rr-05-55.pdf

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Part I

Section 411.--Minimum Vesting Standards

26 CFR 1.411(a)-1: Minimum vesting standards; general rules.

(Also, §§105, 7805; 301.7805-1.)

Rev. Rul. 2005-55

ISSUE
Does a profit-sharing plan fail to satisfy the requirements of § 401(a)(7) of
the Internal Revenue Code if it provides a medical reimbursement account for
each participant from which payments may only be distributed to reimburse the
participant for expenses for medical care?
FACTS
Employer M maintains Plan A, a nongovernmental profit-sharing plan that
is intended to be a qualified plan under § 401(a). Plan A includes two separate
accounts for each participant: a profit-sharing account and a medical
reimbursement account. Plan A provides that 75% of Employer M’s annual
contributions to Plan A on behalf of each participant is allocated to that
participant’s profit-sharing account and the remaining 25% is allocated to the
participant’s medical reimbursement account. Plan A does not provide for (after-
tax) employee contributions.
Plan A provides that amounts in a participant’s medical reimbursement
account may be used to reimburse the participant for any substantiated

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expenses for medical care (as defined by § 213(d)) incurred by the participant or
the participant’s spouse and dependents (as defined in § 152, determined without
regard to § 152(b)(1), (b)(2), and (d)(1)(B)).
Plan A also expressly provides that
under no circumstances may amounts held in the medical reimbursement
account be distributed except to reimburse the participant for expenses for
medical care incurred by the participant or the participant’s spouse or
dependents. The restriction on use of the medical reimbursement account
applies to all participants in the plan (i.e., current and former employees,
including retired employees). Plan A further provides that, upon the death of the
participant, the account is available only to reimburse expenses for medical care
of the participant’s spouse or, if unmarried or the spouse consents (in the manner
required under § 417(a)(2)), the medical care expenses of the participant’s
dependents, if any, and is only available for that purpose as long as those
individuals qualify as the participant’s spouse and dependents for purposes of
§ 105(b). If there is no surviving spouse or dependent(s), upon the participant’s
death, or at such time when no individual qualifies as a surviving spouse or
dependent for purposes of § 105(b), any remaining unused portion of the medical
reimbursement account will be forfeited and will be applied to reduce future
employer contributions to medical reimbursement accounts under the plan.
Plan A provides that amounts in the profit-sharing account of each
participant (and not amounts in the medical reimbursement account of the
participant) are available for distribution to the participant after severance from
employment with Employer M.

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LAW
Section 401(a) provides requirements for a trust forming part of a stock
bonus, pension or profit-sharing plan to be qualified under § 401(a). A profit-
sharing plan is a type of defined contribution plan. Section 414(j) provides that a
defined contribution plan is a plan which provides an individual account for each
participant and for benefits based solely on the amount contributed to the
participant’s account, and any income, expenses, gains and losses, and any
forfeitures of accounts of other participants which may be allocated to the
participant’s account.
Section 1.401-1(b)(1)(ii) of the Income Tax Regulations provides that a
profit-sharing plan, within the meaning of § 401, must provide for distributing the
funds accumulated under the plan after a fixed number of years, the attainment
of a stated age, or upon the prior occurrence of some event such as layoff,
illness, disability, retirement, death, or severance of employment. Section 1.401-
1(b)(1)(ii) further provides that a profit-sharing plan is primarily a plan of deferred
compensation but the amounts allocated to the account of a participant may be
used to provide incidental life or accident or health insurance for him and his
family.
Section 402(a) generally provides that any amount distributed to any
distributee from a plan qualified under § 401(a) is taxable to the distributee, in the
taxable year in which distributed, under § 72.
Rev. Rul. 61-164, 1961-2 C.B. 99, provides that a profit-sharing plan does
not violate the incidental benefit rule in § 1.401-1(b)(1)(ii) merely because, in
accordance with the terms of the plan, each participant’s account under the plan

