Revenue Administrative Bulletin 1990-35

Approved: December 21, 1990

SINGLE BUSINESS TAX TREATMENT OF TERMINATED PENSION PLANS

RAB-90-35. This bulletin explains the single business tax (SBT) treatment of funds reverting to a corporation from a terminated defined benefit pension plan. It illustrates the calculation of a negative compensation adjustment for that portion of the reversion amount that had previously been included in compensation in determining the SBT base.

Definition

A defined benefit pension plan is one in which plan contributions are dependent on promised benefits. Benefits are established under a definite formula and contributions are made at a rate determined to be actuarially necessary to provide those benefits.

Law

MCL 208.9(1); MSA 7.558(9)(1) defines "tax base" as business income, subject to adjustments in subsections (2) through (9). Subsection (5) requires that the tax base be adjusted be adding "compensation as defined in Section 4." Section 4 [MCL 208.4(3); MSA 7.558(4)(3)] includes in the definition of compensation for SBT purposes "payments to a pension, retirement, or profit sharing plan." Because payments to a pension plan are included in the tax base when they are made, a negative compensation adjustment may be made for that portion of the pension plan that reverts to the corporation upon termination of the plan.

Calculation

Distribution of terminated pension plan funds goes to the retirees. Any amounts remaining in the fund after distribution to retirees revert to the corporation.

The corporation will be allowed a negative compensation adjustment for that portion of the reversion amount that had previously been included in compensation in determining the SBT base. Post-1975 contributions that would have been included in compensation in determining the SBT base must be separated from the pre-1976 contributions and from income earned by the plan. The following calculation incorporates those adjustments to allow only that portion of the fund that had been included in the SBT base to be taken as a negative compensation adjustment.

1. Reduce to a fraction that portion of the contributions to the fund that had been included in compensation in determining the SBT base, as follows: Divide post-1/1/76 contributions to the pension fund by the total contributions to the pension fund. This adjustment is necessary as only contributions made after 1/1/76 would have been included in compensation in determining the SBT base.

1. Reduce the proportion of the fund derived from contributions to a fraction, as follows: Total contributions to the pension fund divided by total contributions plus earned income of the fund. This adjustment is necessary as a negative adjustment for interest, dividend, and other income earned by the pension fund as a separate entity is not allowed as a compensation adjustment. Dividend and interest earnings of the fund are not income to the corporation. The portion of the pension plan reversion which constitutes earnings of the fund is not an allowable subtraction for dividend and interest income.

1. Multiply the fractions obtained in steps 1 and 2 above by the amount of the fund distributed to the corporation.

Example

A pension fund is terminated in 1988, and the balance of the fund is distributed to Corporation Z. A contribution of $50,000 was made to the fund in calendar year 1975, and a $150,000 contribution was made in 1976. (These contributions were expensed on the taxpayer's federal income tax returns in 1975 and 1976.) The fund earned $200,000 in interest income. At termination, Corporation Z received $100,000 in distributions. $300,000 had been distributed to retirees.

Step 1: Divide the post-1975 contributions ($150,000) by the total contributions ($200,000). $150,000 divided by $200,000 = 3/4.

Step 2: Divide total contributions to the fund ($200,000) by total contributions plus earned income of the fund ($400,000). $200,000 divided by $400,000 = 1/2.