Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 68-58

1968-1 C.B. 176

Sec. 403

IRS Headnote

An employer purchasing an annuity contract referred to in section 403(b) of the Internal Revenue Code of 1954, pursuant to a salary reduction agreement with an employee, may make contributions based on a prescribed percentage of the employee's compensation each year rather than a fixed dollar amount, in order to take into account any increases or decreases in the employee's compensation during a taxable year. The mere change in the amount of contribution under the percentage formula does not constitute the making of a new salary reduction agreement.

Full Text

Rev. Rul. 68-58

Advice has been requested whether an employer purchasing an annuity contract referred to in section 403(b) of the Internal Revenue Code of 1954, pursuant to a salary reduction agreement with an employee, may make contributions based upon a prescribed percentage of the employee's compensation for each year and, if so, whether a change in the amount of such contribution, resulting from increases or decreases in the employee's compensation, will be considered made pursuant to a new salary reduction agreement during the taxable year.

An organization exempt from Federal income tax under section 501(c)(3) of the Code established for the benefit of its employees an annuity purchase arrangement intended to meet the requirements of section 403(b). Under the arrangement each employee agreed to take a reduction in salary or to forego an increase in salary and the employer agreed to contribute a specified percentage of the employee's compensation toward the purchase of an annuity contract. Any increase or decreases in the employee's compensation will be taken into account automatically.

Section 403(b)(1) of the Code provides that, if the provisions set forth therein are net, amounts contributed by an employer for an annuity shall be excluded from the gross income of the employee for the taxable year to the extent that such amounts do not exceed the applicable exclusion allowance as defined in section 403(b)(2).

Section 1.403(b)-1(b)(3) of the Income Tax Regulations provides that the exclusion allowance is applicable to amounts contributed by an employer for an annuity contract as the result of an agreement with an employee to take a reduction in salary, or to forego an increase in salary, but only to the extent that such amounts are earned by the employee after the agreement becomes effective. Such an agreement must be legally binding and irrevocable with respect to amounts earned while the agreement is in effect. The employee must not be permitted to make more than one agreement with the same employer during any taxable year of the employee beginning after December 31, 1963.

Usually, agreements for the purchase of annuities of the type described in section 403(b) of the Code provide that the employer shall contribute a fixed dollar amount during a particular year. Since the exclusion allowance is based, in part, on the employee's compensation for the year, a change in compensation will result in employer contributions in an amount either less than or greater than the employee's maximum exclusion allowance for the year.

However, no provision of the Code or regulations precludes the use of a contribution formula which is based on a percentage of the employee's salary. Such an arrangement will enable the employer to contribute the maximum amount which the employee can exclude under the exclusion allowance. Any change in the amount of contributions, at the time the employee's salary is increased or decreased, will be accomplished solely under the pre-existing agreement. Therefore, the mere change in the amount of employer contributions under the prescribed percentage formula does not constitute the making of a new salary reduction agreement.

Accordingly, the employer in the instant case may make the contributions for each employee based on a prescribed percentage of the compensation notwithstanding the fact that variations as to the amount may arise due to increases or decreases in the compensation during a taxable year.