Rev. Rul. 70-532

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in PS No. 51--Part B, dated July 31, 1945. The question relates to methods of allocating contributions that will be acceptable for the purposes of determining deductions under section 404(a)(3) of the Internal Revenue Code of 1954 where affiliated employers maintain a profit-sharing plan and the contribution formula is based on the consolidated net income.

Section 401(a)(2) of the Code provides that a plan will not qualify unless under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to the employer's employees and their beneficiaries under the trust, for any part of the corpus or income to be used for, or diverted to, purposes other than the exclusive benefit of the employees or their beneficiaries.

Section 404(a)(3)(A) of the Code sets forth limitations on deductions for contributions to qualified profit-sharing plans. Section 404(a)(3)(B) of the Code permits the deduction of "make-up" contributions by members of an affiliated group of corporations, as defined in section 1504, on behalf of another member of the group that is prevented from making its own contributions because it has no current or accumulated earnings or profits or because such earnings or profits are less than the contributions it would otherwise have been required to make.

In general, section 404(a)(3)(B) of the Code limits the total amount of make-up contributions that may be deducted by the contributing members to the amount that would have been allowable as a deduction by the member for whom the contribution was made if it had had sufficient earnings and profits and had actually made its own contribution. Additional limitations are set forth with respect to the portion of the total make-up contributions that any contributing member may deduct where the affiliated group does not file a consolidated return.

An employees' trust may be qualified under section 401(a) of the Code and exempt under section 501(a) even though several corporations make contributions thereto. However, the provisions relating to qualification under section 401(a) of the Code, as well as the provisions relating to deductions under section 404(a), are applicable to each employer separately. See Rev. Rul. 69-250, C.B. 1969-1, 116.

Regardless of whether the employers file consolidated or separate returns, if the plan specifies a method of allocating contributions among the employers such method must be followed. However, except for "make-up" contributions deductible under section 404(a)(3)(B) of the Code, deductions will be allowable only with respect to contributions made by an employer for his own employees.

Contributions by an employer for the employees of another company do not represent compensation for services rendered to the former. Thus, such contributions would not be deductible under section 162 of the Code (relating to deductions for trade or business expenses) and consequently cannot be deducted under section 404(a). Therefore, unless section 404(a)(3)(B) of the Code is applicable, the only method of allocating contributions among employers that will be acceptable as a basis for deductions under section 404(a)(3) of the Code is a method that will actually reflect the contributions by each employer for the benefit of his own employees. This requires allocating contributions among employers by the same formula that is used in the plan for distributing contributions among the employees covered. For example, if (as in most profit-sharing plans) the aggregate contributions are allocated among participants in proportion to compensation, the contributions should be allocated among employers in proportion to the compensation of covered employees of each employer. On the other hand, where it is not feasible to determine the actual share of each individual employee's compensation paid by one or more related employers, as in a case where the employees are continually shifted between two or more employers, some other method of allocating contributions may be acceptable. For example, allocation of the total of all employers' contributions may be made on the basis of each employer's share of the total gross receipts. A determination in this respect is made on the particular facts involved.

The limits on deductible contributions as set forth in section 404(a)(3)(A) of the Code apply to each employer separately. Thus, except where the carry-over provisions therein are applicable, the allowable deductions for any employer may not exceed 15 percent of the compensation otherwise paid or accrued during the taxable year to his employees covered under the plan. See, however, Rev. Rul. 57-378, C.B. 1957-2, 268, relating to credit carry-overs.

Deductions are allowable for contributions by an employer only to the extent that such contributions are paid out of his current or accumulated profits. Section 1.401-1(b)(2)(ii) of the Income Tax Regulations defines a profit-sharing plan as a plan that is established and maintained by an employer to provide for participation in his profits by his employees or their beneficiaries. Thus, contributions to a profit-sharing trust by an employer who has no profits would not be contributions under a profit-sharing plan within the meaning of section 401(a) of the Code and, therefore, would not be deductible under section 404(a)(3). An employer's contribution need not be in proportion to his share of the net profits on which the contributions are based. As long as his contributions to the plan do not exceed his total net profits for the year, or his accumulated profits up to the end of the year, whichever is larger, they are allowable as deductions, subject to the provisions of sections 162 and 404(a)(3) of the Code.

With regard to acceptable methods of allocating costs under a pension or annuity plan maintained by two or more employers, see Rev. Rul. 69-525, C.B. 1969-2, 102.

PS No. 51-Part B is hereby superseded, since the positions stated therein are restated under current law in this Revenue Ruling.

¹ Prepared pursuant to Rev. Proc. 67-6, C.B. 1967-1, 576.