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CCH® PENSION AND BENEFITS — 2/3/06

Pension underfunding penalties entitled to administrative expense priority in bankruptcy, IRS says

The IRS has clarified its position that pension under-funding taxes related to a bankruptcy estate's postpetition pension obligations are entitled to administrative expense priority. Normally, a 10% tax is imposed via Code Sec. 4971(a) on a retirement plan's accumulated funding deficiency for each taxable year that the plan is maintained, and an additional tax consisting of 100% of the accumulated funding deficiency is imposed if the deficiency is not corrected prior to either the mailing of the notice of deficiency of the 10% tax, or the time the 10% is assessed. The IRS points out that, although these liabilities are labeled "taxes" by the Code, they are considered penalties for bankruptcy purposes.

Under the Bankruptcy Code, administrative expenses of the bankruptcy estate are accorded priority over most prepetition claims. The IRS has stated that penalty taxes under Code Sec. 4971(a) and Code Sec. 4971(b) are administrative expenses if they relate to postpetition pension obligations, and that a debtor-in-possession is obligated to operate its business in accordance with federal pension law. The IRS analogized these penalty taxes to other nonbankruptcy penalties stemming from the operation of a debtor's business, which are also allowable administrative expenses of the bankruptcy estate.

IRS rejects bankruptcy courts' rulings

In its latest guidance, the IRS specifically rejected the finding of two courts, in In re Unitcast, (219 B.R. 741, B.A.P. 6th Cir. 1998) and In re CF&I Fabricators of Utah, Inc., (148 B.R. 332, Bankr. D. Utah 1992). Both bankruptcy courts held that the Code Sec. 4971(a) taxes are not administrative expenses of the bankruptcy estate, and thus were not entitled to administrative expense priority. It is the IRS' view that neither opinion properly considered the application of the list of expenses that are given priority, as provided in Bankruptcy Code Sec. 503(b)(1)(A).

For more information on this and related topics, consult the CCH Pension Plan Guide.

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