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is charged with the cost of the major medical benefits for the participant under
the group hospitalization insurance for the employer’s employees, provided that
the total amount used for life or accident or health insurance for him and his
family is incidental. The revenue ruling further provides that such insurance will
be treated as incidental if the amount expended for such benefits does not
exceed 25% of the funds allocated to a participant’s account that have not been
accumulated for the period prescribed by the plan for the deferment of
distributions. However, Rev. Rul. 61-164 provides that the incidental benefit
requirement does not limit the amount expended for such benefits from funds
allocated to a participant’s account that have been accumulated for the period
prescribed by the plan for the deferment of distributions. The revenue ruling also
concludes that although the purchase of the major hospitalization insurance does
not prevent the qualification of the plan if the insurance is deemed to be
incidental, the use of the funds to pay for the employees' medical insurance is a
distribution within the meaning of § 402.
Section 401(a)(7) provides that a trust shall not constitute a qualified trust
unless the plan of which such trust is a part satisfies the requirements of § 411.
Section 411(a) describes minimum vesting standards that a retirement
plan subject to that section must satisfy in order for the plan to be qualified under
§ 401(a). These standards include § 411(a)(2), which requires that an
employee’s accrued benefit derived from employer contributions become
nonforfeitable in accordance with one of the two schedules specified in §
411(a)(2). Section 411(a)(7) and § 1.411(a)-7(a)(2) provide that, in the case of a

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defined contribution plan, an employee’s accrued benefit is the balance of the
employee’s account under the plan.
Notwithstanding § 411(a)(2), § 411(a)(3) and § 1.411(a)-4(b) permit the
forfeiture of an employee’s accrued benefit under certain circumstances. These
permissible forfeitures include forfeitures on account of death.
Section 1.411(a)-4T(a) provides that, for purposes of § 411, a right to an
accrued benefit is considered to be nonforfeitable at a particular time if, at that
time and thereafter, it is an unconditional right. The regulation further provides
that, subject to the permissible forfeitures of § 411(a)(3) and § 1.411(a)-4(b) and
certain other prescribed situations, a right which, at a particular time, is
conditioned under the plan upon a subsequent event, subsequent performance,
or subsequent forbearance which will cause the loss of such right is a forfeitable
right at that time.
Section 105(a) provides that, except as otherwise provided in § 105,
amounts received by an employee through accident or health insurance for
personal injuries or sickness are included in gross income to the extent such
amounts (1) are attributable to contributions by the employer which were not
includible in the gross income of the employee, or (2) are paid by the employer.
Section 105(b) provides that, except in the case of amounts attributable to (and
not in excess of) deductions allowed under § 213 for any prior taxable year, gross
income does not include amounts described in § 105(a) if such amounts are paid,
directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses
incurred by the taxpayer for the medical care (as defined in § 213(d)) of the

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taxpayer or the taxpayer's spouse or dependents (as defined in § 152,
determined without regard to § 152(b)(1), (b)(2), and (d)(1)(B)).
Section 1.105-2 of the regulations provides that only amounts that are
paid specifically to reimburse the taxpayer for the expenses incurred by the
taxpayer for medical care (as defined in § 213(d)) are excludable from gross
income. Section 105(b) does not apply to amounts that the taxpayer would be
entitled to receive irrespective of whether the taxpayer incurs expenses for
medical care. Accordingly, if an employee is entitled to receive the payment
irrespective of whether or not any medical expenses have been incurred, none of
the payments are excludable from gross income under § 105(b), even if the
employee has incurred medical expenses during the year. See Rev. Rul. 2002-
80, 2002-2 C.B. 925, and Rev. Rul. 2005-24, 2005-16 I.R.B. 892.
Finally, Congress has specifically prescribed rules relating to the funding
of future health benefits on a tax-favored basis. For example, such funding is
addressed by the rules in §§ 419, 419A, 501(c)(9), and 512 for welfare benefit
funds (including Voluntary Employees' Beneficiary Associations) and by §§
401(h) and 420 with respect to retiree health benefits provided through a
qualified plan.
ANALYSIS
Under a profit-sharing plan, as a defined contribution plan, benefits to a
participant must be based solely upon amounts contributed to the participant’s
account and attributable income, gains, expenses and losses. Under the

