Rev. Rul. 72-98

Advice has been requested whether a plan that provides contributions for owner-employees may qualify under section 401 of the Internal Revenue Code of 1954 if it permits an owner-employee who has not attained age 591/2 or become disabled to withdraw his voluntary contributions thereunder on any anniversary date of the plan.

A profit-sharing plan intended to qualify under section 401 of the Code, provides contributions for individuals who are owner-employees within the meaning of section 401(c)(3). In addition, the plan permits participants to make voluntary contributions to the plan in amounts of up to the lesser of $2,500 or ten percent of their compensation or earned income. The plan provides that no distributions may be made to a former or present owner-employee prior to the time he attains age 591/2 or becomes disabled. However, the plan also provides that any participant, including an owner-employee, may withdraw the lesser of either his voluntary contributions or the value of such contributions on any anniversary date of the plan.

Section 401(d)(4)(B) of the Code provides that an otherwise qualified trust forming part of a profit-sharing plan which provides contributions or benefits for employees, some or all of whom are owner-employees, must not permit the payment of benefits to any owner-employee prior to the time he becomes disabled (within the meaning of section 72(m)(7) of the Code) or attains age 591/2. See also section 1.401-12(m) of the Income Tax Regulations.

Section 72(m)(1) of the Code provides that any amounts received under an annuity, endowment, or life insurance contract before the annuity starting date which are not received as an annuity (within the meaning of section 72(e)(2)) shall be included in the recipient's gross income for the taxable year in which received to the extent that (A) such amounts, plus all amounts theretofore received under the contract and includable in gross income under section 72(m)(1) do not exceed (B) the aggregate premiums or other consideration paid for the contract while the employee was an owner-employee which were allowed as deductions under section 404 for the taxable year and all prior taxable years. Section 72(m)(5) of the Code provides certain penalties with respect to amounts received from a qualified trust, by an individual who is or has been an owner-employee, unless he has attained age 591/2 or become disabled.

A provision permitting a participant to withdraw the lesser of his own voluntary contributions or their current value will not normally prevent the qualification of a plan that is not designed to benefit owner-employees. See Rev. Rul. 60-323, C.B. 1960-2, 148. Furthermore, a participant's withdrawal of his own voluntary contributions pursuant to such a plan provision will not, of itself, result in the withdrawn amounts being taxed to him. See section 1.72-1(d) of the regulations. However, different results are provided where the amounts involved may be distributed to an owner-employee.

Section 1.72-1(d) of the regulations provides that where the aggregate premiums or other consideration paid for the contract include amounts for which a deduction was allowed under section 404 of the Code as a contribution on behalf of an owner-employee, any amounts received shall first be included in gross income until the total amount so included equals the amount for which a deduction was allowed.

Thus, any amounts required to be included in gross income under section 72(m)(1) of the Code and section 1.72-1(d) of the regulations are also amounts to which the penalties provided by section 72(m)(5) of the Code apply, if the participant has not attained age 591/2 or become disabled at the time of distribution, and are benefits within the meaning of section 401(d)(4)(B) of the Code. Consequently, a plan that permits distribution of such amounts, even though limiting the distribution to the lesser of the participant's own contributions or their value at the time of withdrawal, fails to comply with the restrictions on payment of benefits set out in section 401(d)(4)(B) of the Code.

Accordingly, it is held that this plan does not qualify under section 401 of the Code.

Under the authority granted by section 7805(b) of the Code, this conclusion will not be applied to deny qualified status prior to March 6, 1972, to plans with respect to which favorable determination letters have been issued or to plans established by joining a master or prototype plan previously approved as to form. If the qualified status of such a plan is to continue after March 5, 1972, (1) no withdrawals may be made, of contributions made after that date, by an owner-employee who has not attained age 591/2 or become disabled, and (2) the plan must be amended to remove the authorization for owner-employees to make such withdrawals no later than the end of the first taxable year of the employer beginning after March 5, 1972. However, voluntary contributions made by an owner-employee before March 6, 1972, may remain subject to the same withdrawal provisions that were in effect when the contributions were made. Where the employer has joined a master or prototype plan that permits an owner-employee to withdraw his own contributions before he attains age 591/2 or becomes disabled, his plan will not fail to qualify because of that provision if the master or prototype plan is appropriately amended no later than March 5, 1973.