Rev. Rul. 83-89

ISSUE

Whether the inclusion of elective contributions under a qualified cash or deferred arrangement as compensation in a defined benefit pension plan may cause the pension plan to be discriminatory within the meaning of section 401(a)(4) of the Internal Revenue Code? FACTS

An employer established a plan which meets the requirements of section 401(a) of the Code and contains a qualified cash or deferred arrangement described in section 401(k). The plan provides that each year all employees will be given an election with respect to a stated percentage of compensation. An employee may elect to receive the entire amount subject to the election in cash, to have the entire amount contributed by the employer to the plan, or to receive part of such amount in cash and have part contributed to the plan. The plan also provides for nonelective employer contributions.

As a result of the different elections made by the employees, the elective contributions to the plan on behalf of highly paid employees are higher as a percentage of compensation than the elective contributions on behalf of rank and file employees.

The employer also established a defined benefit pension plan. Benefits under this plan are based on the participant's compensation. For this purpose, the pension plan defines "compensation" as all current compensation paid to the employee plus the total amount deferred pursuant to the employee's election under the qualified cash or deferred arrangement. However the term "compensation" does not include any nonelective contributions made by the employer under any qualified plan.

LAW

Section 401(a)(4) of the Code provides that the contributions or benefits under a qualified plan must not discriminate in favor of employees who are officers, shareholders, or highly compensated. Section 401(a)(5) of the Code further provides that a plan shall not be considered discriminatory merely because the contributions or benefits, of or on behalf of the employee-participants, bear a uniform relationship to the total compensation, or the basic or regular rate of compensation of the employee.

Section 401(k)(2) of the Code defines a qualified cash or deferred arrangement as any arrangement which is part of a profit-sharing or stock bonus plan which meets the requirements of section 401(a) and under which an eligible employee may elect to have the employer contribute an amount to a trust under the plan or to have the amount paid to the employee in cash. Section 401(k)(2) also provides that the cash or deferred arrangement will not be qualified unless the amounts held by the trust which are attributable to employer contributions made pursuant to the employee's election are subject to certain restrictions on preretirement distributions and are nonforfeitable at all times.

Rev. Rul. 59-13, 1959-1 C.B. 83, holds that amounts contributed by an employer to a qualified employees' bonus or profit-sharing plan and credited to the accounts of the participants in a nondiscriminatory manner, may be used as part of the basis upon which benefits are computed under a separate pension plan maintained by the employer. However, the revenue ruling provides the following examples of situations that could cause the pension plan to be discriminatory within the meaning of section 401(a)(4): (1) if the contributions made to the profit-sharing plan were not fully vested in all cases at the time paid into the trust; (2) if the employer's contributions to the profit-sharing trust were allocated to the employees on a basis other than proportionately to current compensation (for example, by giving effect to years of prior service); and (3) where the basis of the pension to be provided would depend upon the total compensation paid during a particular period of years (such as the average annual compensation for the five years immediately prior to retirement).

ANALYSIS

In the situation described above, benefits under the pension plan are based upon amounts deferred pursuant to the employee's election under the qualified cash or deferred arrangement as well as the employee's total nondeferred compensation. If an individual employee had not made the deferral election under the cash or deferred arrangement, the employee would have taken such amounts in cash and they would clearly have been compensation. Thus, in this case, the amounts deferred as a result of the employee's election under the qualified cash or deferred arrangement may be treated as compensation for purposes of section 401(a)(5) of the Code. Therefore, such deferred amounts may be used to determine whether the pension plan satisfies the requirements of section 401(a)(4). However, in accordance with Rev. Rul. 59-13, the nonelective contributions, whether or not they satisfy the restrictions on preretirement distributions and on nonforfeitability under section 401(k)(2), may be used under the pension plan to compute the employees' benefits only if they do not result in prohibited discrimination under section 401(a)(4). See Rev. Rul. 80-359, 1980-2 C.B. 136.

HOLDING

The inclusion of elective contributions under the qualified cash or deferred arrangement as compensation in the defined benefit pension plan does not cause the pension plan to be discriminatory within the meaning of section 401(a)(4) of the Code. Further, the exclusion of elective employer contributions under the cash or deferred arrangement from compensation also would not cause the plan to be discriminatory.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 59-13 is amplified to explain the treatment of elective contributions under qualified cash or deferred arrangements.