Rev. Rul. 57-163

                                SUMMARY

(a) BACKGROUND.-An employees' trust which is qualified under section 401(a) of the Internal Revenue Code of 1954 is exempt from tax under section 501(a) unless such exemption is denied under section 502 (relating to feeder organizations) or 503 (relating to prohibited transactions). Further, section 511 imposes a tax on the unrelated business taxable income of an exempt organization. A trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries constitutes a qualified trust under section 401(a) if the requirements set forth in such section are met. Nontrusteed annuity plans with respect to which amounts received by employees and their beneficiaries are taxable under section 403(a), and with respect to which deductions claimed for contributions are allowable in accordance with section 404(a)(2), must, except as otherwise provided in section 403(a)(1), also meet the requirements of paragraphs (3) through (6) of section 401(a).

(b) PURPOSE.-It is the purpose of this Revenue Ruling to set forth the guides which have been developed as a result of the determination of various issues relative to the qualification of plans and trusts, to correlate such rules with the applicable requirements of the Internal Revenue Code of 1954, and to codify various individual releases, except in cases where to do so would merely be repetitious or cumulative, and, in such cases, reference is made to the specific release in point. The issues discussed here are not all-inclusive but are those which have been found to be present in many plans. As new issues of general import arise supplemental releases will be issued. See, however, P.S. 35 revised, November 16, 1944, and Rev. Rul. 54-172, C.B. 1954-1, 394.

(c) RULES PREVIOUSLY PROMULGATED.-Revenue Ruling No. 33, C.B. 1953-1, 267, sets forth rules which have been developed with respect to the qualification of plans under section 165(a) of the Internal Revenue Code of 1939. Such rules are accordingly modified to the extent of any inconsistencies with the views here expressed.

(d) REFERENCES.-Certain issues are common to all types of plans while others are applicable to pension and annuity plans, or profit-sharing and stock bonus plans. The various issues are discussed in their relationship to the applicable provisions of the Internal Revenue Code of 1954 and corresponding regulations. Rulings listed in the appendix are incorporated by reference and made a part hereof, with appropriate modifications to conform to the 1954 Code. The omission of certain rulings from the appendix is not to be construed as a revocation or modification of any such rulings. Only those rulings which are appropriate to the particular textual material are referred to. Internal Revenue Bulletin citations are furnished with respect to material published in the Bulletin. P.S. releases have also been made public although not published in the Bulletin. Copies are available in the respective offices of District Directors of Internal Revenue and the National Office in Washington. The present status of such releases is shown in the appendix.

PART 2. -- QUALIFIED PENSION, PROFIT-SHARING, AND STOCK BONUS PLANS

SECTION 401(a) OF THE INTERNAL REVENUE CODE OF 1954-REGULATIONS SECTION 1.401-1

(a) WRITTEN DOCUMENTS.-A qualified plan must be a definite written program setting forth all provisions essential for qualification. See section 1.401-1(a)(2) of Income Tax Regulations. In the case of a trusteed plan, there must be a valid existing trust, recognized as such under the local law, under a plan in effect. See Mimeograph 5985, C.B. 1946-1, 72. The trust must be evidenced by an executed written document setting forth the terms thereof. See Mimeograph 6394, C.B. 1949-1, 118, and Revenue Ruling 56-673, C.B. 1956-2, 281. In the case of a nontrusteed annuity plan which is evidenced by contracts with an insurance company, the plan is not in effect until such contracts are executed and issued. See Mimeograph 6020, C.B. 1946-1, 74.

(b) COMMUNICATION TO EMPLOYEES.-Employees are to be apprised of the establishment of a plan and the salient provisions thereof. The most effective way of doing so is to furnish each employee with a copy of the plan. It may not be feasible, however, to do so in all cases. Various substitutes may therefore be used. For example, it will be sufficient that a booklet summarizing the plan in all its essential features be furnished the employees, or that a notice be posted on the company's bulletin board, which must be in conspicuous view, that a plan has been established, setting forth the type thereof, the eligibility requirements, a synopsis of all benefits provided thereunder, whether employees are to contribute and, if so, the amount of contributions, vesting provisions, and, if a profit-sharing or stock bonus plan, the employer contribution commitment if any, and that a copy of the complete plan may be inspected at a designated place on the company's premises during stated times.

(c) STOCK BONUS, PENSION, OR PROFIT-SHARING PLAN.-The provisions of section 401(a) of the Code are applicable to a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries. See section 1.401-1(b) of the Income Tax Regulations for definitions of the various types of plans. Certain principles within the purview of such section of the Code relate to plans generally while others pertain to pension (including annuity) plans or profit-sharing and stock bonus plans.

(1) Plans generally .-Several employers may join in maintaining a single plan but each must meet all applicable requirements. See section 1.401-1(d) of the Income Tax Regulations and P.S. No. 14, dated August 24, 1944. A qualified plan cannot be maintained when there are no employees, active or retired, who are covered thereunder. See Revenue Ruling 55-629, C.B. 1955-2, 588. An arrangement cannot qualify as a pension, profit-sharing, or stock bonus plan under section 401(a) if the benefits thereunder are not payable to the employee but only to his beneficiary upon his death. See Revenue Ruling 56-656, C.B. 1956-2, 280.

(2) Pension and annuity plans .-An employer may establish a qualified pension plan under which current contributions are made by employees only, but under which he is obligated to pay the full amount of the stipulated retirement benefits to each retired employee participant after the funds in the trust which forms a part of such plan have been fully exhausted. See Revenue Ruling 54-152, C.B. 1954-1, 149. A pension plan, within the purview of section 401(a), does not provide for the payment of benefits not customarily included in that type of plan, such as layoff benefits or benefits for sickness, accident, hospitalization, or medical expenses. See the last sentence of section 1.401-1(b)(1)(i) of the Income Tax Regulations. However, the annuity portion of a contract with an insurance company, by means of which an employees' nontrusteed annuity plan is funded, may, if otherwise satisfactory, meet the applicable requirements for qualification, even though the contract also provides separate group term life insurance and accident and health insurance. See Revenue Ruling 56-633, C.B. 1956-2, 279. A pension plan may provide incidental benefits prior to normal retirement, such as disability and death benefits, but if it permits participants, prior to severance of employment or termination of the plan, to withdraw all or part of the funds accumulated on their behalf, except their own contributions on discontinuance of participation, in times of financial need or otherwise, it will fail of qualification. A similar provision in a profit-sharing plan, however, may, under appropriate circumstances, be acceptable. See Revenue Ruling 56-693, C.B. 1956-2, 282.

(3) Profit-sharing and stock bonus plans .-Funds under a profit-sharing plan must be accumulated for a fixed number of years, or until the attainment of a stated age or prior occurrence of some event, such as layoff, illness, disability, retirement, death, or severance of employment. The term `fixed number of years' is considered to mean at least two years. See Revenue Ruling 54-231, C.B. 1954-1, 150. A stock bonus plan is similar to a profit-sharing plan except that the contributions by the employer are not necessarily dependent upon profits and the benefits are distributable in stock of the employer company. Section 1.401-1(b)(1)(iii) of the Income Tax Regulations.

(d) EMPLOYEES' TRUST.-In order to constitute a qualified trust under section 401(a), which is exempt under section 501(a), an employees' trust must be organized or created in the United States and maintained at all times as a domestic trust. If, however, a foreign situs trust meets the requirements of section 401(a) in all other respects, employers making contributions thereunder are allowed deductions within the applicable limits, in accordance with section 404(a)(4) of the Code, and beneficiaries of such trust are granted the same tax treatment under section 402(c) of the Code as is applicable to beneficiaries of a domestic trust, except in the case of a nonresident alien individual. See sections 871 and 1441 of the Code and the regulations thereunder. Where, under specified conditions, separate qualified and exempt trusts pool their funds in a group trust created to provide diversification of investments, the group trust may also be exempt and the status for exemption of the separate trusts will not be adversely affected. See Revenue Ruling 56-267, C.B. 1956-1, 206.

