Rev. Rul. 66-13

Advice has been requested whether coverage under a profit-sharing plan is acceptable within the meaning of section 401(a)(3)(B) of the Internal Revenue Code of 1954, where it is limited to salaried or clerical employees and the effect of such classification results in covering employees all of whom are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees.

An employer established a profit-sharing plan for the benefit of his full-time salaried employees. Under the plan's eligibility requirements, all salaried or clerical employees who have attained the age of 30 and have completed 6 months of service may participate. The employer has 20 employees, 2 of whom meet the eligibility requirements and are plan participants. Of the 18 ineligible employees, 17 are excluded because they are hourly rated. The other excluded employee is salaried but does not meet the service or minimum age requirements under the plan.

The two participants are officers and supervisors and each is compensated at a substantially higher rate than the hourly rated employees. The employer makes no contributions to any qualified deferred compensation plan for the benefit of the hourly paid employees.

A plan intended to qualify under section 401(a) of the Code must, among other requirements, benefit employees in general. Section 401(a)(3) of the Code prescribes two alternative rules for employee coverage. The first, set forth in subparagraph (A) of such section, calls for coverage of at least 70 percent of the employer's employees or, if at least 70 percent of such employees are eligible to participate, coverage of 80 percent or more of the eligible employees satisfies this requirement. In each case there are excluded from consideration all employees who have been employed not more than a minimum period prescribed by the plan, not exceeding 5 years, employees whose customary employment is for not more than 20 hours in any one week, and employees whose customary employment is for not more than 5 months in any calendar year. The other rule for employee coverage, in subparagraph (B), provides for a classification set up by the employer and found by the Secretary or his delegate not to discriminate in favor of employees who are officers, shareholders, supervisors, or highly compensated.

Coverage under this plan does not satisfy the percentage requirement of section 401(a)(3)(A) of the Code. Therefore, if it is to qualify as to coverage, it must be demonstrated that the plan covers a classification of employees, as described in section 401(a)(3)(B) of the Code, which does not discriminate in favor of officers, shareholders, highly paid, or supervisory employees.

The first sentence of section 401(a)(5) of the Code provides, in part, that a classification of employees shall not be considered discriminatory within the meaning of section 401(a)(3)(B) of the Code, merely because it excludes employees the whole of whose remuneration constitutes wages under section 3121(a)(1) of the Code (relating to the Federal Insurance Contributions Act) or merely because it is limited to salaried or clerical employees.

Section 1.401-1(b)(3) of the Income Tax Regulations provides, in part, "* * * All of the surrounding and attendant circumstances and the details of the plan will be indicative of whether it is a bona fide stock bonus, pension, or profit-sharing plan for the exclusive benefit of employees in general. The law is concerned not only with the form of a plan but also with its effects in operation. For example, section 401(a)(5) specifies certain provisions which of themselves are not discriminatory. However, this does not mean that a plan containing these provisions may not be discriminatory in actual operation."

Part 4(c) of Revenue Ruling 65-178, C.B. 1965-2, 94, at 112, states, in part, that in lieu of meeting the percentage requirements of section 401(a)(3)(A) of the Code, an employer may set up a classification of employees which, if found by the Commissioner of Internal Revenue not to discriminate in favor of the enumerated groups, will satisfy the requirements of section 401(a)(3)(B) of the Code.

A plan covering only salaried or clerical employees may qualify depending on the facts and circumstances of the particular case. The reference to salaried and clerical employees in the first sentence of section 401(a)(5) of the Code clearly indicates that a plan under which participation is so limited will not be considered discriminatory merely because of such limitation. On the other hand this does not mean that all such classifications are ipso facto, nondiscriminatory. If the use of a salaried or clerical classification, or any other classification, results in covering primarily employees in whose favor discrimination is prohibited, the requirements of section 401(a)(3)(B) of the Code are not met. Section 401(a)(5) of the Code does not make a classification acceptable under section 401(a)(3)(B) of the Code where such classification results in discrimination in favor of officers, shareholders, highly paid, or supervisory employees.

In the case under consideration the employer employs 20 persons and has established a profit-sharing plan providing coverage under a classification which benefits only two individuals. The two covered employees are officers, shareholders, supervisors, and are highly compensated when compared to the hourly rated employees excluded from participation. Thus, the effect of this classification discriminates in favor of the enumerated group and the plan therefore does not meet the coverage requirement of section 401(a)(3)(B) of the Code.