Rev. Rul. 65-200

The Internal Revenue Service has been requested to explain the application of section 401(e)(3) of the Internal Revenue Code of 1954, as added by the Self-Employed Individuals Tax Retirement Act of 1962, Public Law 87-792, C.B. 1962-3, 89, with respect to the three-year period used in computing the limitation on the amount of employer contributions used to pay premiums under an insurance contract.

Annual contributions on behalf of an owner-employee which amount to more than the lesser of (1) $2,500, or (2) ten percent of his earned income, are excess contributions which are not permitted under a qualified plan. However, there is an exception to this requirement in cases where the plan requires the contributions to be applied to pay premiums or other consideration for annuity, endowment, or life insurance contracts. In such cases, the premiums shall be based on earned income averaged over a period of three years prior to the date on which the last insurance contract was issued.

Under such circumstances, contributions based on the average earned income are not excess contributions even though the average earned income of the owner-employee may decline and the amount contributed may exceed ten percent of his earned income for the current taxable year. On the other hand, should average earned income increase, an additional contract may be purchased or an existing contract may be enlarged, provided that the total contributions made for the current taxable year on behalf of an owner-employee do not exceed $2,500. In such case, the last insurance contract issued under the plan is considered to be issued in the current taxable year.