Rev. Rul. 68-223

Advice has been requested (1) whether the transfer of funds from a non-exempt employees' welfare fund to an employees' trust forming part of an employees' pension plan will disqualify the plan and trust under the provisions of section 401(a) of the Internal Revenue Code of 1954, or affect the exempt status of the trust under section 501(a) of the Code, and (2) whether the employer-contributors to the pension trust should be considered to be in receipt of taxable income to the extent of the funds transferred by the welfare fund to the pension trust.

As a result of collective bargaining, an association of employers entered into an agreement with a union to create a non-exempt employees' welfare fund. The contributions by the employers were properly deducted in the year made, and the employers received a tax benefit therefrom. These contributions were, for the most part, expended for group hospitalization, life insurance, and medical and vacation benefits. The unexpended contributions were accumulated.

Subsequently, the employers and the union reached another agreement that provided for the establishment of a pension plan and trust for the benefit of the employees. The plan provides for uniform pension benefits to be paid to eligible employees from the corpus and income of a fund created by employer contributions. All employees covered by the plan are rank and file workers. Depending upon the actuarial condition of the fund, eligible employees will receive pensions in amounts proportionate to their service in the particular industry. The collective bargaining agreement between the parties obligates the employers to make contributions under the plan based on a stipulated amount per hour worked by eligible employees. The employers have been making these required contributions since the inception of the trust.

At the time of the adoption of the plan and the formation of the trust it was agreed by all parties concerned that a specified amount of money would be transferred from the welfare fund to the pension trust. The transfer was made with the approval of the trustees of the welfare fund and is said to have been necessary in order to insure the actuarial stability of the plan. The amount of this initial contribution is supported by actuarial computations that were accepted and relied on by the trustees of the pension trust. The plan otherwise meets the requirements for qualification under the provisions of section 401(a) of the Code.

Section 401(a)(1) of the Code provides that 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 shall constitute a qualified trust if contributions are made to the trust by such employer, or employees, or both, or by another employer who is entitled to deduct his contributions under section 404(a)(3)(B) (relating to deduction for contributions to profit-sharing and stock bonus plans), for the purpose of distributing to such employees or their beneficiaries the corpus and income of the fund accumulated by the trust in accordance with the plan.

Revenue Ruling 63-46, C.B. 1963-1, 85, which deals with the qualification of a pension plan funded largely by the transfer to the trust of shares of stock constituting the corpus of a fund created by a third party, rather than by the `employer, or employees, or `both,' states that section 401(a)(1) of the Code does not require that contributions be made only by the employer or by the employees.

Thus, the immediate source of the contributions to the pension trust will not adversely affect the qualified status of the plan and trust, since such contribution may even be made by third parties. Accordingly, in answer to question (1) above, it is held that the transfer of funds from an employees' welfare fund to an employees' pension trust will not, of itself, disqualify the plan and trust under the provisions of section 401(a) of the Code, nor affect the exempt status of the trust under section 501(a) of the Code.

Under the tax benefit rule, when either recovery of a previously deducted item or some other event that is inconsistent with what has been done in the past occurs, adjustment must be made in reporting income for the year in which the change occurs. Williams H. Block v. Commissioner , 39 B.T.A. 338, at 341 (1939), affirmed Sub Nom., Union Trust Co. of Indianapolis v. Commissioner , 111 F.2d 60 (1940), certiorari denied, 311 U.S. 658 (1940). If a deduction was properly taken in a prior year and in a later year, for some reason, such as error, change of circumstances, or action taken by the taxpayer which is inconsistent with that deduction, the amount is `recovered' by the taxpayer, then this amount is includible in gross income. See Buck Glass Co. v. Hofferbert , 176 F.2d 250 (1949); and Revenue Ruling 54-566, C.B. 1954-2, 96. The initial contribution to the pension trust in the instant case belonged to the employers before it was contributed to the welfare fund and the employers, with the consent of the union, have, in effect, `recovered' the funds and transferred them to the pension trust. The transfer to the pension trust is inconsistent with the deductions previously taken for contributions to the welfare fund. This is true even though the employers did not regain physical possession of the funds before they were transferred to the pension trust.

Therefore, in answer to question (2) above, it is held that the part of the funds transferred to the pension trust that had been properly taken as deductions by the employers is prior years for payments to the welfare fund should be included in the employers' gross income, under the provisions of section 61(a) of the Code, in the year transferred to the pension trust, and taken as a deduction by the employers in that year to the extent allowed by section 404(a) of the Code.