(e) PROFIT-SHARING AND STOCK BONUS PLANS OF AFFILIATED COMPANIES.-In the case of a profit-sharing plan, or stock bonus plan in which contributions are determined with reference to profits, of an affiliated group within the purview of section 1504 of the Code, contributions may be made by other members of the group for the benefit of employees of a member which is prevented from making a contribution because it lacks or has insufficient current or accumulated earnings or profits, to the extent and in the manner provided in section 404(a)(3)(B) of the Code and section 1.404(a)-10 of the Income Tax Regulations.

(f) FEEDER PLAN.-A stock bonus or profit-sharing plan which provides that the funds therein may be used to meet the costs of a pension or annuity plan operated concurrently and covering the same employees, if and when the employer suspends contributions to such latter plan, is generally called a `feeder' plan and cannot be a qualified plan since it relieves the employer from contributing to the pension or annuity plan and is therefore not for the exclusive benefit of employees or their beneficiaries. See section 1.401-1(b)(3) of the Income Tax Regulations. An employee who has a vested right under a stock bonus or profit-sharing plan may, however, if the plan so provides, authorize a transfer of all or part of his vested interest to make up for a deficiency in the employer's contribution under a pension or annuity plan. In such case, he will be taxable on the transfer as though a distribution of such interest had been made. See P.S. No. 37, dated October 7, 1944. It should also be observed that a feeder plan is different from a feeder organization. In the latter respect, see section 502 of the Code which denies exemption under section 501 to an organization which is operated for the primary purpose of carrying on a trade or business for profit even though all of its profits are payable to one or more organizations exempt under section 501.

(g) DEFINITELY DETERMINABLE BENEFITS.-Benefits under a qualified pension plan must be definitely determinable. See section 1.401-1(b)(1)(i) of the Income Tax Regulations. Benefits are not definitely determinable if they may be suspended after retirement, without cause. The plan may provide, however, that benefits shall be suspended for any period of time during which primary insurance benefits under the Federal Social Security Act are discontinued because of employment after retirement date. See Revenue Ruling 82, C.B. 1953-1, 288. Benefits which vary with the increase or decrease in the market value of the assets from which such benefits are payable, or which vary with the fluctuations of a specified and generally recognized cost-of-living index, will be recognized as a plan providing for definitely determinable benefits. See Revenue Ruling 185, C.B. 1953-2, 202.

(h) PERMANENCY.-A plan within the meaning of section 401(a) of the Code is a permanent and continuing program. A plan which is set up during years of high tax rates and is abandoned within a few years without a valid business reason when profits fall off is not within the intent of such section. Also, especially in the case of a pension plan under which benefits are funded at a higher rate for employees in whose favor discrimination is prohibited than for other employees, if the plan is discontinued before ample provision is made for comparable benefits for such other employees, it will be deemed not to have been a bona fide program from its inception for the exclusive benefit of employees in general. As for profit-sharing, merely making a single or occasional contribution out of profits for employees does not establish a qualified profit-sharing plan. Under such a plan there must be recurring and substantial contributions. See section 1.401-1(b)(2) of the Income Tax Regulations. For a more detailed discussion of the applicable principles and illustrative cases, see Mimeograph No. 6136, C.B. 1947-1, 58, as modified by Revenue Ruling 55-60, C.B. 1955-1, 37. See also Exhibit `A' of Revenue Procedure 56-12, C.B. 1956-1, 1029, for information to be filed for a determination as to the effect of a curtailment or termination of a plan on its prior qualification; P.S. No. 56, dated June 27, 1946, as to notice by the trustee as to termination of a plan; P.S. No. 57, dated August 5, 1946, as modified by Revenue Ruling 56-596, C.B. 1956-2, 288, as to the effect of a suspension of contributions; and P.S. Nos. 64 and 67, dated November 9, 1950 and April 26, 1951, respectively, and Revenue Ruling 55-681, C.B. 1955-2, 585, as to union negotiated plans. A qualified profit-sharing plan may, under applicable circumstances, provide that an employee may elect each year to participate in the trust forming a part of such plan or to accept his share in cash. See, however, parts 4(e) and 5(a) hereof as to meeting the requirements for coverage and nondiscrimination in contributions or benefits. A profit-sharing plan which does not contain a definite contribution formula may qualify if all other applicable requirements are met. See section 1.401-1(b)(1)(ii) of the Income Tax Regulations and Revenue Procedure 56-22, C.B. 1956-2, 1380.

(i) EXCLUSIVE BENEFIT OF EMPLOYEES OR THEIR BENEFICIARIES.-The plan must be for the exclusive benefit of employees or their beneficiaries.

(1) Partners .-Partners are not employees and therefore are not eligible to participate in the plan. See I.T. 3350, C.B. 1940-1, 64, and PS 23, dated September 2, 1944. Neither are they to be credited for services as partners prior to becoming employees in a successor corporation, both for prior service benefits and for meeting the eligibility requirements. See also section 1361(d) of the Code which provides that a partner or proprietor of an unincorporated business enterprise electing to be taxed as a corporation shall not be considered an employee for the purpose of participating in a qualified plan. Where a group of doctors adopt the form of an association in order to obtain the benefits of corporate status for purposes of section 401(a) of the Code, it is in substance a partnership and the doctor-members are employers and therefore not eligible to participate in a qualified plan as employees. Furthermore, any period of service as members of a prior partnership will not be credited as a period of employment for purposes of such section of the Code. See Revenue Ruling 56-23, C.B. 1956-1, 598.

(2) Stockholder participants .-Stockholders who are bona fide employees of a corporation may participate in the corporation's plan to the same extent as other employees. If, however, the plan is designed as a subterfuge for the distribution of profits to stockholders, even if it includes other employees who are not stockholders, it will not qualify as a plan for the exclusive benefit of employees. The plan must not be weighted in favor of stockholder employees either with respect to eligibility requirements or with respect to contributions, or benefits. See section 1.40-1(b)(3) of the Income Tax Regulations and I.T. 4020, C.B. 1950-2, 61.

(3) Attorneys and other practitioners .-An attorney, or other professional person, may be a bona fide employee, and, as such, eligible to participate in a qualified plan. The mere fact that a practitioner also has an independent income from the practice of his profession will not necessarily preclude him from participating in such a plan. He must, however, be an employee for all purposes, including coverage as an employee for social security or similar public program, if applicable to other employees, and for income tax withholding purposes. Thus, if his actual employment for such purposes commences as of a certain date, he is not entitled to credit for services prior thereto, such as, for example, for the purpose of meeting the years of service requirement to be eligible to participate in the plan or to be entitled to past service credits.

(4) Insurance agents .-Section 7701(a)(20) of the Code provides that for the purpose of contributions to, and distributions from, a stock bonus, pension, or profit-sharing plan or trust, or under an annuity plan, the term `employee' shall include a full-time life insurance salesman who is considered an employee for the purpose of the Federal Insurance Contribution Act, or in the case of services performed before January 1, 1951, who would be considered an employee if his services were performed during 1951. Thus, the same rules apply with respect to treating full-time life insurance salesmen as employees for inclusion in a plan described in section 401(a) as are applicable to taxability for oldage and survivors' insurance purposes. This inclusion does not, however, extend to insurance brokers and others who are not full-time life insurance agents within the purview of section 3121(d)(3)(B) of the Code.

(j) DESIGNATION OF BENEFICIARIES.-Beneficiaries of employees under a qualified plan may be designated by the respective participants without restriction, or they may be restricted under the plan to specified persons, or to a group of persons, who are the natural objects of the employees' bounty, his estate, or his dependents. See Revenue Ruling No. 54-398, C.B. 1954-2, 239.

