Rev. Rul. 81-248

The purpose of this revenue ruling is to restate the position in Rev. Rul. 73-502, 1973-2 C.B. 139, in view of the enactment of the Employee Retirement Income Security Act of 1974, Pub. L. 93-406, 1974-3 C.B. 1.

The issue in Rev. Rul. 73-502 is whether the benefits provided by a pension plan discriminate within the meaning of section 401(a)(4) of the Internal Revenue Code under the circumstances described below.

An employer established a past-service pension plan covering all its employees with one year of service on the effective date of the plan. Employees attaining one year of service subsequent to the effective date of the plan are not eligible to participate.

The normal retirement benefit is an annual annuity equal to seven percent of a participant's past-service compensation multiplied by the years of service with the employer prior to the inception of the plan, reduced by the maximum allowed portion of social security benefits under Rev. Rul. 71-446, 1971-2 C.B. 187. Past-service compensation is defined as a participant's average compensation for the three-year period immediately preceding the establishment of the plan.

Of the eight participants in the plan, two are officer-shareholders with 12 and 11 years of credited service, respectively. The remaining participants are rank and file employees, with credited service ranging from nine to three years. The officer-shareholders are older than any of the rank and file employees.

Section 401(a)(4) of the Code provides that a plan will qualify if, along with other requirements, the contributions or benefits do not discriminate in favor of employees who are officers, shareholders, or highly compensated.

Section 1.401-1(b)(3) of the Income Tax Regulations provides that a plan is not for the exclusive benefit of employees in general if, by any device whatever, it discriminates either in eligibility requirements, contributions, or benefits in favor of employees who are officers, shareholders, or highly compensated. This section of the regulations also indicates that the law is concerned not only with the form of the plan but also with its effects in operation.

The benefits under a plan will be discriminatory within the meaning of section 401(a)(4) of the Code if the plan provides both larger total benefits and larger benefits per year of service (in each case measured as a percentage of compensation), for participants in whose favor discrimination is prohibited.

In the case of a pension plan providing benefits only with respect to past service, the total benefits and benefits per year of service (in terms of percentage of compensation) are determinable at the inception of the plan. Consequently, any discrimination in such benefits existing at the inception of the plan will not be remedied by the continued operation of the plan.

The total benefits, and benefits per year of service, provided under this pension plan for the two officer-shareholder participants, in whose favor discrimination is prohibited, are larger, as a percentage of compensation, than the benefits for the rank and file participants because of the greater number of years of credited service for the officer-shareholders than for the rank and file participants.

Accordingly, the benefits under the pension plan discriminate within the meaning of section 401(a)(4) of the Code.

Rev. Rul. 73-502 is superseded because the position stated therein is restated under current law in this revenue ruling.