SINGLE EMPLOYEE-ELECTED AMENDMENT TO SALARY REDUCTION AGREEMENT WILL NOT VIOLATE RESTRICTION TO ONE AGREEMENT PER TAXABLE YEAR.

Rev. Rul. 87-114

ISSUE

Whether a continuing salary reduction agreement entered into in a prior taxable year precludes an employee from entering into a new salary reduction agreement at any time during the employee's current taxable year?

FACTS

A, an organization exempt from taxation under section 501(c)(3) of the Internal Revenue Code, allows employees of A to agree for an indefinite duration to reduce their salaries. A contributes the amount of the reduction in salary to its annuity program. The salary reduction agreement is irrevocable as to amounts earned while the agreement is in effect but may be revoked as to future earnings. A permits each employee to make one amendment to the agreement during any taxable year of the employee, after the initial taxable year of the agreement, to change prospectively the contribution amount or percentage. This one amendment may be made at any time chosen by the employee within the employee's taxable year.

LAW AND ANALYSIS

Section 403(b)(1) of the Code provides that if an annuity contract which is nonforfeitable except for failure to pay premiums is purchased for an employee by an employer described in section 403(b)(1)(A) (which includes section 501(c)(3) organizations), the amounts contributed by the employer shall be excluded from the gross income of the employee to the extent the aggregate of the amounts contributed does not exceed the exclusion allowance for the taxable year.

Section 1.403(b)-1(b)(3) of the Income Tax Regulations provides that this exclusion from gross income applies to amounts contributed by an employer for an annuity contract as a result of an agreement with an employee to take a reduction in salary or to forego an increase in salary, but only to the extent such amounts are earned by the employee after the agreement becomes effective. Such an agreement must be legally binding and irrevocable with respect to amounts earned while the agreement is in effect. The employee must not be permitted to make more than one agreement with the same employer during any taxable year of such employee and the exclusion provided shall not apply to any amounts contributed under any further agreement made by such employee during the same taxable year. However, the employee may be permitted to terminate the entire agreement with respect to amounts not yet earned.

A salary reduction agreement made for an indefinite period of time and providing for the periodic contributions of a specified percentage of the employee's salary or a specified dollar amount to purchase an annuity is not terminated or modified merely because one taxable year of the employee ends and a new taxable year begins. Rather, the "making of an agreement," for purposes of section 1.403(b)-1(b)(3) of the regulations, describes an affirmative change in such a salary reduction agreement rather than the mere voluntary continuation of the prior salary reduction agreement into a new taxable year. Therefore, permitting an employee covered by such an agreement to make a single new agreement, on a date of the employee's choosing, during any taxable year of the employee after the taxable year in which such agreement was made will not result in the employee's being permitted to make more than one agreement in a taxable year for purposes of section 1.403(b)-1(b)(3) of the regulations.

HOLDING

Under the circumstances described above, a continuing salary reduction agreement entered into in a prior taxable year does not preclude the employee from entering into a new salary reduction agreement at any time during the employee's current taxable year.