Rev. Rul. 70-259

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the positions set forth in Revenue Ruling 55-14, C.B. 1955-1, 302, and Revenue Ruling 61-79, C.B. 1961-1, 138.

The questions presented are (1) whether refunds of employee contributions by an insurer affect the qualified status of an employees' annuity plan, (2) whether such refunds are includible in employees' gross income and (3) whether an amount paid to the insurer by the employer as reimbursement for such refunds is deductible by the employer under section 404(a) of the Internal Revenue Code of 1954.

A corporate employer established a qualified, non-trusteed, annuity plan under which both the employer and employees made contributions. The employer later amended the plan to eliminate the requirement for employee contributions, had the insurer return all contributions previously made by the employees to them without interest, and reimbursed the insurer for such refunds. Employees who received refunds had not received any prior distribution or payment under the annuity plan.

The determinative factor with respect to the continued qualification of the plan after the amendment in this case is whether the amendment produced discrimination in favor of employees who are officers, shareholders, supervisors, or highly compensated. See section 404(a)(2) of the Internal Revenue Code of 1954 which provides that a qualified annuity plan must meet certain requirements of section 401(a), including the requirement of section 401(a)(4) that the plan must not discriminate in favor of the enumerated group.

Since the benefits initially provided under the qualified annuity plan were continued in the same manner after the amendment, except that they were then funded with employer contributions only, the amendment did not produce discrimination prohibited by section 401(a)(4) of the Code. Accordingly, it is held that the amendment did not adversely affect the qualification of the plan.

The amendment in this case would have necessitated a curtailment of benefits if it had not provided for the employer to reimburse the insurance company for refunds to employees. However, such an amendment would not, of itself, have affected qualification of the plan if prohibited discrimination had not resulted therefrom.

With respect to inclusion in the employees' gross income, section 403(a) of the Code provides that, if an annuity contract is purchased by an employer for an employee under a plan which meets the requirements of section 404(a)(2), the employee shall include in his gross income the amounts received under such contract for the year received as provided in section 72 (relating to annuities).

Section 1.72-1(a) of the Income Tax Regulations provides that, in general, amounts subject to the provisions of section 72 of the Code (relating to the inclusion in gross income of amounts received under an annuity, endowment, or life insurance contract) are includible in the gross income of the recipient except to the extent they are considered to represent a reduction or return of premiums or other consideration paid.

In this case, none of the employees had received any prior distributions and the amounts received did not exceed their own contributions. Therefore, the refunds made to employees were in the nature of a return of premiums and are governed by the provisions of section 1.72-1(a) of the regulations. Accordingly, it is held that these amounts are not includible in the gross income of the employees.

Finally, where past service or other supplementary pension or annuity credits are provided by the plan, the employer will be allowed a deduction for contributions to fund such credits to the extent permitted by section 404(a)(1) of the Code.

Here, the aggregate amount paid by the employer to the insurer as reimbursement for refunds to employees is a supplementary cost of annuity credits and, as such, is within the purview of section 404(a)(1) of the Code. Therefore, it is held that the employer may deduct the amount paid to the insurer, subject to the applicable limitations imposed by section 404(a)(1) of the Code.

Revenue Ruling 55-14 and Revenue Ruling 61-79 are hereby superseded since the positions stated therein are restated under current law in this Revenue Ruling.