Rev. Rul. 68-454

Advice has been requested whether a plan will meet the requirements of section 401(a) of the Internal Revenue Code of 1954 where the contributions and benefits provided thereunder for rank-and-file employees are based solely on compensation, whereas the contributions and benefits for certain officer-employees are based on compensation plus credits made to the accounts of such employees under an unfunded arrangement to pay them, at a later date, for services currently rendered.

An employer has entered into unfunded, nonqualified deferred payment arrangements pursuant to individual employment contracts with certain officer-employees. The contracts provide that such officer-employees will receive a specified amount of `compensation' for services to be performed. A stated portion of this compensation will be paid monthly for the current year and the balance will be credited to the employees' accounts and payable upon retirement. The credits made under the contracts are nonforfeitable.

The employer also has a pension and a profit-sharing plan intended to meet the requirements of section 401(a) of the Code. For purposes of the pension and profit-sharing plans the term `compensation' is defined as the fixed compensation of the employees, whether paid currently or credited to the employees' accounts for future payment. Credits made under the unfunded arrangement described above are therefore included in the compensation base upon which contributions and benefits of officer-employees are computed under the plans.

Section 401(a)(4) of the Code provides that contributions or benefits under a qualified plan may not discriminate in favor of employees who are officers, shareholders, supervisors, or are highly compensated. However, section 401(a)(5) of the Code provides that a plan will not 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. See also Part 5(h) and (i) of Revenue Ruling 65-178, C.B. 1965-2, 94, which makes it clear that whatever basis of compensation is used in computing contributions or benefits under a qualified plan must be consistently and uniformly applicable to all participants.

Revenue Ruling 59-13, C.B. 1959-1, 83, holds that amounts contributed by an employer to a deferred payment employees' bonus or profit-sharing plan may be used as part of the basis upon which benefits are computed under an exempt pension plan, provided the total of pension benefits and employer contributions allocable under the bonus or profit-sharing plan, taken together, are not discriminatory. It further holds that this principle would have equal application where the bonus or profit-sharing plan fails to qualify under section 401(a) of the Code, since contributions made thereto ( i.e. , to a funded plan wherein the employee's rights are fully vested), would be currently taxable compensation for service rendered.

The instant transaction is distinguishable from that at issue in Revenue Ruling 59-13. The credits to the employee's account under the arrangement to pay him at some future time, for services currently rendered, represent neither compensation currently taxable to the employee under section 402(b) of the Code nor the equivalent of contributions which would be considered taxable compensation but for the provisions of section 402(a) of the Code and section 1.402(a)-1(a)(1)(i) of the Income Tax Regulations. Rather, these credits are merely evidence of a promise given by the employer to the employee to make payments to stated amounts at some future date; as such, they cannot be recognized as compensation for purposes of determining contributions or benefits under a qualified plan.

Under the employer's pension and profit-sharing plans in this case, the contributions and benefits provided for the officer-employees are based on their compensation plus the credits referred to above, whereas the contributions and benefits provided for rank-and-file employees are based on their compensation alone. Thus, the basis used in computing contributions and benefits under these plans is not consistently and uniformly applicable to all employees, as required by Part 5(h) and (i) of Revenue Ruling 65-178. Instead, the basis of computation significantly favors a selected group of officer-employees and is therefore discriminatory within the meaning of section 401(a) of the Code.

Therefore, it is held that the pension and profit-sharing plans in this case do not meet the requirements of section 401(a) of the Code.

Revenue Ruling 59-13 is distinguished.