(k) INVESTMENT OF TRUST FUNDS.-Trust investments must be for the exclusive benefit of employees or their beneficiaries. While an incidental benefit may also inure to other, the primary purpose of benefiting employees or their beneficiaries must be maintained. For example, a sale of securities to the trust may benefit the vendor in that it may have resulted in a profit to him but, essentially, the purchase by the trustee must have been for the best interests of the trust; i.e. , the cost must not exceed fair market value at the time of purchase, a fair return commensurate with the prevailing rate must be provided, sufficient liquidity is to be maintained so as to permit distributions in accordance with the terms of the plan, and the safeguards that a prudent investor would look to are to exist.

(1) Stock or securities of the employer .-If the trust instrument and local law permit investments in the stock or securities of the employer, and if such investments are consistent with the purpose of benefiting employees or their beneficiaries, they are not otherwise precluded for the purpose of section 401(a) and 501(a) of the Code, unless such investments constitute prohibited transactions under section 503. Notification is to be given if stock or securities of the employer are acquired by the trust so that a determination may be made whether the trust serves any purpose other than constituting part of a plan for the exclusive benefit of employees. Such notification is to be made as part of the annual information return, Form 990-P, unless an advance determination is requested and, if so, at the time of making a request to the appropriate district director for such determination. The notification shall include information certified to by the accounting or other responsible officer as follows:

1. Balance sheets of the employer as at the close of the last accounting period and for the taxable year ended prior thereto.

2. Comparative statements of income and profit and loss for the last and four prior taxable years.

3. An analysis of the surplus account for the last five years, specifically showing the amount and rate of dividends paid on each class of stock.

4. A statement accounting for all material changes from the latest dates of the aforesaid statements to the date of filing the information.

5. A schedule showing the nature and amounts of the various assets in the trust fund.

6. A statement showing the amount of the investment, the type of investment, the present rate of return, the security if a loan is involved, and the reasons for the investment. (The information called for under items 1, 2, and 6 above, and related data, may be submitted in composite form as set forth in Exhibit `B-1' of Revenue Procedure 56-12, C.B. 1956-1, 1029.)

(2) Life Insurance contracts .-An exempt employees' trust may provide for investment of part of its funds in life insurance contracts without adversely affecting its status for exemption and the qualification of the plan, merely because of such provision. Where, however, in a pension plan the life insurance benefits are applied to reduce subsequent contributions by the employer, employer contributions attributable to such insurance may not be currently deductible. See Revenue Ruling 55-748, C.B. 1955-2, 234. If amounts allocated to the respective participants in any type of qualified plan are to be used to provide such participants with life insurance protection, the life insurance feature must be incidental and subordinate to the primary purpose of the plan which is to permit the employees or their beneficiaries to participate in a plan of deferred compensation. See section 1.401-1(b)(1)(i) and (ii) of the Income Tax Regulations. If the plan is used to provide employees only such benefits as are afforded through ordinary life insurance contracts, it is not a plan which can qualify under section 401(a), notwithstanding the fact that the contracts are convertible to life annuities at the normal retirement date. See Revenue Ruling 54-67, C.B. 1954-1, 149. An investment by a profit-sharing trust in an ordinary life insurance contract for the purpose of providing death benefits for each insurable participant under the trust will be considered incidental and subordinate to the primary purpose of a qualified profit-sharing plan where (1) the aggregate premiums for life insurance in the case of each participant is less than one-half of the aggregate of the contributions allocated to him at any particular time; and (2) the plan shall require the trustee to convert the entire value of the life insurance contract at or before retirement into cash or to provide periodic income so that no portion of such value may be used to continue life insurance protection beyond retirement. Under such circumstances the investment will not disqualify the plan under section 401(a). See Revenue Ruling 54-51, C.B. 1954-1, 147.

(3) Unrelated business income .-An exempt employees' trust is taxable under section 511 of the Code on its unrelated business taxable income, as defined in section 512, derived from any unrelated trade or business, as defined in section 513. Special rules are set forth in section 514 with respect to business leases. If business lease indebtedness is incurred, rental income is includible in gross income in the ratio that the business lease indebtedness, at the close of the taxable year, bears to the adjusted basis of the property.

(l) VALUATION OF SECURITIES ON INVENTORY DATE.-Any type of qualified plan which provides for distributions in accordance with amounts, stated or ascertainable, credited to participants ( i.e. , profit-sharing, stock bonus, and some self-administered trusteed money purchase pension plans) must provide for a valuation of securities held by the trust, at least once a year, on a specified inventory date, in accordance with a method consistently followed and uniformly applied. The fair market value on the inventory date is to be used for this purpose. The respective accounts of participants are to be adjusted in accordance with the valuation. For example, if as a result of a valuation on the inventory date, John Doe's account, which previously showed a balance of $1,000 is to be increased by one-tenth of one percent of the increase in the value of the trust securities, and such increase is $50,000, his interest is to be increased by $50.

(m) ALLOCATION OF STOCK BONUS AND PROFIT-SHARING FUNDS.-All funds in an exempt profit-sharing or stock bonus trust must be allocated to participants in accordance with a definite formula. Thus, no reserves are to be provided for by withholding allocations from participants. If suspense accounts are maintained, provision should be made for ascertaining the respective shares of participants in such accounts and such shares are to be included in the distributions.

PART 3. -- IMPOSSIBILITY OF DIVERSION UNDER THE TRUST INSTRUMENT

SECTION 401(a)(2) OF THE INTERNAL REVENUE CODE OF 1954-REGULATIONS SECTION 1.401-2

(a) TRUST INSTRUMENT MUST MAKE PROHIBITED DIVERSION IMPOSSIBLE.-Under section 401(a)(2) of the code the trust instrument must make it impossible, `* * * at any time prior to the satisfaction of all liabilities with respect to employees and their beneficiaries under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees or their beneficiaries * * *.' The term `trust instrument' means a written agreement. Although an oral trust may be effective within the purview of the applicable local law, for the purposes of paragraph (2) of section 401(a) of the Code, there must be a written trust instrument. It must also constitute a valid trust under the law prevailing in the jurisdiction to which it is subject. In addition, it must definitely and affirmatively make it impossible for the nonexempt diversion or use to occur. See Mimeograph 5985, C.B. 1946-1, 72, as to the requisites for the existence of a valid trust and a plan in effect and, also Mimeograph 6394, C.B. 1949-1, 118, as to the requirements for compliance with the provisions of section 401(a)(2) of the Code. A plan will not fail to qualify merely because it contains a provision whereby, except as to claims of the employer, the rights of the employee under the plan are not subject to the claims of creditors. See Revenue Ruling 56-432, C.B. 1956-2, 284.

(b) ERRONEOUS ACTUARIAL COMPUTATION.-Trust funds must not be used for purposes other than for the exclusive benefit of employees or their beneficiaries prior to the termination of the trust and the satisfaction of all liabilities with respect to employees and their beneficiaries under the trust, and, only then, may recovery be had in the case of a pension trust to the extent of any surplus existing because of an actuarial error. In determining whether any surplus exists on termination of a trust, and the amount thereof, all liabilities, contingent as well as fixed, with respect to employees and their beneficiaries under the trust must be taken into account. Fixed liabilities are the benefits payable to those who have become entitled to them. Contingent liabilities are the benefit credits accrued up to the time of termination of the trust for employees (and their beneficiaries) who might have become entitled to benefits if the trust had been continued indefinitely. If such liabilities are to be discharged by commuting the payments (other than through the purchase of insurance company contracts), the value thereof at the time of termination of the trust must be determined for this purpose by use of assumptions no less conservative in any respect than were used in determining costs during the previous life of the trust, and no discount for severances other than death may be assumed.

