Rev. Rul. 74-418

Advice has been requested whether the employees' profit-sharing plan described below satisfied the requirements of section 401(a)(3)(A) of the Internal Revenue Code of 1954.

A corporation established a profit-sharing plan for the benefit of its full-time salaried employees. The plan provides that an employee shall be considered full-time if his customary employment is for more than 20 hours a week and is for more than 5 months in a calendar year.

Employees A and B were hired as clerical employees on October 1, 1972. Their employment contract provided that they would work 40 hours every week for a period of 50 weeks each year.

During calendar year 1972, the corporation had a total of six employees, including A and B. Four of the employees (all of whom were shareholders) were covered under the profit-sharing plan. Employees A and B were excluded from the plan on the grounds that their actual employment during 1972 was less than 5 months (October through December).

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 employee who are eligible to benefit under the plan if 70 percent or more of all employees are eligible to benefit under the plan. In each case, there are excluded from consideration as "all employees" those employees who have been employed not more than a minimum period prescribed by the plan (not exceeding five years), employees whose customary employment is for not more than 20 hours a week, and employees whose customary employment is for not more than 5 months in any calendar year. For application of this provision see the example in section 1.401-3(a)(3) of the Income Tax Regulations.

Even though the actual employment period of employees A and B during 1972 was less than 5 months, as they were only employed in October of that year, their employment contract required them to customarily work for more than 5 months in a year. Thus, employees A and B cannot be excluded from the total of all employees used in determining whether the percentage tests of section 401(a)(3)(A) of the Code were met. Since employees A and B were excluded from the plan, only 662/3 percent of all employees were covered in this case.

Accordingly, the profit-sharing plan did not satisfy the requirements of section 401(a)(3)(A) of the Code.