Rev. Rul. 73-502

Advice has been requested whether, under the circumstances described below, a pension plan discriminates within the meaning of section 401(a)(4) of the Internal Revenue Code of 1954.

An employer established a past-service pension plan covering all its employees with three years of service on the effective date of the plan. Employees attaining three years of service subsequent to the effective date of the plan are not eligible to participate.

The normal retirement benefit is a monthly annuity purchasable by a lump-sum amount equal to seven percent of a participant's past-service compensation multiplied by his years of service with the employer prior to the inception of the plan. Past-service compensation is defined as a participant's average compensation for the three-year period immediately preceding the establishment of the plan.

Of the eight participants in the plan, two are officer-shareholders with 12 and 11 years of credited service, respectively. The remaining participants, all rank-and-file employees, have credited service ranging from nine to three years.

Section 401(a)(4) of the Code provides that in order for a plan to qualify under that section there must be no discrimination in contributions or benefits in favor of employees who are officers, shareholders, supervisors, or highly compensated.

Section 1.401-1(b)(3) of the Income Tax Regulations provides that a plan is not for the exclusive benefit of employees in general if, by any device whatever, it discriminates either in eligibility requirements, contributions, or benefits in favor of employees who are officers, shareholders, supervisors, or highly compensated. Section 1.401-1(b)(3) of the regulations also indicates that the law is concerned not only with the form of the plan but also with its effects in operation.

In the case of a pension plan providing benefits only with respect to past service, the total benefits (in terms of percentages of compensation) are determinable at the inception of the plan. Consequently, any discrimination in such benefits existing at the inception of the plan will not be remedied by the continued operation of the plan.

Because of the higher number of years of credited service for the two participants in whose favor discrimination is prohibited, their total benefits provided under the pension plan are larger, as a percentage of past-service compensation, than the benefits for the rank-and-file participants.

Accordingly, the pension plan discriminates within the meaning of section 401(a)(4) of the Code.