(c) NO REVERSION IN PROFIT-SHARING OR STOCK BONUS PLANS.-Allocations under profit-sharing and stock bonus plans are not predicated upon amounts actuarially necessary to provide stipulated retirement benefits. See I.T. 3660, C.B. 1944, 136. See also section 1.401 -1(b)(1)(i) of the Income Tax Regulations to the effect that a plan designed to provide benefits for employees or their beneficiaries to be paid upon retirement or over a period of years after retirement will, for the purposes of section 401(a) of the Code, be considered a pension plan if the employer contributions under the plan can be determined actuarially on the basis of definitely determinable benefits, or, as in the case of money purchase pension plans, such contributions are fixed without being geared to profits. Consequently, in profit-sharing and stock bonus plans there can be no reversion of any kind since such plans do not provide benefits which are predicated on actuarial assumptions or computations.

(d) APPLICATION OF DIVIDENDS AND OTHER CREDITS UNDER GROUP ANNUITY CONTRACTS.-Provisions analogous to that set forth in section 401(a)(2) of the Code, prohibiting diversion of funds from exempt trusts, are contained in section 404(a)(2) of the Code, relating to deductions of contributions under non-trusteed annuity plans, and in section 403(a)(2)(A)(ii) of the Code, relating to the capital gains treatment for certain distributions under non-trusteed annuity plans. Section 404(a)(2), for example, requires that, where retirement annuities are purchased, refunds of premiums, if any, must be applied within the current taxable year or next succeeding taxable year towards the purchase of such retirement annuities. To satisfy this requirement, there must be a definite written arrangement between the employer and the insurer, either as part of the annuity contract or by separate written direction from the employer to the insurer, or partly in one form and partly in the other, providing that:

(1) No credits or returns, other than those arising from corrections of errors in records or computations, such as misstated ages or similar corrections, may be paid to the employer prior to permanent discontinuance of contributions.

(2) All dividends, experience rating credits, or employer surrender or cancellation credits ascertained prior to permanent discontinuance or contributions are to be applied regularly as they are determined toward the premiums next due for purchase of annuities under the plan before any further employer contributions are so applied.

(3) If surrender or cancellation credits may be made after discontinuance of the plan but before all retirement annuities with respect to service prior to discontinuance of the plan have been purchased, such credits will be applied regularly as they are determined to purchase such retirement annuities by a procedure which does not contravene the conditions of section 401(a)(4) of the Code.

(4) Any dividends or experience credits similar to dividends made after permanent discontinuance of contributions or any surrender or cancellation credits made after permanent discontinuance of contributions and after all retirement annuities with respect to service prior to discontinuance of the plan have been purchased may be paid to the employer provided they are paid as nearly as practicable as they are determined so that no substantial accumulation results. (It may be noted that this possibility of return to the employer after discontinuance is analogous to the provision permitting return to the employer, on termination of an exempt pension trust of any surplus arising from erroneous actuarial computations.)

PART 4. -- REQUIREMENTS AS TO COVERAGE

SECTION 401(a)(3)(A) AND (B), (5), AND (6) OF THE INTERNAL REVENUE CODE OF 1954-REGULATIONS SECTION 1.401-3

(a) PLAN MUST BENEFIT EMPLOYEES IN GENERAL.-Section 401(a)(3) of the Code permits an employer to designate several pension, stock bonus, profit-sharing, and annuity plans as constituting parts of a plan which he intends to qualify under such section. If all of the plans so designated cover a sufficient portion of all employees, there is no requirement that a definite proportion of the employees be included in any one plan. The plan, or plans, must benefit employees in general and, towards this end, must cover either a number which is at least equal to that determined under the percentage provisions of section 401(a)(3)(A) of the Code, or such employees as qualify under a nondiscriminatory classification within the purview of section 401(a)(3)(B) of the Code. A plan will not necessarily fail of qualification merely because it covers only the employer's one employee, provided, however, that it is not designed, or is not operated, as a means of siphoning profits to a shareholder-employee or otherwise limiting participation to an employee of a class in whose favor discrimination is prohibited under section 401(a)(3)(B) and (4) of the Code. See Revenue Ruling 55-81, C.B. 1955-1, 392.

(b) CONTINUING PARTICIPATION IN THE EVENT OF LEAVE OF ABSENCE.-Plans may provide for continued participation in the event of leave of absence for a specified purpose, such as service in the Armed Forces, sickness, or disability. All participants under similar circumstances, however, must be treated alike.

(c) PERCENTAGE COVERAGE REQUIREMENTS.-The percentage coverage requirements of section 401(a)(3)(A) of the Code may be met by including in the plan a number of employees at least equal to that determined by applying either of the alternative percentage provisions. The percentages are applied after excluding certain short service, seasonal, and part-time employees. For example, if out of a total of 1,200 employees, 100 have less than three years of service (the minimum period prescribed by the plan), 25 do not customarily work for more than 20 hours in any one week, and 75 are employees whose customary employment is for not more than five in any calendar year, the percentages are applied to the balance of 1,000. The alternative percentage provisions are:

1. Seventy percent or more of all employees (70%of 1,000 in the above example) must be covered under the plan.

2. Seventy percent or more of all employees (70%of 1,000 in the above example) must be eligible to benefit under the plan, and, if so, at least 80 percent of all eligible employees must actually be covered.

Under the first alternative, on the basis of the figures used, if at least 700 employees are covered, the requirements of section 401(a)(3)(A) of the Code are satisfied. Under the second alternative, on the same basis, 700 or more employees must be eligible to participate and at least 80 percent of those eligible must actually participate. For example, if employees are also required to contribute five percent of compensation in order to participate, and, say, 750 of them are eligible to do so, then if at least 600 actually do contribute and are covered under the plan, the requirements of section 401(a)(3)(A) of the Code are also met.

(d) CLASSIFICATION OF EMPLOYEES.-In lieu of meeting the percentage requirements of section 401(a)(3)(A) of the Code, an employer may set up a classification of employees which, if found by the Commissioner not to discriminate in favor of officers, shareholders, supervisors, or highly compensated employees, will satisfy the requirements of section 401(a)(3)(B) of the Code. Under such section, plans may qualify which are limited to employees who are within a prescribed age group, have been employed for a stated number of years, have been employed in certain designated departments, or are in other classifications, provided that the effect of covering only such employees does not discriminate in favor of employees within the enumerations with respect to which discrimination is prohibited. See section 1.401-3(d) of the Income Tax Regulations.

(e) IMMEDIATE AND DEFERRED PROFIT-SHARING PLANS.-A profit-sharing plan which is qualified under section 401(a) of the Code is a plan of deferred compensation and, as such, provides for distributing the funds accumulated thereunder after a fixed number of years, the attainment of a stated age, or upon the prior occurrence of some event such as illness, disability, retirement, death, layoff, or severance of employment. Thus, employees who receive the amounts allocated to their accounts before the expiration of such period of time or the occurrence of such contingency are not considered covered under the plan for the purposes of section 401(a)(3)(A) and (B). See section 1.401-3(c) of the Income Tax Regulations. If the employee has a right of election to receive his share of the profits in cash or to have it deferred through payment into a trust for his benefit, qualification of the plan is made by reference only to those employees who participate in the trust. See Revenue Ruling 56-497, C.B. 1956-2, 284. See also the last sentence of part 5(a), below.

