Rev. Rul. 81-123

The purpose of this revenue ruling is to restate the position in Rev. Rul. 57-378, 1957-2 C.B. 268, in view of the enactment of the Employee Retirement Income Security Act of 1954, Pub. L. 93-406, 1974-3 C.B. 1 (ERISA).

Rev. Rul. 57-378 discusses the specific application of the deduction limits under section 404(a)(3) of the Internal Revenue Code for contributions to a certain type of profit-sharing plan when the employer makes the payment subsequent to the time prescribed by section 404(a)(6).

Under the provisions of a certain qualified employees' profit-sharing plan, the employer corporation, an accrual basis taxpayer, is obligated to make an annual contribution equal to the lesser of 10 percent of corporate profits or 15 percent of the participating employees' compensation. For the year 1976, 10 percent of corporate profits equalled $10,000 while 15 percent of compensation of participating employees equalled $15,000. The contribution of $10,000 thus required for the year 1976, however, was not made until a few days after the expiration of the time within which a taxpayer may make a contribution to an employees' trust which will be allowable as a deduction for the prior taxable year under section 404(a)(6) of the Code.

For the taxable year 1977, a contribution of $15,000 was required of the employer since 10 percent of corporate profits equalled $15,000 and 15 percent of compensation of participating employees equalled $15,000. The $15,000 contribution for 1977 was timely made. Thus, a total of $25,000 was paid into the profit-sharing trust by the employer within the taxable year 1977. No carryovers of any kind existed from years prior to 1976.

Section 404(a)(3)(A) of the Code sets forth the limitations on deductible contributions to profit-sharing trusts. That section provides that contributions shall be deductible in the taxable year when paid, in an amount not in excess of 15 percent of the compensation otherwise paid or accrued during the taxable year to all employees under the profit-sharing plan. If in any taxable year there is paid into the trust amounts less than 15 percent of the participating employees' compensation, the excess, or if no amount is paid, the amounts deductible, shall be carried forward and be deductible when paid in the succeeding taxable years in order of time. However, the amount so deductible under this limitation in any such succeeding taxable year shall not exceed 15 percent of the compensation otherwise paid or accrued during such succeeding taxable year to beneficiaries under the plan. Also, the amount so deductible under the preceding sentence in any one succeeding taxable year together with the amount so deductible under the second sentence of this paragraph shall not exceed 25 percent of the compensation otherwise paid or accrued during that same succeeding taxable year to the beneficiaries under the plan.

Section 1.404(a)-9 of the Income Tax Regulations states that the primary limitation on deductions for a taxable year is 15 percent of the compensation otherwise paid or accrued during such taxable year to the employees who, in such year, are beneficiaries of the trust funds accumulated under the plan. So long as the contributions do not in any year exceed the primary limitation, this is the only limitation under section 404(a)(3)(A) of the Code which has any effect. If after a taxable year in which contributions are less than the primary limitation there is a taxable year in which contributions exceed the primary limitation, deductions in that later year and in each succeeding year are subject to a secondary limitation instead of the primary limitation.

The secondary limitation for a taxable year is equal to the lesser of (1) 25 percent of compensation paid to all participants, or (2) the excess of the aggregate primary limitations for all prior years and the current year over the aggregate of the deductions allowed or allowable in prior years. The excess of the aggregate of the primary limitations for all prior years over the aggregate of the deductions allowed or allowable under the limitations provided in section 404(a)(3)(A) for all prior years is referred to as the "credit carryover."

Under the provisions of section 404(a)(6) of the Code, a taxpayer is deemed to have made a payment to a profit-sharing trust created or organized within the United States on the last day of the year if the payment is on account of such taxable year and is made not later than the time prescribed by law for filing the return for such taxable year, including extensions thereof.

With the enactment of ERISA section 404(a)(6) of the Code was amended to provide the same treatment for cash basis taxpayers as had been available for accrual basis taxpayers.

To the extent an accrual basis taxpayer obligates itself to make contributions to a profit-sharing plan in effect on the last day of a particular taxable year, the amount of the contribution required accrues at the end of such year. But for the requirement of section 404(a) of the Code that the contribution be paid in order to be allowed as a deduction, the entire amount of the contribution would be deductible for the year of accrual to the extent it represents an ordinary and necessary business expense and constitutes reasonable compensation for services rendered. This would be true whether the contribution is paid in the year of accrual or in some subsequent year. However, when the contribution is paid after the period described in section 404(a)(6) the requirements of section 404(a) of the Code have the effect of (1) deferring a deduction of the accrued contribution until the taxable year when paid and (2) limiting the amount of the deduction to the percentage set forth therein for a particular taxable year.

Thus, if contributions required for the year 1976 are paid within the taxable year 1976, including the period provided by section 404(a)(6) of the Code, they represent amounts deductible, subject to the limitations of section 404(a)(3)(A). If the contributions do not exceed the 15 percent primary limitation provided therein, then the credit carryover is not applicable. On the other hand, if such contributions exceed such primary limitation, then, to the extent that they do not exceed the lesser of (a) 25 percent of compensation of participating employees for such year, or (b) the primary limitation of 15 percent plus the credit carryover, they are deductible.

The application of the principles set forth above, as applied to the facts stated herein, is illustrated in the following tabulation (figures represent thousands of dollars):

                         Primary

Rev. Rul. 57-378 is superseded because the position stated therein is restated under current law in this revenue ruling.