Rev. Rul. 80-359

The purpose of this revenue ruling is to restate the positions in Rev. Rul. 69-145, 1969-1 C.B. 126, and Rev. Rul. 71-225, 1971-1 C.B. 124, under current law.

The issue in the revenue rulings is whether a pension plan that determines benefits under the circumstances described below may fail to satisfy section 401(a)(4) of the Internal Revenue Code.

An employer adopted a nonqualified, deferred-payment arrangement for its employees. Under the arrangement any employee of the employer may elect, before the beginning of any taxable year, to defer, until retirement, the receipt of 5 percent of the compensation earned in that year. The deferred amounts are allocated to the employee's account as nonforfeitable credits. The employer has not made any contributions to fund the deferred-payment arrangement.

In the same year, the employer also adopted a pension plan for its employees. The plan provides that all compensation will be considered as the base for purposes of computing benefits regardless of the deferment of payment of any part of such compensation.

Section 401(a)(4) of the Code provides that a plan will satisfy that section if the contributions or benefits under the plan do not discriminate in favor of employees who are officers, shareholders, or highly compensated. However, section 401(a)(5) provides that a plan will not be considered discriminatory merely because the contributions or benefits of or on behalf of the employees under the plan bear a uniform relationship to the total compensation or the basic or regular rate of compensation of such employees.

The amounts credited under an unfunded, deferred payment, under which the amounts will not be paid until retirement, are not considered compensation for the purposes of section 401(a)(5) of the Code. Therefore, such deferred amounts may not be used under a qualified plan to compute the employees' benefits if it results in discrimination prohibited under section 401(a)(4). However, these amounts may be used under a qualified plan if they do not result in prohibited discrimination.

In this case, if the proportion of compensation deferred under the unfunded arrangement by rank-and-file employees participating in the qualified plan equals or exceeds that deferred by employees participating in the qualified plan who are officers, shareholders, or highly compensated, the basis for computing benefits does not cause prohibited discrimination.

On the other hand, if in the plan under consideration only a few of the lower paid employees elected to participate under the unfunded deferred-payment arrangement, the use of the amounts credited under the unfunded arrangement benefits primarily the highly paid employees and, therefore, the plan in operation may result in discrimination prohibited under section 401(a)(4) of the Code.

Accordingly, the use of deferred amounts and current compensation as the basis for computing benefits will not automatically cause the plan to fail to satisfy section 401(a)(4) of the Code. However, the basis of benefits may, in operation, result in failure to satisfy section 401(a)(4).

This revenue ruling does not deal with whether the nonqualified deferred-payment arrangement may fail to satisfy the funding requirements of Part 3 of Title I of the Employee Retirement Income Security Act of 1974, Pub. L. 93-406, 1974-3 C.B. 1.

This revenue ruling does not consider whether the basis of benefits for the pension plan may result in a violation of the limits of section 415 of the Code.

Rev. Ruls. 69-145 and 71-225 are superseded because the positions stated therein are restated under current law in this revenue ruling.