(f) DIFFERENT ELIGIBILITY REQUIREMENTS FOR PRESENT AND FUTURE EMPLOYEES.-A provision for different eligibility requirements for present and future employees is not necessarily discriminatory within the purview of section 401(a)(3)(B) of the Code. If present employees who are officers, shareholders, supervisors, or highly compensated can meet the requirements for new employees there is no objection to the dual requirements. For example, if all present employees regardless of age are eligible and only those new employees who are at least 30 years old may participate, but all present employees who fall within one or more of the categories enumerated in section 401(a)(3)(B) of the Code are at least 30 years of age, the eligibility provision is not objectionable, even though there are other present employees who are under 30 years of age. Similarly, if all present employees are eligible regardless of years of service but only those future employees who will complete five years of service will be eligible, but all present employees who are officers, shareholders, supervisors, or highly compensated have at least five years of service, although there are other present employees who have less than five years, the eligibility provision is acceptable. If however, in the above illustrations, there are employees within the enumerated categories who are under 30 years of age or have less than five years of service, the prohibited discrimination is likely to arise in operation when new employees are added, and, therefore, in such a case such a provision would not be acceptable as a basis for a favorable advance ruling.

(g) BURDENSOME CONTRIBUTIONS.-Section 1.401-3(d) of the Income Tax Regulations provides in part: `* * * if a contributory plan is offered to all of the employees, but the contributions required of the employee participants are so burdensome as to make the plan acceptable only to the highly paid employees, the classification will be considered discriminatory in favor of such highly paid employees.' For example, if the plan requires employee contributions of ten percent of compensation, it will be necessary to determine whether lower paid employees are kept out of the plan because of such requirement. If it is found that lower paid employees are not participating because of the contribution requirement, the classification may be held to discriminate in favor of a group enumerated in section 401(a)(3)(B) and (4) of the Code. As a general rule, however, employee contributions of six percent or less are not deemed to be burdensome. In cases where the plan provides for optional rates of contribution by employees, and employer contributions or the benefits are geared to the employee contributions in such a way that a higher rate of employee contributions will result in larger benefits from employer contributions, the employee contributions may similarly be found to be burdensome and result in discrimination in contributions or benefits in contravention of section 401(a)(4) of the Code, but generally only if the highest rate of employee contribution permitted is in excess of six percent of compensation. The test is whether the contribution provisions operate to deprive lower paid employees of benefits at least as high in proportion to compensation as are provided for higher paid employees, after taking into account differentials permitted under the requirements for integration with social security benefits. See subparagraph (i) below.

(h) CLASSIFICATION WITHIN PURVIEW OF STATUTE BUT DISCRIMINATORY IN OPERATION.-A classification may appear to be satisfactory on paper but if in actual operation of the plan it discriminates in favor of employees who are highly compensated, etc., the plan will fail of qualification. For example, a plan ostensibly covers all employees regardless of service but nonforfeitable rights are provided only for those who have at least 15 years of service and stay on until normal retirement age 65. Except for a handful of executives who are shareholders and officers, employees are migratory workers who stay on a job for a relatively short time and then move elsewhere. Although the coverage provisions on paper seem satisfactory, in actual operation only the executive employees will benefit. Accordingly, both paragraphs (3)(B) and (4) of section 401(a) of the Code are considered together in determining whether the requirements of each are met. It is possible in the illustration used that the plan may qualify if satisfactory provisions for vesting are incorporated therein. See part 5(b) hereof. In the case of a profit-sharing plan under which employees may elect to receive their shares in cash or to participate in a trust, the trust must include enough lower paid employees to demonstrate that in the operation of the plan there is no discrimination in favor of higher paid employees. See Revenue Ruling 56-497, supra .

(i) INTEGRATION.-Plans which exclude employees who earn less than a specified amount or provide proportionately lesser benefits for such employees may qualify if the benefits under the plan integrate with those provided under the social security or similar (e.g., Railroad Retirement Act) program. The total benefits, inclusive of those under the social security or similar program, are used for comparative purposes. If a plan is properly integrated, a classification which excludes all employees who are compensated below the compensation level used for integration purposes will not be considered discriminatory solely because the contributions or benefits based on that part of excluded remuneration differ from contributions or benefits based on that part of remuneration which is not so excluded.

(1) Integration rules .-The rules for integrating benefits under a plan with those provided under the Social Security Act, prior to the 1950 amendments, are set forth in Commissioner's Mimeograph 5539, C.B. 1943, 499. Supporting rulings under that mimeograph are contained in I. T.'s 3613, 3614, and 3615, C.B. 1943, 475, 476 and 477, respectively, and in P.S. Nos. 5, 13, and 30, dated July 29, 1944, August 24, 1944, and September 16, 1944, respectively. Rules as to integration of deferred benefit plans of employers with the old-age and survivors insurance benefits provided by the Social Security Act Amendment of 1950 are contained in Mimeograph 6641, C.B. 1951-1, 41, and the modification effected as a result of amendments to the Social Security Act by Public Law 590, 82d Congress, 2d Session, approved July 18, 1952, are set forth in Revenue Ruling 13, C.B. 1953-1, 294. P.S. No. 34, dated September 23, 1944, sets forth the rules applicable to integrating benefits under a plan with those under the Railroad Retirement Act, as in effect as of September 23, 1944, and Revenue Ruling 12, C.B. 1953-1, 290 prescribed the applicable integration rules as effected by amendments to the Railroad Retirement Act through October 1951. Section 1.401-3(e) of the Income Tax Regulations establishes the general basis for integrating pension, annuity, profit-sharing, and stock bonus plans which limit coverage to employees earning in excess of $4,200 a year, or which base contributions or benefits only on compensation in excess of that amount, with the benefits provided by the Social Security Act as amended through 1956. Revenue Ruling 56-692, C.B. 1956-2, 287, extends the provisions of Mim. 6641, supra , except paragraphs 11 and 15 thereof, to plans which are integrated at $4,200 a year and gives effect to the more liberal definition of `average annual compensation,' as provided by section 1.401-3(e)(2)(i) of the Regulations.

(2) Death benefits involved in integration under Mimeograph 5539 .-In applying integration tests under Mimeograph 5539, supra , any benefits payable in the event an employee dies before retirement (or before normal retirement age) may be disregarded to the extent that such benefits do not exceed the reserve or the accumulated prior contributions. In the event employees contribute under a plan, the increase in limits provided by paragraph 9 of Mimeograph 5539, supra , applies only to employee contributions which are exclusive of those applicable to the current cost of insurance or death benefits in excess of the reserve or cash value. Where integration is required and the normal form of benefits beginning at retirement (or at normal retirement age) include death benefits provided by employer contributions and payable on behalf of the employee which are more valuable than a life annuity with a ten year certain provision, it must be shown that the equivalent benefits of a life annuity ten year certain basis satisfy the integration requirements. For the purpose of demonstrating such equivalence there may be used the factors in the insurance or annuity contract involved or, where normal retirement age is 65 and the normal form of benefit is one of those indicated below, there may be used the corresponding factor shown:

                                                    Reduction factor to

(3) Death benefits under Mimeograph 6641 and Integration of profit-sharing plans .-Death benefits within the purview of Mimeograph 6641, supra , and integration of profit-sharing plans are discussed in such mimeograph.

(j) COVERAGE REQUIREMENTS MUST BE MET ON AT LEAST ONE DAY IN EACH QUARTER.-The coverage requirements of section 401(a)(3) of the Code, either on the percentage basis under subparagraph (A) or on the basis of a nondiscriminatory classification under subparagraph (B), may be satisfied for an entire taxable year if such requirements are met on at least one day in each quarter of the taxable year. For example, assuming that the taxable year coincides with the calendar year, if the percentage basis is applicable and on the first day of the taxable year 1,000 employees have at least the minimum service requirements prescribed by subparagraph (A), it is sufficient if not less than 700 employees are eligible to participate and not less than 80 percent of those eligible are actually participating on that day even though employee turnover changes the percentages to less than 70 and 80 on all other days prior to April 1 of the same year. The percentage requirements will again have to be met on at least one day during the quarter commencing with April 1, and so on for the other quarters during the year.

