Rev. Proc. 75-49

Section 1. Purpose.

This Revenue Procedure provides guidelines which will be followed by the Internal Revenue Service in determining, for purposes of an advance determination letter under section 601.201(o) of the regulations (Statement of Procedural Rules), whether the vesting schedule of an employee plan may discriminate in favor of employees who are officers, shareholders, or highly compensated (the "prohibited group"). These guidelines are concerned only with the circumstances in which a faster vesting rate than would otherwise be required is appropriate for advance determination purposes due to actual or potential discrimination in the accrual of benefits or forfeitures in favor of the prohibited group. This Revenue Procedure establishes tests by which such discrimination will be ascertained in connection with an advance determination letter. A "key employee" test is applied during the first seven years of an employer's existence, which is satisfied (and, thus, additional vesting will not be required) if the number of key employees covered by the plan does not exceed a specified percentage of the number of prohibited group employees covered by the plan. The seven-year period is reduced in certain cases where there is adequate experience in a shorter period. A "turnover" test is also applied (but not for the employer's first two years), which is satisfied if the turnover rate for rank and file employees does not exceed the turnover rate for the prohibited group by more than a specified percentage. If an employer cannot satisfy these tests (when applicable), an advance determination letter will in no event be issued if the plan provides vesting at a rate less rapid than 40 percent after four years of employment, an additional 5 percent for each of the next two years, and an additional 10 percent for each of the following five years. It is to be observed that a plan which satisfies the requirements of this "four-forty" vesting test is not required to satisfy the "key employee" test or the "turnover" test, for purposes of an advance determination as to its qualified status.

Sec. 2. Background.

.01 Under section 401(a)(4) of the Internal Revenue Code of 1954, contributions or benefits under a qualified plan may not discriminate in favor of employees who are officers, shareholders, or highly compensated. Without regard to whether or not such discrimination obtains in a given case, section 411 provides three alternative minimum vesting standards that must be satisfied by all qualified employee plans (hereinafter called the statutory standards).

.02 Generally, a rate of vesting complying with any one of the three statutory standards will be adequate to satisfy the nondiscrimination requirement of section 401(a)(4) of the code. Notwithstanding the foregoing, in certain circumstances where the rate of turnover for officers, shareholders, or highly compensated employees is or may be significantly lower than the rate of turnover for other employees, a rate of vesting more rapid than any of the three statutory standards may be required to prevent discrimination prohibited by section 401(a)(4). Under section 411(d)(1), vesting more rapid than any of the three statutory standards is not to be required to prevent the prohibited discrimination, however, unless there has been, or there is reason to believe there will be, an accrual of benefits or forfeitures tending to discriminate in favor of employees who are officers, shareholders, or highly compensated.

Sec. 3. Issuance of Determination Letters.

.01 Application of Procedure.--This Revenue Procedure applies to an advance determination letter with respect to the initial qualification or the amendment of a plan that provides contributions or benefits for any employee who is an officer, shareholder, or highly compensated.

.02 General Rule.--A favorable advance determination letter will not be issued with respect to a plan to which this Revenue Procedure applies unless--

(1) if the relevant employment period (see section 5.02) does not exceed 24 months, the requirements of section 3.031, (relating to key employee test) or 3.033 (relating to four-forty vesting test) are satisfied,

(2) if the relevant employment period exceeds 24 months but does not exceed 84 months--

(a) the requirements of section 3.031 (if applied) and 3.032 (relating to turnover test) are satisfied, or

(b) the requirements of section 3.033 are satisfied, or

(3) if the relevant employment period exceeds 84 months, the requirements of section 3.032 or 3.033 are satisfied.

.03 Special Tests--

(1) Key employee test.--The requirements of this paragraph are satisfied if for each day of the pre-application year (see section 5.05) the number of plan participants who are key employees (see section 5.01) at any time during the pre-application year is less than the number which represents the applicable percentage of employees who are officers, shareholders, or highly compensated. For purposes of this paragraph, the applicable percentage is determined under the following table:

     Number of months in

(2) Turnover test.--The requirements of this paragraph are satisfied if the rank and file turnover rate (see section 4.02) for the 60-month period ending on the last day of the pre-application year (see section 5.05), or for the relevant employment period if shorter, does not exceed the greater of (i) 6 percent or (ii) the applicable percentage of the prohibited group turnover rate (see section 4.01) for such period; except that the aforesaid 60-month (or shorter) period shall be modified as provided in section 4.041 where the failure to satisfy the requirements of this paragraph is due to a material reduction in force (see section 4.042). For purposes of this paragraph, the applicable percentage is determined under the following table:

     Number of months in

(3) Four-forty vesting test.--The requirements of this paragraph are satisfied if, under the plan, each participant in whose favor discrimination is not prohibited by section 401(a)(4), who has completed at least 4 years of employment (see section 5.04) with the employer, has a nonforfeitable right to a percentage of his accrued benefit derived from employer contributions which, at the end of any year, is not less than the percentage determined under the following table--

     Completed years

Sec. 4. Turnover Rates.

For purposes of this Revenue Procedure--

.01 Prohibited group turnover rate.--The term "prohibited group turnover rate" means the annual rate of turnover for employees in whose favor discrimination is prohibited by section 401(a)(4) of the Code.

.02 Rank and file turnover rate.--The term "rank and file turnover rate" means the annual rate of turnover for employees other than those in whose favor discrimination is prohibited by section 401(a)(4) of the Code.

