It should be stated at the outset that this strategy for recapturing the excess assets from an overfunded plan has been upheld by various courts and rulings, but that certain IRS opinions leave the door open for the IRS to challenge the outcome of the approach, especially with respect to the elimination of the punitive 4980 excise tax --which is a primary purpose of this approach.
The strategic sale of the sponsor of an overfunded plan requires a strategic buyer who is the sponsor of an underfunded plan that can be merged with the overfunded plan after the sale. The result of the plan merger is the amelioration of two sets of problems: one set related to the overfunded plan, and a different set related to the underfunded plan. It should be noted that the Pension Benefit Guaranty Corporation (PBGC) more than welcomes the relief provided to the underfunded plan since this also eliminates some of the exposure of the PBGC to unfunded benefits that it might otherwise have to fund in the future. In turn, the reduced risk to the PBGC is a benefit to the public at large, since it reduces the potential for a future PBGC bailout.
Sponsor B negotiates an agreement to acquire the stock of Sponsor A.
The negotiated purchase price of the stock takes into account the value of the overfunding of Plan A.
The business sale is transacted.
Sponsor B subsequently merges Plan A into Plan B.
Sponsor B terminates the employment of any employees acquired from Sponsor A and distributes benefits to the participants from Plan A. The benefits of participants from Plan A are fully protected by law throughout the entire process.
The excess assets from the overfunding of Plan A remain in Plan B as assets of the merged plan and reduce or eliminate the underfunding of Plan B.
The market rate placed on the value for the overfunding is typically 70% to 75% of the actual overfunding. That is, the seller can expect to receive 70 to 75 cents on the dollar for the excess assets in the plan, and this amount will be subject to Capital Gains treatment and taxation.
The specific details of the transaction can vary; they may involve transfer of subsidiaries or divisions, stock-swaps, or the retention of active employees.
The strategic sale strategy is incredibly beneficial when compared to an employer taking a reversion of the excess plan assets. Note that there are other alternatives that should be considered, however, before going through this complex--and potentially scrutinized--alternative. (See article on Overfunded Defined Benefit Plan alternatives.)
Take a closely held C-Corp that has a terminating plan with $2,900,000 in assets but only $1,900,000 in lump sum payouts, leaving $1,000,000 in excess assets as a potential reversion. We also assume that the owner(s) will benefit from the Replacement Plan or the Prorata Benefit Increase (different scenarios), and, specifically, that the owner's portion of such benefits will amount to 80% of the total. The table compares the strategic sale option on the right to the 3 reversion options (see 4980 - excise tax article for further discussion).
20% Used to
Excise Tax (50% or 20% rates)
Income Tax (40%
Net Reversion to
Shareholder/Owner Level Transactions
Income Tax (40%
Net After-Tax Recovery to Owners(s)
Owner's Benefit Allocation
assumed effective rate)
After-Tax Value of Deferred Benefits
Amount to Owner(s)
% of Excess Retained by Owner(s)
Clearly, if a reversion cannot be avoided through other means (see Overfunded Defined Benefit Plans ), a strategic sale of the business is an attractive alternative.
One high profile example of a strategic sale and subsequent plan merger is the purchase of DeSoto, Inc. by Keystone Consolidated Industries, Inc. in 1996.
DeSoto was a manufacturer of household cleaning products facing bankruptcy with current debts of about $9 million, but with a pension plan that was overfunded by about $53 million.
On the other hand, Keystone, a fencing manufacturer, was currently profitable but had grossly underfunded pension plans. In fact, their $84 million in underfunding placed them on the PBGC's "hit list".
Through a tax-free stock-swap that was approved by shareholders of both companies, DeSoto became a wholly owned subsidiary of Keystone, Keystone paid off DeSoto's debts, Keystone merged its 3 underfunded plans with the overfunded plan from DeSoto. The underfunding was reduced to less than $30 million. The funded ratio of the Keystone plans jumped from 57% to 90%. The PBGC heartily approved of the arrangement, having given their approval for Keystone to borrow funds that were necessary in the acquisition process. More details are found in:
There are numerous professional advisers who promote and even broker strategic sale transactions, yet there are also professionals who are cautious about this strategy. Caution and knowledge of the potential risks seem advisable.
In a recent article with detailed argumentation on the "Sale of Overfunded Pension Plans and Indirect Reversions," Christopher Guldberg raises questions regarding the central goal of the strategic sale strategy. Specifically, he questions whether the IRS might impose the section 4980 on the proceeds of such a transaction as an "indirect reversion." Guldberg bases his concerns on explicit language from the original Conference Committee that wrote the law which "makes it clear that Congress did not intend to limit the Treasury's ability to apply the excise tax in the context of corporate transactions." He also analyzes an important IRS ruling (TAM 9650002) that determined certain taxes were applicable on such a transaction but failed to address the applicability of section 4980 simply "because the date of the plan termination was before January 1, 1986," the date 4980 first applied. It's been suggested by some that the value placed on the overfunding should not be explicit in the buy-sell agreement, but this matter of form-over-substance may be immaterial. Guldberg also notes that there is no statute of limitations for the IRS to pursue this excise tax on strategic sale transactions because no Form 5330 is every filed reporting the "reversion" in question.
Bill Miner of Watson Wyatt Worldwide is also reported as cautioning, "There are so many rules and regulations and laws governing these plans that things are not clean and well-defined. There's a gray area that may be challenged" (quoted in "When Assets Runneth Over").
It is generally agreed that the buy-sell arrangement should include other business motivations and considerations involved in the buy-sell transaction other than just the recovery of excess assets from an overfunded plan. It may also be advisable to restructure the business prior to the sale, such as incorporating a business that has operated as a sole-proprietorship. Some advisers suggest that the purchaser be a non-profit entity, but most information does not point in this direction.
Having stated these words of caution, it must be noted that the IRS has not taken any action to curtail business transactions that include the transfer of an overfunded plan. As noted above (under "Example"), the PBGC has stated their view of such transactions very positively. In addition, the IRS has audited numerous employers and plans involved in such transactions without raising any issues about the strategic sale transaction. Which is why experienced professionals in this area are both comfortable and confident that a strategic sale can be a sound solution to the problem of an overfunded plan.