Rev. Rul. 66-92

Revenue Procedure 65-27, C.B. 1965-2, 1017, sets forth procedures relating to the tax classification of professional service organizations. The purpose of this Revenue Ruling is to furnish further guides for resolving issues arising in connection with deferred compensation plans, established by professional service organizations, which are intended to qualify under section 401(a) of the Internal Revenue Code of 1954.

1. Qualification and Operation .-For purposes of determining whether a deferred compensation plan established and operated by a professional service organization (as defined in section 301.7701-2 of the Regulations on Procedure and Administration and Revenue Procedure 65-27) is a qualified plan within the meaning of section 401(a) of the Code for any taxable year, the same rules are applicable to such plan as are applicable to the plans of other employers.

2. Effect of Change of Tax Classification .-A change in the tax classification of a professional service organization may affect the continued qualification of its deferred compensation plan under section 401(a) of the Code. Several alternatives are available if the organization established and operated a qualified plan during taxable years ending on or before December 31, 1964 (for which such organization is treated by the Internal Revenue Service as if it were a corporation), and if such organization desires to maintain a qualified plan for taxable years ending after December 31, 1964, for which such organization is classified as a partnership or as a sole proprietorship for purposes of taxation.

(a) Continued coverage for common-law employees only .-For taxable years ending after December 31, 1964, a professional service organization may continue its qualified plan only for those employees of the organization who are common-law employees. If the plan is continued only for such employees, the following is applicable:

(i) If any contributions to the plan made for any taxable year ending after December 31, 1964, are by or in respect of individuals who were covered by the plan and treated as common-law employees for taxable years ending on or before December 31, 1964, and those individuals are not so treated and are not common-law employees for any taxable year ending after December 31, 1964, such contributions must be returned to those who made the contributions together with the increments thereon.

(ii) The vested interests on December 31, 1964, subject to the requirements of section 401(a) of the Code, of individuals who are not common-law employees during taxable years ending after December 31, 1964, are to be credited to a separate account for each such individual and earmarked for subsequent distribution in accordance with the terms of the plan in effect on December 31, 1964. Such accounts shall be credited with their proportionate share of increments for taxable years ending after December 31, 1964. They may not, however, be increased by further contributions or by forfeitures in later taxable years.

(b) Amendment to cover owner-employees .-For taxable years ending after December 31, 1964, a professional service organization may amend its plan to cover self-employed individuals (including owner-employees), as defined in section 401(c) of the Code. If such amendment is made, the restrictions and limitations contained in section 401(a) of the Code, relating to plans covering self-employed individuals, would be applicable. Such an amendment would be effective on the date it is made, and would not have retroactive effect for any prior taxable year.

(c) Termination of the plan .-A professional service organization may terminate its qualified plan without affecting its prior qualified status, provided that such termination is by reason of business necessity and that the plan otherwise meets the requirements of section 401(a) of the Code. See Part 6 of Revenue Ruling 65-178, C.B. 1965-2, 94, at page 125. If a professional service organization terminates a plan because the Service treats such organization, for purposes of taxation, as a partnership or as a sole proprietorship for any taxable year ending after December 31, 1964, and such organization was treated by the Service as if it were a corporation for taxable years ending on or before December 31, 1964, the change in tax classification will be recognized as a valid business reason for termination. In the event of such a termination, the following is applicable:

(i) Amounts actually distributed or made available to any distributee pursuant to the terms of a qualified plan which is terminated by a professional service organization shall be taxable to such distributee in the taxable year in which such amounts are distributed or made available in the manner and to the extent provided by sections 402(a) and 403(a) of the Code. However, no person, who is treated as a common-law employee of a professional service organization for any taxable year for which the organization is treated by the Service as if it were a corporation for Federal income tax purposes, shall be deemed in any later year to have been separated from the service of the organization solely because such organization is no longer treated as a corporation for Federal income tax purposes and the change in status has come about without any action of the organization or its members. See section 5.03 of Revenue Procedure 65-27, C.B. 1965-2, 1017, at page 1021. Thus, the capital gain treatment for distributions provided in sections 402(a)(2) and 403(a)(2) of the Code is available only on account of a covered employee's death or his actual separation from the service of the professional service organization. See Revenue Ruling 60-292, C.B. 1960-2, 153.

(ii) The vested interest of each individual, subject to the requirements of section 401(a) of the Code, must be credited to a separate account, as of the last day of the taxable year of such professional service organization ending on or before December 31, 1964. Each separate account must be credited with its proportionate share of increments for taxable years ending after December 31, 1964. The trust, holding the frozen interests and increments thereon, forming part of a qualified plan, will maintain its exempt status under section 501(a) of the Code.

Issues involving the qualification of plans not expressly covered by the foregoing will be considered by the District Director upon request in accordance with established procedures. See paragraph (0) of section 601.201, Statement of Procedural Rules, C.B. 1963-1, 431, at page 448.