Rev. Rul. 72-94

Advice has been requested concerning the inclusion in gross income of amounts deducted from compensation as contributions by an employee participant under an employees' nonqualified pension plan where participation is compulsory and contributions are forfeitable.

A number of states and municipalities have, by virtue of an ordinance or a statute, established nonqualified pension or retirement plans for their employees. In many of these plans, participation is compulsory and the employees are required to contribute a certain percentage of their compensation to the trust forming a part of the plan. Contributions are made by deduction from the employees' periodic pay checks. In some cases, the statute specifically provides for the forfeiture of all or a part of the employees' contributions upon termination of employment prior to retirement, death, or before completion of a stated length of service; while, in others, the statute is silent as to a refund of contributions in such an event.

Similar plans, where participation is compulsory, etc., have also been established by the governing bodies of churches and other organizations for their ministers and other employees.

Revenue Ruling 56-473, C.B. 1956-2, 22, holds that where an employee of the State of Arizona impliedly consents to the withholding of a part of his compensation for the purpose of purchasing an annuity that becomes a vested right upon his retirement the amounts deducted from compensation should be reported in gross income for the year in which deducted. While it appears that the holding is based only on the ground that the employee, by accepting employment with the state, "impliedly consents to the withholding of a part of his compensation" the result is justified, rather, by the fact that contributions are nonforfeitable because the deducted contributions "are held by a retirement board and become available to the employee only when the employee terminates his employment with the state and withdraws his contribution."

Revenue Ruling 57-326, C.B. 1957-2, 42, holds that where participation in an employees' retirement plan, established under an ordinance or statute of a municipality or state, is compulsory and the plan provides for the refund of employee contributions in the event of termination of services prior to retirement or death, the amounts contributed by participants are includible in gross income for Federal income tax purposes.

Revenue Ruling 57-326 also holds that, where under such a plan participation is voluntary but the employee forfeits his contributions upon termination of services prior to retirement or death, the amount of the employee's contributions deducted from his salary shall be included in his gross income. In this latter case, the employee has voluntarily directed that a part of his salary be paid to procure for himself or his beneficiaries the benefits of the plan.

Where, under an ordinance or statute of a municipality or state, or the rules of a governing body of an organization establishing an employees' nonqualified pension or retirement plan, participation is compulsory and the ordinance, statute, or other rules (1) require the employee to forfeit his contributions in the event of termination of service prior to death or before becoming eligible for retirement, or (2) are silent as to the refund of employee contributions and, in the administration of the plan, no refund will be made in such event, the amounts withheld from the salary of an employee as contributions to the plan and applied solely to provide deferred pensions are to be treated as employer contributions. Accordingly, it is held that those contributions are not required to be included in his gross income for the year in which so contributed.

Where only a portion of the these contributions is required to be forfeited in the event of the termination of his services, as stated above, it is held that only the amount not subject to forfeiture is required to be included in his gross income each year.

If upon completion of a stated period of service, an employee's right to the accumulated contributions deducted from his pay becomes no longer subject to a substantial risk of forfeiture, at that time such accumulated contributions are includible in his gross income to the extent provided in sections 83 and 402(b) of the Code. However, section 83 of the Code applies only to contributions made to the trust after August 1, 1969.

Amounts deducted from an employees' compensation as contributions to a plan, which are forfeitable at the time contributed in accordance with the above holding, are not wages subject to the withholding of income tax at source (Chapter 24 of the Code).

Revenue Ruling 56-473, is hereby clarified.