Rev. Rul. 62-206

Advice has been requested whether the qualification of an employees' pension plan will be adversely affected by contributions the amounts of which are based on compensation imputed to certain uncompensated employees.

A labor union established a money-purchase retirement plan and trust for the benefit of the employees of each local which elected to participate. The plan requires each participating local to contribute annually to a common trust an amount equal to ten percent of the annual salary of each of its employees. The plan has been held to meet the requirements of section 401(a) of the Internal Revenue Code of 1954 and the trust is exempt from tax under section 501(a).

One local with ten employees, consisting of five clerical workers and five business representatives of whom three are also officers of the local, elected to participate in the plan as of January 1, 1960. The local pays all but two of the business representatives a salary of approximately twice the salary it pays the clerical empoloyees. Two of the business representatives, who are also officers of the local, do not receive a salary from the local for the performance of services in their respective capacities. Therefore, both of the uncompensated employees fall within the group with respect to which discrimination is prohibited by section 401(a)(4) of the Code.

Since contributions under the pension plan are based on the amount of the annual salaries of the employee participants, there is no basis on which to determine the amount of contribution to be made on behalf of these two uncompensated business representatives. Therefore, by the very terms of the plan, they are both ineligible for participation in the local's contribution to the common trust unless they may be included by imputing compensation to them.

Section 1.401-4(a)(2)(iii) of the Income Tax Regulations provides, in part, that variations in contributions or benefits may be provided so long as the plan, viewed as a whole for the benefit of employees in general, with all its attendant circumstances, does not discriminate in favor of the employees within the enumerations with respect to which discrimination is prohibited by section 401(a)(4) of the Code. Imputing income in the instant case for the purpose of allocating contributions will result in prohibited discrimination. This conclusion follows from the application of the tests set forth in Revenue Ruling 61-157, C.B. 1961-2, 67.

Part 5(k) of that Revenue Ruling, which discusses section 401(a)(5) of the Code, provides that total compensation, basic compensation, or regular rate of compensation may be used provided that whatever is used is consistently and uniformly applicable to all participants. In the instant circumstances this provision would preclude allowing benefits for uncompensated personnel to be based on imputed compensation.

Furthermore, as indicated in Parts 5 (a) and (g) of Revenue Ruling 61-157, the ratio of benefits to compensation is important in determining whether the application of the benefit formula results in discrimination in favor of employees who are officers, shareholders, highly compensated, or persons whose principal duties consist in supervising the work of other employees. Clearly, when examined in terms of this ratio, any benefits flowing from contributions which are based on imputed compensation are discriminatory in favor of the individuals who are to receive the benefits.

Accordingly, it is held that since the basis of compensation on which benefits are computed would not be consistently and uniformly applicable to all participants, and since the benefit formula would result in the prohibited discrimination, the local may not base contributions under the pension plan, for the benefit of the uncompensated employees, on imputed compensation without adversely affecting the qualified status of the plan under section 401(a) of the Code.