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§ 411(a)(7) definition of accrued benefit for a defined contribution plan, all
amounts credited to a participant’s account under the plan are part of the
accrued benefit and must satisfy the nonforfeiture requirements of § 411(a)(2).
Plan A provides that under no circumstances may any amounts held in a
medical reimbursement account be distributed to any participant except to
reimburse the participant for substantiated medical expenses incurred by the
participant or the participant’s spouse and dependents. Plan A thereby imposes
a condition on the entitlement of the participant (and the participant’s
beneficiaries) to the amounts held in the medical reimbursement accounts and,
as a result of that restriction, these amounts fail to be nonforfeitable.
However, if Plan A instead provided that amounts payable from the
medical reimbursement account were available for distribution under the same
terms as the amounts held in the profit-sharing account (e.g. after severance of
employment with Employer M), Plan A would not fail to satisfy § 411 merely
because Plan A also permitted amounts held in the medical reimbursement
account to be distributed both before and after severance of employment to
reimburse medical expenses (or to pay the cost of major medical insurance as
described in Rev. Rul. 61-164). However, in that case, no amounts paid from
Plan A would be excludable under §105(b). Therefore, any distribution from Plan
A would be includable in gross income under § 402(a).
HOLDING
Plan A fails to satisfy the vesting requirements of § 411 because it
imposes conditions on the use of the amounts held in the participants’ accounts.
Accordingly, the plan fails to satisfy § 401(a)(7).

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In addition to the requirements of §§ 401(a)(7) and 411, a profit-sharing
plan which only permits distribution of amounts held in a separate medical
reimbursement account for reimbursement of substantiated medical care
expenses, as described in the facts above, may fail to satisfy various other
qualification requirements of § 401(a), including § 401(a)(9), § 401(a)(11), and
§ 401(a)(14).
CORRECTIVE PLAN AMENDMENTS
Pursuant to the authority contained in § 7805(b) and § 301.7805-1 of the
Procedure and Administration Regulations, the Commissioner has determined
that a profit-sharing plan or stock bonus plan will not fail to be qualified under §
401(a) for plan years beginning on or before August 15, 2005, merely because
the plan provides for a separate medical reimbursement account for each
participant and for the amounts in the participant’s medical reimbursement
account to be only used to reimburse the participant for any substantiated
expenses for medical care provided that (i) the plan (including the provisions of
the plan relating to the medical reimbursement accounts) is the subject of a
favorable determination letter (or in the case of a pre-approved plan, a favorable
advisory or opinion letter) issued before August 15, 2005, and (ii) the plan is
amended effective on the first day of the first plan year beginning after August
15, 2005, to provide that amounts in each participant’s medical reimbursement
account are available for distribution under the same terms as amounts held in
the participant’s other accounts under the plan (e.g. upon severance from
employment). Further, any distributions made from a plan that is the same as or
similar to the plan described under the FACTS section of this revenue ruling

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before the first day of the first plan year beginning after August 15, 2005, to
reimburse the participant for any substantiated expenses for medical care (as
defined by § 213(d)) incurred by the participant or the participant’s spouse or
dependents (as defined in § 152, determined without regard to § 152(b)(1), (b)(2),
and (d)(1)(B)) will not fail to be excluded from income under § 105(b) merely
because, due to the publication of this revenue ruling, the plan is amended
effective as of the first day of the plan year beginning on or after August 15,
2005, to allow distribution of the amounts held in the medical reimbursement
account for reasons other than for reimbursement for any substantiated
expenses for medical care.
DRAFTING INFORMATION
The principal author of this revenue ruling is Robert Walsh of the
Employee Plans, Tax Exempt and Government Entities Division. For further
information regarding this revenue ruling, contact the Employee Plans taxpayer
assistance telephone service between the hours of 8:00 a.m. and 6:30 p.m.
Eastern time, Monday through Friday, by calling (877) 829-5500 (a toll-free
number). Mr. Walsh may be reached at (202) 283-9888 (not a toll-free number).
For further information regarding this revenue ruling as it pertains to § 105,
please contact Barbara E. Pie of the Office of Division Counsel/Associate Chief
Counsel (Tax Exempt and Government Entities) at (202) 622-6080 (not a toll-free
number).