Rev. Rul. 84-155

PURPOSE

The purpose of this Revenue Ruling is to restate the positions of Rev. Rul. 68-652, 1968-2 C.B. 176; Rev. Rul. 68-653, 1968-2 C.B. 177; and Rev. Rul. 68-654, 1968-2 C.B. 179, under current law.

ISSUE

The issue in these revenue rulings is whether the contribution under profit-sharing plans which provide for the allocation of contributions using different types of formulas that take into consideration years of service meet the requirements of section 401(a)(4) of the Internal Revenue Code and section 1.401-4 of the Income Tax Regulations, which prohibit discrimination in favor of highly-compensated employees.

FACTS

SITUATION 1

A profit-sharing plan provides for contributions equal to ten percent of the employer's annual profits. The profits for the relevant year amounted to $6,400,000 and, accordingly, $640,000 was contributed for that year. Pursuant to the plan's allocation formula, this amount was allocated among the plan participants on the basis of one unit for each full $200 of compensation, limited to a maximum of 200 compensation units, multiplied by the number of full years of completed service, as shown in the following tabulation.

                                           Number         Total

                                           Number         Total

A profit-sharing plan provides for annual contributions out of the employer's profits for the year. In the relevant year $400,000 was paid into the fund. Pursuant to the plan, this amount was allocated among the participants on the basis of each participant's compensation, weighted by the participant's years of service, over the total weighted salary of all participants, as shown in the following tabulation.

                                           Number         Total

Section 401(a)(4) of the code provides that a trust forming part of a profit-sharing plan of an employer will not constitute a qualified trust unless the contributions or benefits provided under the plan do not discriminate in favor of employees who are officers, shareholders, or highly compensated.

Under section 1.401-4(a)(2)(iii) of the regulations, variations in contributions or benefits may be provided so long as the plan, viewed as a whole for the benefit of employees in general, does not discriminate in favor of the employees who are officers, shareholders, or highly compensated. Thus, contributions or benefits that vary by reason of an allocation formula that takes into consideration years of service, or other factors, are not prohibited unless such formula results in prohibited discrimination.

In SITUATION 1, limiting the maximum compensation units to 200 results in an effective ceiling of $40,000 on compensation to be taken into account and reduces the extent of discrimination in favor of employees whose earnings exceed that amount. That ceiling, however, does not prevent discrimination with respect to lower-paid employees who have the least number of years of service. Thus, an employee in Group 9 participates to the extent of six percent of compensation and the percentage increases until Group 4 is reached, for which 20 percent is provided on $40,000 of compensation. The fact that a participant who earns $100,000 derives but 8.8 percent of compensation does not offset the discrimination that exists in favor of other highly-compensated groups.

In SITUATION 2, discrimination is not present since employees in the lowest compensation group participate to the extent of 15.35 percent of compensation, and as the compensation increases the percentages decrease, with the result that the highest-paid employee, having 40 years of service, participates to the extent of 14.415 percent of compensation.

In SITUATION 3, discrimination is present since the employees in the lowest salary group are credited with an amount that is equal to 3.33 percent of compensation, and the percentages increase for each higher salary group until the highest group is reached, in which 40 percent is provided for a single participant.

HOLDING

In SITUATION 1, the contributions under the profit-sharing plan did not satisfy the requirements of section 401(a)(4) of the Code and section 1.401-4 of the regulations.

In SITUATION 2, contributions under the profit-sharing plan did not discriminate in favor of highly-compensation employees within the meaning of section 401(a)(4) of the Code and section 1.401-4 of the regulations.

In SITUATION 3, contributions under the profit-sharing plan did not satisfy the requirements of section 401(a)(4) of the Code and section 1.401-4 of the regulations.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 68-652, Rev. Rul. 68-653, and Rev. Rul. 68-654 are superseded, because the positions stated therein are restated under current law in this revenue ruling.