(k) DENIAL OF PARTICIPATION FOR FAILURE TO ENTER PLAN UPON BECOMING ELIGIBLE.-Plans may provide for denial of participation for failure to enter plan upon becoming eligible provided that participation requires something substantially more than mere consent on the part of the employee. For example, under an employee contributory plan, if the employee refuses to sign a prescribed form for participation authorizing salary deductions in accordance with the plan, the plan may provide for the denial of participation at any other time or for a limited time. Similarly, under an insured plan which requires a physical examination and information as to condition of health, the plan may provide that refusal to take the examination or furnish the information will bar the employee from participation. Adequate notice, however, must be given the employee and the consequences of his failure to comply must be clearly presented to him after which, if he refuses to join, the exclusion provisions of the plan become operative as to such employee. Such provisions must be uniformly applied so as not to result in the prohibited discrimination.

(1) REENTRY INTO PLAN AFTER DISCONTINUANCE OF PARTICIPATION.-Plans may provide for reentry after discontinuance of original participation upon severance of employment or for other reasons, such as failure to continue contributions on the part of the employee. Such provisions, however, must be uniformly applied and in no event should they permit a duplication of benefits.

(m) DELAY IN PURCHASING INSURANCE CONTRACTS.-Generally, a statement in a plan exonerating the trustee from liability in the event of a reasonable delay in the purchase of insurance contracts for participants will not adversely affect the qualification of the plan, provided, however, that the benefits are calculated from the effective date of participation.

(n) BENEFITS BASED ON COMPENSATION RECEIVED FROM MORE THAN ONE EMPLOYER.-In the case of a pension plan maintained by more than one employer, where employees covered by the plan may receive compensation from more than one of the participating employers, the aggregate compensation may be used in determining the employee's eligibility for benefits in the plan. See Revenue Ruling 55-276, C.B. 1955-1, 401.

PART 5. -- DISCRIMINATION AS TO CONTRIBUTIONS OR BENEFITS

SECTION 401(a)(4) OF THE INTERNAL REVENUE CODE OF 1954-REGULATIONS SECTION 1.401-4

(a) Nondiscriminatory contributions or benefits.-In order for a plan to qualify under section 401(a) of the Code, there must, among other things, be no discrimination in contributions or benefits in favor of officers, shareholders, supervisors, or highly compensated employees as against other employees either within or without the plan. Thus, for example a profit-sharing plan which provides employer allocations of 20 percent of compensation for participants who are within a group in whose favor discrimination is prohibited, and only 10 percent for all other participants, fails to meet the requirements of section 401(a)(4) of the Code. See I.T. 3678, C.B. 1944, 321. Similar considerations apply to contributions and benefits in a pension or annuity plan, except that certain differences in favor of higher paid employees may be acceptable if integration rules are satisfied. See part 4(i) hereof. Also, as provided in section 1.401-4(a)(1)(ii) of the Income Tax Regulations, any amount allocated to an employee which is withdrawn before the expiration of the time or the occurrence of the contingency required by section 1.401-1(b)(1)(ii) of the Income Tax Regulations is not considered in determining whether the contributions under the plan discriminate in favor of employees who are officers, etc. See also Revenue Ruling 56-497, supra .

(1) Application of forfeitures .-Funds under a qualified plan arising from forfeitures because of termination of service, or other reason, must not be allocated to the remaining participants in a manner that will effect the prohibited discrimination. In a pension plan, this requirement is met by complying with the rule under section 1.401-1(b)(1)(i) of the Income Tax Regulations, regarding definitely determinable benefits, to wit: `Benefits are not definitely determinable if funds arising from forfeitures on termination of service, or other reason, may be used to provide increased benefits for the remaining participants instead of being used to reduce the amount of contributions by the employer.' This provision is equally applicable to so-called `money purchase' pension plans. See Revenue Ruling 109, C.B. 1953-1, 288. Similarly, in a stock bonus or profit-sharing plan the contribution formula may provide that forfeitures be used to reduce the employer contributions which would otherwise be required by the formula, but such application of forfeitures is not mandatory in such plans. Nevertheless, it should be observed that whatever provision is made for absorbing forfeitures under a stock bonus or profit-sharing plan the prohibited discrimination must not result.

(2) Variations in contributions or benefits .-Contributions or benefits for the respective participants may vary provided that the plan in its over-all operations does not discriminate in favor of officers, etc. In some cases, benefits in a profit-sharing plan may vary by reason of a distribution formula which takes into consideration years of service. See I.T.'s 3685 and 3686, C.B. 1944, 324 and 326, respectively, and P.S. No. 28, dated September 2, 1944. While the case covered in I.T. 3685, supra , illustrates the result, in that case, of the addition of units of compensation and units of service as not creating the prohibited discrimination and the case mentioned in I.T. 3686, supra , illustrates the result, in that case, of the multiplication of units of compensation by units of service as creating such discrimination, it was not intended to imply, by the promulgation of those rulings, that any formula using the method shown in I.T. 3685, supra , would be acceptable and any formula using the method shown in I.T. 3686, supra , would not be acceptable. The result of the operation of the formula is controlling in each case. If the application of either type of formula is found to result in the prohibited discrimination, as measured by the ratio of benefits to compensation, then the formula is objectionable.

(b) VESTED RIGHTS IN EMPLOYER'S CONTRIBUTIONS.-The Code does not require that an employee be granted immediate vested rights in his employer's contributions as a condition for qualification of a plan. Various provisions for vesting are in use, ranging from complete and immediate vesting through different forms of graduated vesting, upon completion of stated service or participation requirements, to no vesting until attainment of normal or stated retirement age.

(1) Determination as to provisions for vesting .-A determination as to satisfactory vesting provisions will of necessity depend on the facts in the particular case involved. For example, a company which ordinarily employs few people obtains a defense contract, engages a larger number of employees to work on such contract, establishes a plan under which all employees are eligible to participate, makes contributions on the basis of all employees, but vested rights are not granted until normal retirement age, and it has no need for the additional employees except for work on the defense contract. It is apparent that upon termination of the defense contract, if another contract is not obtained, the additional employees will be released and whatever credits may have inured to them under the plan will be forfeited. A favorable ruling on such a plan is not warranted unless satisfactory provision is made for effectuating benefits to all covered employees. This may be accomplished, for example, by granting fully vested rights after a reasonable waiting period. See P.S. No. 22, dated September 2, 1944.

(2) Requirement for ultimate vesting .-A plan will not be acceptable as to qualification unless an employee who has reached the normal retirement age (in a pension or annuity plan) or the stated age (or other definitely determinable event has transpired, in a profit-sharing or stock bonus plan), and has satisfied any reasonable and uniformly applicable requirements as to length of service or participation, is vested in the benefits received under the plan. This, however, does not preclude a provision for discontinuance of benefits to a retired employee for cause, which must be distinctly specified, such as, for example, taking a position with a competitor of the employer or divulging the employer's trade secrets to competitors. Similarly, provision may be made for the granting of less liberal rights under such circumstances. Provisions for the vesting of rights in employees, however, must not discriminate in favor of officers, shareholders, supervisors, or highly compensated employees.

(3) Distribution of funds upon termination .-Qualified plans are to provide for distribution of funds upon termination. At such time the rights of all participants are to be fully vested. Any provision for distribution is acceptable if it specifies the method to be used and (1) is not in conflict with the restrictions set forth in Mimeograph 5717, C.B. 1944, 321 (see paragraph (d) below), and (2) cannot otherwise discriminate in favor of employees who are officers, shareholders, supervisors, or highly compensated. See section 1.401-4(c) of the Income Tax Regulations. The distribution of unallocated funds may be in cash or in the form of other benefits provided under the plan. The distribution among employees, other than those whose benefits have been restricted in accordance with the provisions of Mimeograph 5717, supra , need not necessarily benefit all such other employees. For example, a distribution which benefits only the employees over the age of 50 at the time of termination of the plan, or only those who then have at least ten years of service, or only those who meet both such age and service requirements may be acceptable if there is no possibility of discrimination in favor of employees who are highly compensated, etc. Such a situation may exist in a plan covering only wage and hourly rated employees. Upon termination, again provided that there is no possibility of the prohibited discrimination, the funds may be used first to continue benefits to retired employees, then for employees who have met the requirements for retirement but have not actually retired, then for employees over age 60, and so on until the funds are fully exhausted.

