Sec. 404(a) sets forth a general rule regarding the type of contributions that may be deductible by an employer (i.e., contributions to stock bonus, pension, profit-sharing or annuity plans), while the paragraphs beneath Sec. 404(a) set forth the timing and amount of the permitted deduction (depending on the type of plan contribution).

Read this way, the initial issue is whether the contribution is a type otherwise deductible under Chapter 1 of the Code. An employer contribution to a qualified plan should be otherwise deductible under Sec. 162 or 212 because it is an ordinary, necessary and reasonable expense. Continuing this approach, assuming the contribution is otherwise deductible under Chapter 1, an employer then must determine when the contribution is deductible. Under Sec. 404(a)(1)-(3), qualified plan contributions are deductible "in the year paid"

FSA 9922005 had agreed that the otherwise deductible language did not require a qualified plan contribution to satisfy the Sec: 461 rules to be deductible...