Rev. Rul. 69-286

Advice has been requested concerning the treatment, for purposes of the taxes imposed under the Federal Insurance Contributions Act and the Federal Unemployment Tax Act, and for purposes of Collection of Income Tax at Source on Wages (chapters 21, 23, and 24), respectively, subtitle C, Internal Revenue Code of 1954) of payments made by a corporation to certain former employees under the circumstances described below.

In the instant case, a corporation maintains a pension plan for all its employees with provisions for an optional retirement age of 60 years and a mandatory retirement age of 65. In addition, the corporation has established an incentive compensation plan for the purpose of enabling salaried employees in managerial and similar key positions, whose individual attributes and efforts the corporation feels have contributed to its financial success, to share in that success. Pursuant to the incentive compensation plan, an incentive compensation reserve fund has been established, the maximum amount of which is dependent upon the profits realized by the corporation and its affiliates. Payments (allotments) from this fund are made to these key employees upon termination of their services with the corporation.

An eligible employee may take payment of his allotment at any time he terminates his services with the corporation. As a consequence, a number of employees receive their allotments soon after they are made. The treatment of the payments in such cases, for Federal employment tax purposes, is not here involved. With respect to certain other employees, however, all or part of the allotment is contingently credited by the corporation in shares of its common stock. That part (together with dividend equivalents thereon) is then transferred to the individual employee in equal annual installments (ranging from 15 to 20, depending on the employee's age), beginning in the year following the year in which the employee terminates his employment with the corporation. Payment of the allotment is subject to cancellation if the former employee engages in certain employment considered competitive with that of the corporation.

The question in the instant case is whether an allotment thus contingently credited in shares of the corporation's common stock and subsequently transferred to a former employee in equal annual installments after his employment has been terminated by retirement or by disability, or an allotment paid to a beneficiary of an employee whose employment has been terminated by death, is "wages" for purposes of the taxes imposed under the Federal Insurance Contributions Act and the Federal Unemployment Tax Act, and for Federal income tax withholding purposes.

Sections 3121(a)(2) of the Federal Insurance Contributions Act and 3306(b)(2) of the Federal Unemployment Tax Act exclude from the term "wages," as defined in the Acts, the amount of any payment made to an employee under a plan or system established by an employer which makes provision for his employees generally or for a class or classes of his employees on account of retirement, sickness or accident disability, medical or hospitalization expenses in connection with sickness or accident disability, or death.

Whether an allotment made to an employee, under the circumstances described above, who has retired, or who has become disabled, or to a beneficiary of an employee who has died, is excluded from "wages" under sections 3121(a)(2) and 3306(b)(2) of the Acts depends upon whether such an allotment may be said to have been made "on account of" retirement, disability, or death, within the meaning of these sections.

A contingent allotment paid to a former employee under the circumstances presented in the instant case represents remuneration attributable to services performed by the employee in employment prior to the termination of the employer-employee relationship. It is additional remuneration to key employees whose services the corporation feels have been essential to its success. See Rev. Rul. 57-92, C.B. 1957-1, 306. It is in the nature of a bonus, to which bonus the individual is entitled at any time he leaves the employ of the corporation. The occasion upon which the employee elects to receive it does not change the character of the payment. If an employee chooses to take payment at the time he retires, that event does not serve to convert a payment that is in the nature of a bonus to a payment "on account of retirement."

Accordingly, a contingent allotment paid, under the circumstances described, to a former employee whose employment relationship has been terminated by retirement or by disability, or to the beneficiary of an employee whose employment has been terminated by death is not a payment "on account of retirement" within the meaning of sections 3121(a)(2) and 3306(b)(2) of the Federal Insurance Contributions Act and the Federal Unemployment Tax Act. The allotment is not, therefore, excluded from the term "wages" under these sections, but is "wages" at the time of payment to the employee for purposes of the taxes under the Acts.

The above conclusions apply to contingent allotments made by the corporation, under the circumstances described prior to January 3, 1968. Sections 3121(a)(13) of the Federal Insurance Contributions Act and 3306(b)(10) of the Federal Unemployment Tax Act, which were added to the Internal Revenue Code by section 504(a) and (b) of the Social Security Amendments of 1967 (Public Law 90-248, January 2, 1968, C.B. 1968-1, 648, at 656) exclude from the term "wages" with respect to remuneration paid after January 2, 1968, any payment or series of payments by an employer to an employee or any of his dependents which is paid--

"(A) upon or after the termination of an employee's employment relationship because of (i) death, (ii) retirement for disability, or (iii) retirement after attaining an age specified in the plan referred to in subparagraph (B) or in a pension plan of the employer, and

"(B) under a plan established by the employer which makes provision for his employees generally or a class or classes of his employees (or for such employees or class or classes of employees and their dependents), other than any such payment or series of payments which would have been paid if the employee's employment relationship had not been so terminated."

Accordingly, a contingent allotment paid by the corporation after January 2, 1968, to an employee whose employment relationship has been terminated because of retirement (at the retirement age specified in the pension plan) or because of disability, or to a beneficiary of an employee upon the employee's death, is excluded from the term "wages" for purposes of the taxes under the Federal Insurance Contributions Act and the Federal Unemployment Tax Act pursuant to the provisions of sections 3121(a)(13) and 3306(b)(10) of those Acts, respectively.

The treatment of the contingent allotment for Federal income tax withholding purposes is not affected by the January 2, 1968, date. If the allotment is paid to a former employee who has retired or become disabled, the amount is "wages" for income tax withholding purposes. If the allotment is paid to a beneficiary of an employee whose employment has been terminated by death, the allotment is not subject to income tax withholding. See Revenue Ruling 59-64, C.B. 1959-1, 31, which holds that payments made to the beneficiary of a deceased employee that represent unpaid compensation for services rendered by the decedent are not "wages" subject to the withholding of income tax at source.