(4) Discontinuance or Suspension of Contributions .-A discontinuance of contributions is in effect a termination of the plan except that the formal steps to accomplish such result are not taken. Employees who become eligible to enter the plan subsequent to the discontinuance receive no benefits, and no additional benefits attributable to employer contributions accrue to any of the participants, unless contributions are resumed. The same requisites which pertain to a termination, therefore, are applicable to a discontinuance. In such case, vesting of employees' rights is required. See sub-paragraph (3) hereof and Revenue Ruling 55-186, C.B. 1955-1, 39, as modified by Revenue Ruling 56-596, C.B. 1956-2, 288. A suspension is a temporary cessation of contributions which may ripen into a discontinuance. In the case of a pension or annuity plan, however, a suspension of contributions will not necessitate vesting of employees' rights, merely because of the existence of such situation, and the applicability of a prior ruling as to the qualification of the plan under section 401(a) of the Code will not be affected thereby if the following conditions are met, namely: (1) the benefits to be paid or made available under the plan are not affected at any time by the suspension, and (2) the unfunded past service cost at any time (which includes any unfunded prior normal cost and unfunded interest on any unfunded cost) does not exceed the unfunded past service cost as of the date of establishment of the plan (plus any additional past service or supplemental costs added by amendment). See P.S. No. 57, as modified by Revenue Ruling 56-596, supra . In the case of a profit-sharing plan, contributions must be recurring and substantial. See section 1.401-1(b)(2) of the Income Tax Regulations. A determination as to whether a suspension of contributions under a profit-sharing plan constitutes a discontinuance will be made upon the basis of all the relevant facts and circumstances of the particular case. If under the terms of a profit-sharing plan, authority is specifically reserved to discontinue contributions without terminating the trust, the plan must also contain an appropriate provision for the purpose of granting fully vested rights to participants upon discontinuance of contributions by the employer, similar to a case in which actual termination of the trust occurs. See Revenue Ruling 56-596, supra .

(c) TOPHEAVINESS.-Paragraph (5) of section 401(a) of the Code provides, in part, that a plan shall not be considered discriminatory within the meaning of paragraphs (3)(B) or (4) of such section merely because the contributions or benefits of or on behalf of the employees under the plan bear a uniform relationship to the total compensation, or the basic or regular rate of compensation, of such employees. however, in the case of pension and annuity plans which are based on a salary classification, i.e., exclusion of employees earning less than a specified amount, such as $3,600 or $4,200 per annum, the benefits under the plan must integrate with those provided under the Social Security Act or similar public retirement plan. See part 4(i) hereof. If under the benefit formula of a pension or annuity plan benefits are provided which bear a uniform relationship to compensation or which do not discriminate in favor of the group with respect to which discrimination is prohibited when social security or similar Federal or State retirement benefits are taken into account, the benefits and contributions are not discriminatory provided the plan contains adequate safeguards against discrimination in the event of termination of the plan or failure to meet the current costs during the first ten years. See paragraph (d) hereof. A pension or annuity plan which is not in conformance with the aforesaid does not comply with the requirements of paragraph (4) of section 401(a) of the Code, with respect to nondiscrimination as to contributions or benefits. A ceiling or similar limitation on the amount of benefits is not required in view of the provisions of section 401(a)(5) of the Code but a plan under which benefits are limited may satisfy the applicable requirements whereas otherwise certain essential requirements may not be fully met.

(d) TERMINATION RULE.-If benefits for employees who are officers, etc., are funded, or substantially so, because of their nearness to retirement, and benefits for other employees are not similarly funded prior to termination of the plan, the prohibited discrimination will result. Consequently, under the applicable circumstances, an advance favorable determination letter as to the qualification of a pension or annuity plan will not be issued unless the plan contains satisfactory provisions limiting the benefits from officers, etc., in the event of early termination of the plan. The rules for this purpose are set forth in Mimeograph 5717, C.B. 1944, 321. Explanatory releases consist of P.S. Nos. 8, 25, 29, 31, 38, 42, 50, and 52 as modified by Revenue Ruling 55-60, C.B. 1955-1, 37. Similar rules are not applicable to stock bonus and profit-sharing plans since acceptable allocation formulae under such plans are designed to preclude the prohibited discrimination under comparable circumstances. The requirements pertaining to permanency, however, are applicable to all types of plans. See part 2(h) hereof.

(e) NORMAL RETIREMENT AGE.-The normal retirement age in a pension or annuity plan is the lowest age specified in the plan at which the employee has the right to retire without the consent of the employer and receive retirement benefits based on service to date of retirement at the full rate set forth in the plan ( i.e. without actuarial or similar reduction because of retirement before some later specified age). Ordinarily, the normal retirement ae under pension and annuity plans is 65, the same as the retirement age under the old-age and survivors' insurance provisions of the Social Security Act. A different age may be specified, provided that if it is lower than 65 it represents the age at which employees customarily retire in the particular company or industry and is not a device to accelerate funding. In profit-sharing or stock bonus plans, where there is a stated retirement age it is merely one of several events which may be designated as fixing the time for making distributions. Since the amount of the distributions is dependent upon profits, there is no definitely stated rate of benefits payable at such age. Consequently, the stated retirement age in a profit-sharing or stock bonus plan does not have the same significance as `normal retirement age' in a pension plan.

(f) OPTIONAL RETIREMENT PRIOR TO NORMAL RETIREMENT AGE.-Any reasonable optional early retirement age will generally be acceptable provided that, if the employer's consent is required, the value of the early retirement benefits does not exceed the value of the employee's vested benefits at that time. See, however, paragraph (k) below as to retirement for disability. If the optional early retirement age is earlier than 65 (60 for women), and if integration with Old Age and Survivors Insurance or Railroad Retirement benefits is involved (see part 4(i), the benefits which depend on integration must be appropriately limited. See paragraph 9 of Mimeograph 6641, as extended by Revenue Ruling 56-692, C.B. 1956-2, 287, or paragraph 7 of Revenue Ruling 12, C.B. 1953-1, 290, 292, whichever is applicable.

(g) PARTICIPATION AFTER NORMAL RETIREMENT AGE.-The normal retirement age is the time from which definitely determinable benefits under a pension plan become fixed and payable. Accordingly, an employee who has reached such age and has fulfilled the service requirement and other uniformly applicable provisions of the plan must be permitted to retire and to commence receiving the benefits payable thereunder. Arrangements, however, may be mutually made for continued employment beyond normal retirement age. In such event, provision may be made with respect to the treatment of the pension benefits such as, for example, payment as though the employee had actually retired, deferment to actual retirement without increment for the interval between normal retirement date and actual retirement, or actuarial equivalent on actual retirement of the benefit at normal retirement age. Whatever provisions are made, however, must be uniformly applied to all participants.

(1) Additional benefits for service after normal retirement age .-Provision may be made for additional benefits on account of service after normal retirement age provided such provision is uniformly applicable to all employees under similar circumstances and does not result in the prohibited discrimination. In a unit benefit plan, the units may be continued during the time of the extended service and the total computed to the time of actual retirement. Under a money purchase plan, the regular rate of contributions may continue to actual retirement. Under a fixed benefit plan the benefits payable at actual retirement may be the actuarial equivalent of those payable at normal retirement age.

