Rev. Rul. 74-165

The Internal Revenue Service has reconsidered its position in Revenue Ruling 71-503, 1971-2 C.B. 206, and considered an additional situation concerning differences in vesting when contributions are used to demonstrate whether two plans are comparable.

Situation 1. In Revenue Ruling 71-503, an employer established a fixed benefit--fixed contribution pension plan pursuant to a collective bargaining agreement for its relatively low paid hourly employees, and a profit-sharing plan for its salaried employees, each of whom was highly compensated within the meaning of section 401(a)(3)(B) of the Internal Revenue Code of 1954. The profit-sharing plan, in order to qualify under section 401(a) of the Code, had to be comparable with the pension plan. The salaried plan provided immediate vesting of all contributions. The hourly plan provided vesting of contributions only upon attainment of normal retirement age. Identical contributions as a percentage of annual compensation were required to be made to both plans, except that contributions to the profit-sharing plan were required to be made out of profits. Although not stated in Revenue Ruling 71-503, the benefits in and the rate of contributions to the hourly plan were fixed only for the duration of the collective-bargaining agreement then in effect and were subject to renegotiation upon expiration of the contract. Revenue Ruling 71-503 states that contributions that are nonforfeitable when made are more beneficial to participants than contributions in which the participants' interest will be subject to forfeiture over an extended period of time. Revenue Ruling 71-503 then holds that the profit-sharing plan does not meet the requirements of section 401(a)(4).

Situation 2. An employer established, effective January 1, 1970, a fully and immediately vested money purchase pension plan requiring annual employer contributions of 5% of annual compensation on behalf of its salaried employees, each of whom was highly compensated within the meaning of section 401(a)(3)(B) and (4) of the Code. The employer also established, effective January 1, 1970, a money purchase pension plan for its hourly paid employees requiring annual employer contributions of 7% of annual compensation, less forfeitures. The hourly plan provided less favorable vesting than the salaried plan. In 1970 the employer contributed 7% of annual compensation to the hourly plan. In 1970, turnover in the hourly plan produced forfeitures which subsequently reduced the employer contribution in 1971 to 5.2% of annual compensation. In 1971, turnover in the hourly plan further reduced the employer contribution in 1972 to 4.8% of annual compensation.

The salaried plans in situations 1 and 2 do not satisfy the coverage requirements of section 401(a)(3) of the Code and, therefore, standing alone, cannot qualify. However, both plans in each situation, taken as a unit, satisfy such requirements. See section 4.401-3(f) of the Income Tax Regulations.

The specific question to be considered in each situation is whether the salaried plan is comparable to the hourly plan. This Revenue Ruling deals only with the comparability of contributions.

Section 401(a)(4) of the Code requires that either benefits or contributions must not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees.

When two plans are considered as a unit, section 401(a)(4) of the Code will be satisfied if the plan not containing members of the prohibited group (the "lower" plan) is at least comparable to the plan containing members of the prohibited group (the "higher" plan).

Vesting applies to benefits, not contributions. It is therefore inappropriate, for purposes of comparability, to consider vesting when comparing contributions.

Since the contribution rate, as a percentage of compensation, is identical for both plans in situation 1 for the duration of the collective bargaining agreement, the profit-sharing plan did satisfy the requirements of section 401(a)(4) of the Code for such period. Furthermore, the profit-sharing plan would continue to qualify as long as the rate of contribution as a percentage of compensation to the collectively-bargained plan does not fall below the rate of contribution actually made to the profit sharing plan.

In situation 2 the salaried plan satisfied the requirements of section 401(a)(4) of the Code in 1970 and 1971 since the rate of contribution to the hourly plan for those years was not less than the rate of contribution to the salaried plan. Furthermore, the salaried plan would fail to satisfy the requirements of section 401(a)(4) in 1972 since the rate of contribution (4.8% of annual compensation) to the hourly plan is less than the rate of contribution (5% of annual compensation) to the salaried plan, unless the contribution rates can be demonstrated to be nondiscriminatory after imputing a value to the employer's contributions to social security. See Revenue Ruling 70-580, 1970-2 C.B. 90.

Revenue Ruling 71-503 is hereby revoked.