Rev. Rul. 81-105

This revenue ruling provides guidance with respect to the application of section 414(m) of the Internal Revenue Code, as added by the Miscellaneous Revenue Act of 1980, Pub. L. 96-605, 1980-2 C.B. 702. The guidance emphasizes the interaction of section 414(m) of the Code with the nondiscrimination requirements of sections 410(b) and 401(a)(4) in response to questions that have arisen as to how those sections interact. This revenue ruling also obsoletes Rev. Rul. 68-370, 1968-2 C.B. 174, and Rev. Rul. 75-35, 1975-1 C.B. 131.

SEC. 2. APPLICABLE LAW

.01 Section 414(m)(1) of the Code provides that, for purposes of certain employee benefit requirements designated in section 414(m)(4), except to the extent otherwise provided in regulations, all employees of the members of an affiliated service group shall be treated as employed by a single employer.

.02 Section 414(m)(2) defines an affiliated service group as a first service organization (FSO) and one or more of:

(1) any service organization (A-ORG) which is a shareholder or partner in the FSO and which regularly performs services for the FSO or is regularly associated with the FSO in performing services for third persons, and

(2) any other organization (B-ORG) if

(A) a significant portion of the business of that organization is the performance of services for the FSO or A-ORG of a type historically performed in the service field of the FSO or A-ORG by employees, and

(B) 10 percent or more of the interest of the B-ORG is held by persons who are officers, highly compensated employees, or owners of the FSO or A-ORG.

.03 The list of employee benefit requirements in section 414(m)(4) of the Code includes the following:

(1) Section 410(b) which requires that, to satisfy the requirements of section 410(a), a retirement plan must cover either a certain percentage of employees or a classification of employees that does not discriminate in favor of employees who are officers, shareholders, or highly compensated (the prohibited group).

(2) Section 401(a)(4), which requires that, to satisfy the requirements of section 401(a), either the contributions or the benefits under a retirement plan must not discriminate in favor of the prohibited group.

SEC. 3. EXAMPLES

.01 Example 1--

(1) Facts--P, a law partnership consists of corporate partners A, B, C and 10 individual partners. Each of the partners owns less than 10% of the partnership. The partnership employs as common law employees some lawyers, paralegals, and clerical employees. The partnership has a qualified plan, Plan P, covering some but not all of the common law employees. Corporation A and B each have only one employee, the sole shareholder. Corporation A maintains a retirement plan, Plan A. Corporation B maintains no plan. Corporation C employs the sole shareholder, a lawyer employee, and three clerical employees. Corporation C maintains a retirement plan, Plan C, for all its employees. Corporations A, B, and C regularly perform services for P. No individual is a participant in more than one plan and none of the statutory exclusions of section 410(b) applies.

(2) Determination of who are employees of a single employer under section 414(m) of the Code--In order to determine whether the employees covered by Plans A and C satisfy the coverage requirements of section 410(b), it first must be determined what employees are considered as employed by a single employer. Under section 414(m)(2), the partnership, P, may be designated as a FSO. Corporations A, B, and C are partners in the FSO, and regularly perform services for the FSO. Accordingly Corporations A, B, and C are A-ORGS. Because Corporations A, B, and C are A-ORGS for the same FSO, Corporations A, B, and C and the FSO constitute an affiliated service group. Consequently all the employees of Corporations A, B, C, the common law employees of P, and the partners of P are considered as employed by a single employer, and must be taken into account when testing whether the coverage requirements of section 410(b) are satisfied. This group is hereafter called the total aggregated employees.

(3) Determination of whether Plan A satisfies the coverage and nondiscrimination requirements--Plan A covers only one employee, the sole shareholder of Corporation A. Because none of the statutory exclusions of section 410(b) of the Code applies, 1 participant does not satisfy the percentage tests in section 410(b)(1)(A) when compared to the total aggregated employees. Because Plan A covers only prohibited group employees and the total aggregated employees contain several rank and file employees, the non-discriminatory classification test of section 410(b)(1)(B) is not satisfied, either. When a plan does not, considered alone, satisfy the requirements of section 410(b), the employer may designate other plans of the employer to be considered as a unit with the first plan. Such plans, considered as a unit must, among other things, satisfy the coverage and nondiscrimination requirements.

Assuming Plan P were so designated, the first question to consider is whether a plan covering only Employee A and the participants of Plan P satisfies the requirements of either section 410(b)(1)(A) or (B) of the Code when compared to the total aggregated employees. (Alternatively, the employer may designate Plans A, C, and P as a unit or simply Plans A and C as a unit.) If neither coverage test is satisfied Plan A is not a qualified plan. If either coverage test is satisfied, in order for Plan A to be qualified, Plans A and P, considered as a unit must also satisfy the non-discrimination requirements of section 401(a)(4). In making this determination the rules for testing discrimination, including rules which permit imputing social security benefits, apply. In testing for discrimination, all the compensation paid by the affiliated service group to the participants of Plan P is considered, without regard to the percentage ownership of Corporation A in the partnership.