(2) Continued participation under a profit-sharing or stock bonus plan .-A provision for continued participation under a profit-sharing or stock bonus plan and for contributions to provide additional benefits for employees who remain in employment beyond the stated age does not adversely affect the qualification of the plan, provided, however, that such provision is uniformly applied to all employees under similar circumstances and does not result in the prohibited discrimination.

(h) BASIS OF COMPENSATION ON WHICH BENEFITS ARE COMPUTED.-Section 401(a)(5) of the Code provides in part: `Neither shall a plan be considered discriminatory * * * merely because the contributions or benefits of or on behalf of the employees under the plan bear a uniform relationship to the total compensation, or the basic or regular rate of compensation , of such employees * * *.' Italics supplied. Thus, total compensation (which may include bonuses, commissions, or overtime pay), basic compensation, or regular rate of compensation may be used, provided that whatever is used is consistently and uniformly applicable to all participants. In this respect, attention is invited to section 1.401-1(b)(3) of the Income Tax Regulations which provides in part:

`* * * a plan is not for the exclusive benefit of employees in general if, by any device whatever, it discriminates either in eligibility requirements, contributions, or benefits in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or the highly compensated employees. See section 401(a)(3), (4), and (5).' Thus, benefits computed at a uniform rate of compensation for all participants may be nondiscriminatory but if compensation is adjusted to favor one or a select few the plan may become discriminatory in operation. See section 401(a)(5) of the Code. For example, under a 50 percent fixed benefit plan, a $10,000 a year officer who fulfills all requirements for retirement would be entitled to an annuity of $5,000, but if shortly before retirement his compensation is increased to $20,000 per annum his retirement annuity computed on final salary would be $10,000, or 100 percent of compensation before the increase, whereas others would only be receiving 50 percent. Section 1.401-1(b)(3) of the Income Tax Regulations also points out: `The law is concerned not only with the form of a plan but also with its effects in operation. For example, section 401(a)(5) specifies certain provisions which of themselves are not discriminatory. However, this does not mean that a plan containing these provisions may not be discriminatory in actual operation.' Accordingly, in any case where increases in compensation during the last five years of employment are taken into account for the purpose of computing benefits, provision is generally made that such benefits are to be based on compensation averaged over a period of at least five years. In a pension plan which provides both past and future service credits the past service credits may be computed on the average compensation for the five-year period immediately preceding the establishment of the plan.

(i) ADJUSTMENT OF BENEFITS DUE TO INCREASES OR DECREASES IN COMPENSATION.-Consistent and uniform bases of compensation for determining benefits under a plan are essential in order to preclude the prohibited discrimination. If benefits are based on compensation at the time the plan is established, and if certain highly compensated employees are within a few years of retirement, their benefits will be based on the highest, or nearly the highest, compensation, while lower paid employees who entered the service of the employer shortly before the plan was established will receive benefits based on the lowest, or nearly the lowest, compensation. To eliminate discrimination, a consistent and uniform application should prevail as between both groups, e.g. where compensation within a few years before retirement, which includes salary increments since original employment, is used for the highly compensated employees, similar compensation should be used for the lower paid employees. Therefore, provision is to be made for increases in benefits when compensation on which benefits are computed is increased. (See Mimeograph 5677, C.B. 1944, 320.) Plans may also provide for decreases in benefits because of decreases in compensation but since the aforesaid reason is not applicable such provision is not required.

(j) DISCRETION AS TO PAYMENT OF BENEFITS UNDER BASIC OPTIONS.-Plans may include various modes of settlement for payment of benefits thereunder if under each mode of settlement the distribution has the same value as a distribution determined under any other mode of settlement provided for under the plan, and further, if, upon retirement (or event calling for a distribution in a profit-sharing plan) each participant is entitled to a fully vested right in the amount which has been accumulated for his benefit. In an insured plan, any type of benefit which is provided under the options contained in the insurance contract is the actuarial equivalent of any other option. Consequently, discretion in the trustee to determine under which option benefits will be paid does not result in the prohibited discrimination. Similar discretion may be provided for in a profit-sharing plan which, for example, permits the trustee to determine whether lump-sum or periodic distributions are to be made in particular cases. The amounts distributable must be fully vested in the employee in either situation, and, if periodic distributions are to be made to some as against lump-sum payments to others, the present value of all such periodic amounts payable to any employee is to be equal to the immediate lump-sum otherwise distributable to him.

(k) PROVISIONS FOR DISABILITY AND HARDSHIP CASES.-Pension plans may contain provisions for early retirement because of disability provided that the term `disability' is defined and the rules with respect thereto are uniformly and consistently applied to all employees in similar circumstances. Provisions may also be made in stock bonus and profit-sharing plans for accelerated distributions because of hardship provided that the term `hardship' is defined, the rules with respect thereto are uniformly and consistently applied, and the distributable portion does not exceed the employee's vested interest. Similar provisions, however, are not permissible under a pension plan, since, as provided for in section 1.401-1(b)(1)(i) of the Income Tax Regulations, such a plan is established and maintained `primarily to provide systematically for the payment of definitely determinable benefits to * * * employees over a period of years, usually for life, after retirement.' See Revenue Ruling 56-693, C.B. 1956-2, 282.

(l) Provision that benefits be based on cash surrender value in insured plans .-If an insured plan provides that benefits shall be based on cash surrender values, all contracts purchased must provide uniform cash surrender values with respect to all employees under similar circumstances.

(m) LOAN PRIVILEGES.-Provision may be made for the granting of loans to participants up to the extent of their vested interests subject to the application of specified uniform rules consistently followed. (It should be noted that so-called `loans' may constitute `distributions' if there is tacit understanding between the parties that collection is not intended.)

(n) PAST SERVICE BENEFITS IN PLANS WHICH CONTAIN A MINIMUM AGE OR SERVICE REQUIREMENT FOR ELIGIBILITY.-A plan which contains a minimum age or service requirement for eligibility and provides for past service credits for all prior service of original, but not subsequent, participants will generally, be considered objectionable within the purview of section 401(a)(3)(B) and (4) of the Code unless it can be demonstrated that such credits do not result in the prohibited discrimination. (Where the difference is only one year, however, e.g. , if there is a one-year waiting period for eligibility, but original participants are given credit for all prior service, including the one-year waiting period, and new participants do not receive credit based on the one year, such a provision may be acceptable.) Provision may, however, be made for credits on account of past services rendered after attainment of a specified age or completion of minimum service, if applied to original as well as subsequent participants.

(o) RIGHT OF TRUSTEE TO BORROW ON INSURANCE CONTRACTS.-Provision may be made granting the trustee the right to borrow against the loan values of insurance contracts provided that in doing so the remaining interest of employees who are officers, etc., is proportionately no greater than the interest of other employees.

(p) EARMARKED INVESTMENTS.-Where amounts to be distributed to participants under a profit-sharing trust are measured by investments which have been earmarked for their respective accounts, the trustee is to invest each participant's interest proportionately, unless all participants have the right to direct the trustee to select the type of investment with respect to their individual shares.

APPENDIX

RULINGS INCORPORATED BY REFERENCE

COMMISSIONER'S MIMEOGRAPHS

Number Reference

 5539                      C. B. 1943, 499

² Extended to cover integration at $4,200 by Revenue Ruling 56-692.

I. T. RULINGS

 3350                      C. B. 1940-1, 64

 12                        C. B. 1953-1, 290

/**/ Modified by Revenue Ruling 56-596

REVENUE PROCEDURES Rev. Proc. 56-12 C. B. 1956-1, 1029 Rev. Proc. 56-22 C. B. 1956-2, 1380

STATUS OF P.S. RELEASES

The following list is designed to give current information as to the status of P.S. Releases issued under the Internal Revenue Code of 1939, which, to the extent consistent with the Internal Revenue Code of 1954 and the regulations thereunder, remain effective except as indicated.

STATUS

P.S. No.

 1             Administrative--inapplicable as a result of action