Rev. Rul. 74-55

Further consideration has been given to Rev. Rul. 72-275, 1972-1 C.B. 109, relating to whether a profit-sharing plan qualifies under section 401(a) of the Internal Revenue Code of 1954 if it contains the provisions described below.

In accordance with the plan, each participant must contribute an amount each month equal to two percent of his current compensation. A participant may make additional contributions each month in an amount equal to one, two, or three percent of his compensation. The employer contributes each month for each participant, out of profits, an amount equal to the participant's required and optional contributions. A participant may withdraw all or any part of his own contributions at any time without penalty and without affecting the employer contributions and earnings allocated to his account. A participant's share of employer contributions and trust earnings may be withdrawn, however, only upon termination of the participant's employment.

Rev. Rul. 72-275 states that optional employee contributions to which the employer contributions are geared are part of the funds accumulated under the plan within the meaning of section 1.401-1(b)(1)(ii) of the Income Tax Regulations. That Revenue Ruling states further that allowing employer contributions to be allocated on the basis of employee contributions that may be withdrawn immediately after they are made would permit manipulation of the allocation and contravene the requirement of section 1.401-1(b)(1)(ii) for a definite predetermined allocation formula. That Revenue Ruling accordingly holds that the plan does not qualify under section 401(a) of the Code.

Section 1.401-1(b)(1)(ii) of the regulations provides that a profit-sharing plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants and for distributing the funds accumulated under the plan after a fixed number of years, the attainment of a stated age, or upon the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment. Rev. Rul. 71-295, 1971-2 C.B. 184, holds that the term "fixed number of years" means at least two years.

Although it is recognized that employee contributions are funds accumulated under the plan for certain purposes, the term "funds accumulated under the plan", as used in section 1.401-1(b)(1)(ii) of the regulations, does not include employee contributions. The employee contributions under this plan are, therefore, not a part of the funds accumulated under the plan within the meaning of that provision.

Allowing employer contributions to be allocated on the basis of employee contributions that may be withdrawn immediately after they are made, however, could reasonably be expected to result in manipulation of the allocation and contravention of the definite predetermined allocation formula requirement of section 1.401-1(b)(1)(ii) of the regulations. In general, a profit-sharing plan containing a withdrawal provision that can reasonably be expected to result in the manipulation of the allocation in contravention of the requirement of section 1.401-1(b)(1)(ii), that a profit-sharing plan must provide a definite predetermined formula for allocating the contributions made to the plan among participants, does not satisfy the qualification requirements of section 401(a) of the Code.

Accordingly, the plan does not qualify under section 401(a) of the Code since the withdrawal provision can reasonably be expected to result in the manipulation of the allocation.

Rev. Rul. 72-275 is hereby modified to remove therefrom the statement that the employee contributions are a part of the funds accumulated under the plan within the meaning of section 1.401-1(b)(1)(ii) of the regulations.

¹ Also released as Technical Information Release No. 1270, dated January 10, 1974.