Rev. Rul. 71-225

Advice has been requested whether a profit-sharing plan qualifies under section 401(a) of the Internal Revenue Code of 1954 if contributions are determined under the circumstances described below.

The plan covers all employees and provides that the employer will make contributions for each employee equal to ten percent of (1) the salary that was paid to him during the preceding calendar year and (2) any amounts credited to his account for such year under an unfunded deferred-payment arrangement.

Under the deferred-payment arrangement, an employee may elect, before the beginning of any taxable year, to defer, until retirement, the receipt of five percent of his "base" salary. Almost all of the employees who elected to take part in this deferred-payment arrangement were highly compensated, within the meaning of section 401(a)(4) of the Code.

Section 401(a)(4) of the Code provides that, in order for a plan to qualify, contributions or benefits must not discriminate in favor of employees who are officers, stockholders, supervisors, or highly compensated.

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.

The amounts credited under an unfunded, deferred-payment arrangement, under which the amounts will not be paid until retirement, are not considered compensation for the purposes of section 401(a)(5) of the Code. Therefore, such deferred compensation may not be used under a qualified plan to compute the employer's contributions if it results in discrimination prohibited under section 401(a)(4) of the Code. See Rev. Rul. 68-454, C.B. 1968-2, 164. However, it may be used under a qualified plan if it does not result in prohibited discrimination. See Rev. Rul. 69-145, C.B. 1969-1, 126. In the plan under consideration, only a few of the lower paid employees elected to participate under the unfunded deferred-payment arrangement. The use of the amounts credited under the unfunded arrangement benefits primarily the highly paid employees and, therefore, the plan in operation results in discrimination prohibited under section 401(a)(4) of the Code.

Accordingly, it is held that the plan does not qualify under section 401(a) of the Code.