Rev. Rul. 73-265

Advice has been requested whether, under the circumstances described below, coverage under a pension plan meets the requirements of section 401(a)(3)(A) of the Internal Revenue Code of 1954.

A corporation with three full-time employees established a pension plan intended to meet the requirements of section 401(a) of the Code. The plan provides that all full-time employees will become plan participants upon the completion of 60 continuous months of service with the employer. Two of the employees are shareholders with over 60 months of continuous service with the employer and are plan participants. The third employee is a low-paid employee with over 5 years of service with the employer but is not a plan participant because such service has not been continuous due to the fact that he works only ten months a year.

Section 401(a)(3)(A) of the Code provides that a plan may qualify under section 401(a) if it benefits 70 percent or more of all employees, or 80 percent or more of all employees who are eligible to benefit under the plan if 70 percent or more of all employees are eligible to benefit under the plan. In the alternative, section 401(a)(3)(B) provides that a classification may be set up by the employer but it must not discriminate in favor of employees who are officers, shareholders, supervisors, or highly compensated. In determining whether a plan meets the percentage coverage requirements of section 401(a)(3)(A), employees who have been employed not more than a minimum period prescribed by the plan (not exceeding five years) and employees whose customary employment is for not more than 20 hours a week or not more than five months in any calendar year, may be excluded. For an application of this provision, see the example in section 1.401-3(a)(3) of the Income Tax Regulations.

In determining whether coverage under a plan meets the percentage coverage requirements of section 401(a)(3)(A) of the Code, that section permits the exclusion of employees who have been employed not more than the minimum period prescribed by the plan, but only if the minimum period prescribed by the plan does not exceed five years. In effect, the minimum period prescribed by the plan in the instant case is not limited to five years since the employee who works only ten months a year will never become eligible for participation. This is so because the annual break in his employment will prevent accumulation of 60 months of continuous service. Consequently, this employee may not be excluded in determining whether the percentage coverage requirements of section 401(a)(3)(A) are met.

Since, in this case, only two of the employer's three employees, or 662/3 percent, are eligible and participating, it is held that coverage under this plan does not meet the requirements of section 401(a)(3)(A) of the Code.