Rev. Rul. 71-28

Advice has been requested whether a noncontributory profit-sharing plan may meet the requirements of section 401(a)(4) of the Internal Revenue Code of 1954 if the contributions thereunder are allocated as described below.

A corporation that operates a restaurant has 10 employees, including the president, who is also the sole stockholder, and five waiters. The president receives a salary of $25,000 per year. Each of the waiters receives a salary of $1,000 per year and is allowed to keep the tips he receives. The waiters' tips average about $9,000 per year each. The other employees earn from $5,000 to $20,000 per year.

The corporation established a profit-sharing plan that covers all employees. The plan provides that contributions are to be allocated to each employee's account based on such employee's compensation. Compensation is defined in the plan as total compensation paid or accrued for services rendered to the company by the employee during the company's fiscal year, exclusive of declared gratuities, bonuses, overtime pay, commissions, and other extra compensation.

Section 401(a)(4) of the Code provides that a plan may be qualified if the contributions or benefits provided under the plan do not discriminate in favor of employees who are officers, shareholders, supervisors, or highly compensated.

Section 1.41-4(a)(2)(i) of the Income Tax Regulations provides that a plan will not be considered discriminatory merely because the contributions or benefits bear a uniform relationship to total compensation or to the basic or regular rate of compensation.

For purposes of section 1.401-4(a)(2)(i) of the regulations, compensation contemplates amounts paid or accrued to the employees by the employer on account of personal services rendered. Reported tips are not a part of compensation paid by the employer for purposes of section 1.401-4(a)(2)(i) of the regulations.

Accordingly, it is held that the plan in this case does not fail to meet the nondiscrimination requirements of section 401(a)(4) of the Code merely because the contributions are allocated on the basis of compensation when compensation as defined in the plan excludes tips received by the employees.

This conclusion does not apply where the tips are paid over by the employee to the employer, are paid by the patron to the employer as a service charge, or are accounted for by the employee to the employer (as opposed to merely being reported). See Williams et al. v. Jacksonville Terminal Co., 315 U.S. 386 (1942); Restaurants and Patisseries Longchamps Inc. v. United States, 52 F. Supp. 174 (1943); Employment Security Commission v. Great Western Hotel Management, Inc., 452 P. 2d 211 (S.C. Wyo. 1969).