(4) Determination of whether Plan C satisfies the coverage and nondiscrimination requirements--Plan C covers one shareholder, one lawyer employee, and three clerical employees. Coverage of five participants is not adequate to satisfy the percentage tests of section 410(b)(1)(A) of the Code when compared to the total aggregated employees. Whether the nondiscriminatory classification test of section 410(b)(1)(B) would be satisfied by Plan C if its participants are compared to the total aggregated employees depends on additional facts and circumstances not herein provided. See section 1.410(b)-1(d)(2) of the Income Tax Regulations. If section 410(b)(1)(B) were satisfied, the nondiscrimination requirements of section 401(a)(4) would be applied considering the participants of Plan C only (without considering the participants of Plans A or P). However, if the requirements of section 410(b)(1)(B) were not satisfied by Plan C alone, then the plan could be considered in combination with other plans, as described in (3).

.02 Example 2-- (1) Facts--Corporation S provides secretarial services. Corporations A and B, both of which are professional corporations formed by doctors, each own a portion of S. A owns 11 percent of the stock of S and B owns eight percent of the stock. Approximately one-third of S's services are performed for A and one-third for B, while the other one-third are performed for other firms. A and B each maintain a retirement plan (Plan A and Plan B) and each plan covers the corporations only employee. None of the statutory exclusions of section 410(b) of the Code applies.

(2) Determination of who are employees of a single employer under section 414(m) of the Code--In order to determine whether the employees covered by Plans A and B satisfy the coverage requirements of section 410(b), it first must be determined which employees are considered as employed by a single employer. Under section 414(m)(2), Corporations A and B may each be designated as separate FSOs. Corporation S is a B-ORG for A because a significant portion of S's business is the performance of services for A, the services are of a type historically performed in the FSO's service field by employees, and 11 percent of the interest in S is held by owners of the FSO. S is not a B-ORG for B because the owners of B do not hold 10 percent or more of the interest in S.

Because Corporation S is a B-ORG for Corporation A, a FSO, the two constitute an affiliated service group. Consequently, all the employees of A and S are considered as employed by a single employer and must be taken into account when testing whether the coverage requirements of section 410(b) are satisfied. Corporation B is not part of an affiliated service group with either Corporation A or S. Thus, the employee of B is not aggregated with any other employees for purposes of testing coverage.

(3) Determination of whether Plan A satisfies the coverage and nondiscrimination requirements--Plan A covers only one employee, the sole shareholder of Corporation A. Because none of the statutory exclusions of section 410(b) of the Code applies, one participant does not satisfy the percentage tests of section 410(b)(1)(A) when compared to the total employees of the A and S affiliated service group. Because Plan A covers only prohibited group employees and the total aggregated employees of the affiliated service group includes rank and file employees, the nondiscriminatory classification test of section 410(b)(1)(B) is not satisfied, either. Accordingly, unless a sufficient number of the employees of S were covered by Plan A or by another plan so that at least one of the tests of section 410(b) were satisfied, Plan A is not a qualified plan. If, however, section 410(b) were satisfied, the single plan or combination of plans which satisfied that section must also satisfy the nondiscrimination requirements of section 401(a)(4). As in Example 1, the normal rules apply in testing for discrimination under section 401(a)(4) and all the compensation paid to the employees of Corporation S is considered, without regard to the percentage ownership of Corporation A in Corporation S.

(4) Determination of whether Plan B satisfies the coverage and nondiscrimination requirements--Because Plan B covers the only employee of Corporation B, and the corporation is not a part of any affiliated service group, Plan B satisfies both sections 410(b) and 401(a)(4) of the Code.

.03 Example 3--

(1) Corporations A and B are professional corporations formed by doctors (A and B). Corporation A and Corporation B each own one-half of P, a lock repair shop. Corporations A and B utilize the services of P, however, these corporations are an insignificant portion of P's customers.

(2) Under the rules of section 414(m)(2) of the Code there is no affiliated service group based on these facts. Considering A or B Corporations as a FSO, P is not a B-ORG for either FSO because the services performed by P are not of a type historically performed by employees in the service field of the FSO. Furthermore, the service performed for A and B Corporations is not a significant portion of P's business.

(3) Considering P as a FSO, A and B Corporations are not A-ORGS for P because they are not regularly associated with P in performing service for third persons.

SEC. 4. AREAS OF LAW AFFECTED BY SECTION 414(m) OF THE CODE

This section provides a list of some, but not all, other requirements for retirement plans which are affected by section 414(m)(2) of the Code.

 Code Section                         Effect

SEC. 6. EFFECT ON OTHER DOCUMENTS

Rev. Ruls. 68-370 and 75-35 are obsoleted.