Payments to nonqualified trust that replaced terminated pension plans were not exempt from employment taxes.

• Author: Fiore, Nicholas J.

The L Company, a steel company, was formed in 1984 from the R and J Companies. R and J each maintained a defined benefit pension plan for their hourly workers; those plans were the products of collective bargaining with the steelworkers' union. In addition, R and J maintained separate defined benefit plans for their salaried employees. All four of these plans qualified under Sec. 401.

In 1986, L was part of a bankruptcy reorganization. The Pension Benefit Guaranty Corporation (PBGC) terminated L's four pension plans. The PBGC began paying guaranteed basic benefits to the funds' beneficiaries; however, these benefits were substantially less than the amounts L had been paying under the plans themselves.

The steelworkers' union went to court, seeking to force L to make up the lost benefits. L and the union settled in 1987. Under the settlement agreement, L agreed to make payments to an individual account trust (IAT); those funds would then be used to pay most of the difference. L agreed to a similar arrangement with its salaried workers. L established the IATs as nonqualified plans.

The PBGC concluded that the IAT programs were "follow-on" plans--new benefit arrangements, instituted after the termination of a qualified plan, that supplement the benefits paid by the PBGC to provide beneficiaries of the terminated plans substantially the same benefits they would have received had no termination occurred. The PBGC views follow-on plans as abusive (because they result in the PBGC subsidizing an employer's ongoing pension plan). The PBGC therefore directed that three of L's pension plans be restored. L objected to this order and brought suit. Ultimately, the Supreme Court held for the PBGC. L restored the three plans and resumed making payments to the beneficiaries.

For the payments L had made under the two IAT programs, it had paid FICA and FUTA taxes. L then filed a claim for refund of those payments. The Court of Federal Claims held for L and directed the government to refund FICA and FUTA taxes to L. The Federal Circuit (opinion Bryson, J.) reverses; because the payments were made from the IATs (which were nonqualified), they were not exempt from FICA and FUTA taxes.

Before 1983, all payments to pension plan beneficiaries were exempt from FICA and FUTA taxes. In that year, Congress changed the tax laws so that only qualified plans would continue to be exempt from FICA taxes. The following year, Congress made a parallel change in the tax laws to...