Rev. Rul. 81-10

1981-1 C.B. 172, 1981-2 I.R.B. 8.

                       Internal Revenue Service
                                 Revenue Ruling

       FORFEITURE ON TERMINATION OF SERVICE: ALLOCATION BASED ON ACCOUNT
                                    BALANCES

                          Published: January 12, 1981

26 CFR 1.401-4: Discrimination as to contributions or benefits

  Forfeiture on termination of service: allocation based on account balances. A profit-sharing plan will not fail to qualify under section 401 of the Code merely because it provides for the allocation of forfeitures arising from termination of service among the remaining participants on the basis of their account balances.  Whether this provision results in prohibited discrimination must be determined on a year-to-year basis.  Rev. Rul. 71-4 superseded.

  The purpose of this Revenue Ruling is to restate the position in Rev. Rul. 71-4, 1971-1 C.B. 120, in view of the enactment of the Employee Retirement Income Security Act of 1974, P.L. 93-406, 1974-3 C.B. 1.

  The issue in Rev. Rul. 71-4 is whether, under the circumstances described below, a profit-sharing plan that provides for the allocation of forfeitures on the basis of account balances may qualify under section 401(a) of the Internal Revenue Code.

  A corporation established a profit-sharing pan that provides for the allocation of the employer's contributions to participants in proportion to the participants' current annual compensation.  Vesting is at the rate of 10 percent per year of service.  The plan provides that forfeitures arising when a participant's service is terminated are to be allocated proportionately among the remaining participants in the ratio that each participant's account balance bears to the total of account balances for all participants.

  Section 401(a)(4) of the Code provides that a profit-sharing plan may qualify if the contributions or benefits provided under the plan do not discriminate in favor of employees who are officers, shareholders, or highly compensated.

  Section 1.401-4(a)(1)(iii) of the Income Tax Regulations provides that funds in a profit-sharing plan arising from forfeitures on termination of service must not be allocated to the remaining participants in such a manner as will effect the prohibited discrimination.  Section 1.401-4(a)(2)(iii) of the regulations provides that benefits in a profit-sharing plan that vary by reason of an allocation formula that takes into consideration years of service, or other factors, are not prohibited unless they discriminate in favor of the employees enumerated in section 401(a)(4) of the Code.

  Forfeitures, like employers' contributions, may be allocated to participants' accounts pursuant to a formula that takes into account factors other than current compensation.  However, if such factors are used, it must be shown on a year-to-year basis that their use has not resulted in discrimination in favor of the groups enumerated in section 401(a)(4) of the Code.  A permissible method for determining whether the allocation formula produces prohibited discrimination in any given year is to compare the allocations to employees in the enumerated groups as opposed to other employees where such allocations are expressed as a percentage of compensation. Further, the allocation formula must not produce the discrimination prohibited by section 411(d)(1) of the Code. Account balances are, however, merely one of the other factors that may be taken into account in allocating forfeitures if the prohibited discrimination does not thereby result.

  Accordingly, this plan will not fail to qualify under section 401(a) of the Code merely because it provides that forfeitures will be allocated to participants on the basis of their account balances.  Whether this provision results in prohibited discrimination must be determined on a year-to-year basis.

  Rev. Rul. 71-4 is superseded because the position stated therein is restated under current law in this Revenue Ruling.

Rev. Rul. 81-10, 1981-1 C.B. 172, 1981-2 I.R.B. 8.