Keystone Consolidated Industries: Supreme Court holds property contributions to pension plans for funding obligations to be prohibited transactions.

• Author: Knight, Ray A.

The prolonged economic downswing has made it increasingly difficult for some employers to satisfy their obligations to fund their benefit plans. Some employers have sought to reduce transaction costs or improve cash flow by contributing property rather than cash to their benefit plan obligations. The problem with such action is that the Department of Labor and the Internal Revenue Service have taken a position limiting the availability of this funding technique to discretionary profit-sharing techniques.

Until recently, the courts did not agree on this issue. The Tax Court and Fifth Circuit agreed that contributions of property to discretionary profit-sharing plans are permissible, but disagreed on the possible use of this technique to fund pension plans. In contrast, the Fourth Circuit held that the assignment of third-party promissory notes to a qualified plan to satisfy a minimum funding obligation constitutes a prohibited transaction. The conflict among the circuits provided employers with a basis to aggressively pursue property contributions. The IRS estimates that in 1989 alone, $243 million in property was contributed by employers to more than 400 separate pension plans.

To resolve the conflict between the Fifth and Fourth Circuits, the Supreme Court granted a writ of certiorari in Commissioner v. Keystone Consolidated Industries, Inc. (Doc. No. 91-1677). In an 8-to-1 decision, the Court in May 1993 ruled in favor of the government, restricting the ability of employers to make contributions of unencumbered property to a defined benefit plan. This article explores the lower court decisions, including their differing interpretations of section 4975 of the Internal Revenue Code, and then analyzes the Supreme Court's decision.

1. Background

   The prohibited transaction rules of section 4975 of the Internal Revenue Code were signed into law nearly two decades ago. Basic questions regarding these rules, however, remained unresolved until the Supreme Court's decision in Keystone Consolidated Industries. In Keystone Consolidated Industries, Inc. v. Commissioner, 952 F.2d 76 (5th Cir. 1992), the Fifth Circuit held that the contribution of unencumbered, non-cash property by an employer to its defined benefit retirement plan in satisfaction of its required contribution obligation was not a prohibited transaction. Fourteen days later, in Wood v. Commissioner, 955 F.2d 908 (4th Cir. 1992), the Fourth Circuit decided that it was.

   Prior to the Keystone and Wood cases, the IRS had issued two revenue rulings. In Rev. Rul. 77-379, 1977-2 C.B. 887, the IRS concluded that a private foundation's transfer of stock to a disqualified person in repayment of an interest-free loan was an act of self-dealing because it was tantamount to a sale or exchange of property between a private foundation and a disqualified person. In Rev. Rul. 81-40, 1981 C.B. 508, the IRS ruled that the transfer of real estate by a disqualified person to a private foundation to correct an indebtedness constituted a new act of self-dealing.

   The IRS had also promulgated a regulation relating to the maximum amount that may be allocated in a qualified defined contribution plan. Treas. Reg. [section] 1.415-6(b)(4) provides that a contribution by an employer of property other than cash will be considered a contribution in an amount equal to the fair market value of the property on the date of contribution, cautioning that the contribution "may, however, constitute a prohibited transaction within the meaning of section 4975(c)(1)."

   Prior to Keystone and Wood, the Department of Labor had issued an advisory opinion regarding sections 406(a)(1)(A) and 406(c) of the Employee Retirement Income Security Act of 1974, which are basically identical to the Code provisions at issue in Keystone and Wood. Department of Labor Advisory Opinion 81-69A states that a contribution of an option to purchase a residential condominium unit by an employer to its qualified defined benefit plan in discharge of its contribution obligation would be a prohibited transaction.

2. Source of Controversy: Interpretation

   of Statutory Provisions

   The Department of Labor's position is relevant because the prohibited transaction provisions under section 406 of ERISA are nearly identical to the prohibited transaction provisions in the Code. Section 4975(c) of the Code imposes two excise taxes on any disqualified person who participates in a prohibited transaction. It expressly prohibits the direct or indirect -

   * sale, exchange, or leasing of any property between a plan and a disqualified person;

   * lending of money...