Payments to Nonqualified Trust That Replaced Terminated Pension Plans Were Not Exempt from Employment Taxes

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 impose FUTA taxes on benefit payments from nonqualified pension plans.

Although the 1983 and 1984 legislation imposed FICA and FUTA taxes on payments made from nonqualified plans, Congress enacted a "transitional rule," which provided that "in the case of an agreement in existence on March 24, 1983, between a nonqualified deferred compensation plan" and an individual, FICA and FUTA taxes would not be imposed on payments made with respect to services performed before the end of 1983 (for FICA taxes) and 1984 (for FUTA taxes). The Court of Federal Claims ruled that, under this transition rule, the payments made from the IATs for services performed before 1984 (for FICA taxes) and before 1985 (for FUTA taxes) were exempt.

The government's position is that the transition rule is inapplicable because the payments made under the IAT programs were not made "in the case of an agreement in existence on March 24, 1983." The IAT programs do not qualify as agreements "in existence on March 24, 1983," the government argues, because they were set up in 1987 pursuant to the settlement agreements among L, the steelworkers' union and the L retirees. Because the transition rule does not apply and the IATs were nonqualified plans, the government concludes that the payments from the IATs are subject to FICA and FUTA taxes.

The Court of Federal Claims rejected that argument on the ground that L "had a continuing obligation to pay accrued benefits after PBGC termination," and thus the payments made by the IATs "were made with respect to agreements that were in existence on March 24, 1983." L agrees and argues that, even though payments from the IATs were not made "pursuant to" a pre-1983 agreement, they were nonetheless made "in the case of" a pre-1983 agreement (the statutory language), because the payments from the IATs were made in settlement of L's legal obligation to pay pension benefits under the pre-1983 qualified plans, even though those plans had been terminated by the PBGC.

We agree with the government: While it is true that the reason for the 1987 settlement agreements was to resolve L's legal obligations to pay pension benefits, and while it is true that L's original pension obligations stemmed from agreements or other undertakings that pre-dated the 1983 cut-off date, the payments at issue were made pursuant to the 1987 agreements, not pursuant to the earlier pension plans, all of which were terminated and no longer paid benefits to any beneficiaries.

L argues that the language of the statute, which refers to funds paid "in the case of an agreement in existence on March 24, 1983" (rather than funds paid "under" or "pursuant to" such an agreement), is broad enough to reach a case such as this one, in which the employees accrued rights under an earlier agreement but received benefits under a later agreement. That argument is not convincing; the payments were not made "in the case of" any pre-1983 agreement, but "in the case of" the 1987 settlement agreements. The 1987 agreements dictated the amount of the payments, the structure of the various benefits, the mechanism for funding the trusts and the consequences of default. The 1987 agreements terminated the beneficiaries' rights under the pre-1983 agreements and replaced them with a new and significantly different set of rights under the IAT programs. At that point, the pre-1983 agreements became matters only of historical interest. Therefore, while the reason for the payments under the IAT programs ultimately derived from L's obligations under the pre-1983 agreements, the payments cannot be said to have been made "in the case of" any pre-1983 agreement.

L's interpretation of the transitional rule is inconsistent with the regulation that Treasury has adopted for administering the rule. In referring to the trigger for FICA liability, Regs. Sec. 31.3121(v)(2)-2(c)(2) refers to benefits "paid under" an agreement that post-dates March 24, 1983 (i.e., the regulation interprets the statutory reference to funds paid "in the case of" an agreement post-dating March 24,1983, as meaning funds "paid under" such an agreement).

L argues that such a reading of the transitional rule would deny the FICA and FUTA tax exemption to any nonqualified plan amended in any way after March 24, 1983, but that is clearly not the case. Regs. Sec. 31.3121(v)(2)-2(b)(6) makes clear that an agreement in existence on March 24, 1983 "does not fail to be [such an agreement] merely because the terms of the plan are changed after March 24, 1983." Thus, a pension plan does not fall outside the scope of the transitional rule simply because it is amended in some fashion after the date the transitional rule was enacted. Amending an ongoing plan, however, is quite different from terminating a plan and resuming the payment of benefits under a new and different plan. Plans are frequently amended in response to statutory changes, economic conditions and agreements between the parties, and the parties are free to amend plans within broad statutory limits. Termination, however, constitutes the death of a plan; it can be effected only in circumstances strictly defined, and its consequences are prescribed in detail by statute.

The plans in existence on March 24, 1983 were terminated, not amended. Even though L used the IATs to make the payments that settled all its obligations stemming from pre-1983 agreements, the IATs created in 1987 were new trusts, not simply amended continuations of pre-1983 plans. Accordingly, the benefits paid pursuant to the IATs were made pursuant to the 1987 agreements, not to plans terminated during the previous year. For that reason, the transitional rule did not make any of those payments exempt from FICA and FUTA taxes.

LTV Steel Company, Inc., Fed. Cir., 6/12/00