.03 Computation of turnover.--

(1) Participants included.--Turnover rates shall be computed on the basis of turnover other than by reason of death. Such rates shall be computed by taking into account the turnover of all employees who would have been plan participants had the plan (as in effect at the time the advance determination is requested) been in effect throughout the relevant employment period.

(2) Basis of computation.--

(a) Pre-plan years.--For periods prior to the time the plan is established, turnover rates shall be computed on the basis of the actual number of employees who separate from service of the employer.

(b) Post-adoption years.--For plan years ending after a plan is adopted, such rates shall be computed by taking into account employee turnover only to the extent of the forfeited interest of separated employees. For examples, if an employee separated from service during a plan year at a time when 40 percent of his accrued benefit was nonforfeitable under the plan as in effect at the time of separation, that employee's separation would increase the total of the number of employees who separated from service during that year by only 0.6 rather than by 1. For optional rule applicable in certain cases, see subparagraph (c) of this paragraph.

(c) Optional calculation.--For the period beginning on the day a plan is established and ending on the last day of the last plan year commencing before November 1, 1975, turnover rates shall be computed as provided by subparagraph (a) or (b) of this paragraph as the plan administrator may select.

.04 Material reduction in force--

(1) For purposes of section 3.032 (relating to turnover test), a period of 12 consecutive months in which a material reduction in force occurs (hereinafter called the 12-month base period) shall not be taken into account if, throughout the 12-month base period, the plan satisfies the requirements of section 3.031 (relating to key employee test).

(2) For purposes of this subsection, a material reduction in force is considered to occur in a 12-month period only if the average number of employees of the employer for any period of 90 consecutive days beginning within the 12-month period is at least 20 percent less than the average number of employees of the employer for the corresponding 90-day period beginning within the immediately preceding 12-month period by reason of the separation from service of employees whose jobs are eliminated for reasons other than cyclical business conditions. For purposes of this paragraph, separation from service will be considered to be attributable to cyclical business conditions unless (A) the employer demonstrates that a casualty (within the meaning of section 165(c)(3) of the Code) is the cause of such turnover, or (B) the rank and file turnover rate for the 12-month base period exceeds 200 percent of the rank and file turnover rate experienced by the employer during each of the consecutive 12-month periods (not in excess of 10) preceding the 12-month base period. For purposes of this paragraph, a job will not be considered to have been eliminated unless it is vacant for a period in excess of 12 consecutive months or until the submission of the request for an advance determination if occurring less than 12 months after the job becomes vacant.

Sec. 5. Definitions.

For purposes of this Revenue Procedure--

.01 Key employee.--The term "key employee" means an employee-- (1) who is a shareholder, or

(2) who is an officer of the employer and among the five most highly compensated employees of the employer, or

(3) who, in the case of a partnership, is a partner who owns more than 5 percent of either the capital interest or the profits interest in such partnership.

For this purpose the term "shareholder" means a person who owns, or is considered as owning, within the meaning of section 1563(e) of the Code (determined without regard to section 1563(e)(3)(C)), stock possessing five percent or more of the total combined voting power of all classes of stock entitled to vote or 5 percent or more of the total value of shares of stock of the employer.

.02 Relevant employment period.--The term "relevant employment period" means the period of consecutive full calendar months during which an employer has had one or more employees, ending with the last month of the pre-application year.

.03 Plan.--The term "plan" means a pension, profit-sharing, or stock bonus plan.

.04 Year of employment.--The term "year of employment" means a year of service, required by section 411(a)(4) of the Code to be taken into account in computing an employee's nonforfeitable percentage (without regard to subparagraphs (A), (B), and (C) of section 411(a)(4)).

.05 Pre-application year.--The term "pre-application year" means the period of 12 consecutive full calendar months ending with the month preceding the month in which an application for a determination with respect to the qualified status of a plan (and any related trust) under section 401(a), 403(a), or 405(a) of the Code is filed in accordance with sec. 601.201(o) (Statement of Procedural Rules).

Sec. 6. Scope of Revenue Procedure.

This Revenue Procedure applies solely for purposes of advance determination letters, and, therefore, does not apply in case of a determination with respect to the qualified status of a plan or trust upon an audit of its operations under section 401(a), 403(a), or 405(a) of the Code. This Revenue Procedure also does not apply in determining whether there has been a pattern of abuse under the plan (such as the intentional dismissal of employees to prevent vesting) or actual misuse in the operation of the plan which affects the qualified status of the plan or trust.

Sec. 7. Filing of Applications.

A favorable advance determination letter will not be issued with respect to a plan unless an exhibit showing compliance with this Revenue Procedure is attached to the application for such advance determination letter.

Sec. 8. Multiemployer Plans.

The District Director may waive the requirements of this Revenue Procedure in the case of a multiemployer plan if he finds that (1) vesting more rapid than that provided by the plan is unlikely to be required to prevent the discrimination prohibited by section 401(a)(4) of the Code, and (2) such requirements are unduly burdensome in the case of such plan.

Sec. 9. Effect On Other Documents.

Rev. Proc. 75-47, page 581, is hereby amplified.

Sec. 10 Effective Date.

This Revenue Procedure applies to determination letters issued after October 31, 1975.

¹ Also released as TIR-1411, dated November 3, 1975.