Rev. Rul. 57-37

Advice has been rquested as to the Federal income and employment tax treatment of contributions made by an employer, pursuant to a collective bargaining agreement, to individual trusts providing for certain unemployment and other benefits to its employees.

In 1955, corporation M entered into an agreement with representatives of its hourly-rated employees. The agreement, which was the result of collective bargaining negotiations and supplementary to a general labor agreement, provided for the establishment of a `security benefit plan,' hereinafter referred to as the plan. Under the plan, certain unemployment and other benefits are to be paid to the employees covered by the collective bargaining agreement, provided they are eligible to participate in the plan. Pursuant to the provisions of the plan thus established, corporation M entered into an agreement with a trustee, selected by it, establishing for each employee eligible to participate in the plan, a trust, to be known as the employee's `security benefit account.' Under the plan, corporation M contributes to each employee's security benefit account an amount computed at a specified rate per hour for each hour actually worked by the employee subsequent to the date on which he became eligible to participate in the plan. Contributions to each of such accounts will continue to be made by corporation M until the balance in the account reaches a specified maximum amount; thereafter, no further contributions to the account are required to be made until the balance in the account falls below the maximum amount provided for in the plan. The trustee will hold the amount contributed by corporation M to each of such accounts and the interest earned thereon as a separate trust estate for the exclusive benefit of the particular employee. No part of the amount contributed by corporation M is recoverable by such corporation. The amounts held in the individual employees' accounts, however, may be consolidated by the trustee for investment purposes.

In the event a participating employee's lay-off results from a reduction in force or is temporary in character, or the employer is absent from work because of injury or sickness for at least two consecutive pay periods, he will be eligible to receive payments from his security benefit account for each full pay period of such lay-off or absence. The plan provides that, for the protection of the employee, the funds held by the trustee in the employees' security benefit accounts may not be sold, transferred, assigned, pledged, or otherwise encumbered. Upon termination of employment or retirement of the employee, the balance in his security benefit account will be paid to him. In the event of his death, such balance will be distributed to his designated beneficiary or to his estate. Upon termination of the plan, the trustee will, within one year of the termination date, liquidate the assets of the trusts and pay to each participating employee his pro rata share thereof, computed on the basis of the balances in the security benefit accounts on the date of such termination. Therefore, each participating employee has a fully vested and nonforfeitable beneficial interest in all amounts contributed or credited to his security benefit account.

In accordance with the provisions of the plan, corporation M entered into a trust agreement with a national bank which, acting as trustee, agreed to accept and hold the funds contributed to the security benefit account of each eligible employee as a separate trust estate for the exclusive benefit of each such employee. The trust agreement provides that the funds of all the separate trusts may be commingled, managed, and invested as one or more consolidated funds in United States Government bonds or other equivalent securities. The trustee is required to credit, as of December 31 of each year, earnings, including capital gains less capital losses, from investment of the consolidated funds to the individual employee's security benefit account. However, the trustee is prohibited from making any payment from a security benefit account to the beneficiary thereof until corporation M certifies that the beneficiary is eligible to receive such payment. The trust agreement provides, also, that no part of any trust shall ever be diverted to or recovered by corporation M , or be used for or diverted to purposes other than the exclusive benefit of the persons entitled thereto, and that no modification of the trust agreement shall be made to make any such use or diversion possible thereunder.

Section 61 of the Internal Revenue Code of 1954 provides, in part, that gross income means all income from whatever source derived, including compensation for services. As stated in Commissioner v. John H. Smith , 324 U.S. 177, Ct. D. 1633, C.B. 1945, 49, `Section 22(a) of the Revenue Act of 1938, to which section 61 of the 1954 Code corresponds is broad enough to include in taxable income any economic or financial benefit conferred on the employee as compensation, whatever the form or mode by which it is effected.' Contributions paid into an irrevocable and nonforfeitable trust by an employer for the benefit of an employee are taxable to the employee when the contributions are made. Revenue Ruling 55-691, C.B. 1955-2, 21.

Section 3401 of the 1954 Code provides that, for the purpose of income tax withholding, the term `wages' means all remuneration paid in cash or other form to an employee for services performed (with certain exceptions not here material) for his employer. Sections 3121 and 3306 of the Code contain similar provisions in defining the term `wages,' for purposes of the taxes imposed by the Federal Insurance Contributions Act and the Federal Unemployment Tax Act (chapters 21 and 23, respectively, of subtitle C, 1954 Code).

In the instant case, each employee eligible to participate in the plan agreed through his bargaining representatives that amounts computed at a specified rate on hours worked shall be contributed by corporation M to the trustee of the employee's security benefit account. Such contributions, though not made directly to each employee, constitute additional compensation to such employees, are includible in his gross income under section 61 of the Code, and are subject to income tax withholding under section 3402 of the Code, and to the taxes imposed by the Federal Insurance Contributions Act and the Federal Unemployment Tax Act, Supra , at the time paid into the trusts.

Section 162(a) of the Code provides that there shall be allowed as a deduction from gross income all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business, including a reasonable allowance for salaries or other compensation for personal services rendered. However, section 404(a) of the Code provides that if contributions are paid under a stock bonus, pension, profit-sharing, or annuity plan, or if compensation is paid or accrued on account of any employee under a plan deferring the receipt of such compensation , such contributions or compensation shall not be deductible under section 162 or section 212 (relating to expenses for the production of income), but if they satisfy the conditions of either of such sections, they shall be deductible under section 404 of the Code, subject to certain limitations as to amounts. Section 404(a)(5) provides that contributions so paid under a plan (other than pension trusts, employees' annuities, or stock bonus and profit-sharing trusts), where the employees' rights to or derived from such employer's contributions or such compensation are nonforfeitable at the time the contribution or compensation is paid, are deductible by the employer in the year paid.

In the instant case, the contributions by M corporation represent compensation for services rendered by the covered employees and, thus, constitute ordinary and necessary expenses within the meaning of that term as used in section 162(a) of the Code. However, since such compensation is paid under a plan which defers the receipt thereof to the participating employees or their beneficiaries, the deductibility of the payments is governed by the provisions of section 404 of the Code. The employees' rights to or derived from the contributions to the employees' accounts are nonforfeitable at the time contributed. Therefore, the amounts thereof will be deductible under the provisions of section 404(a)(5) of the Code in the taxable year or years during which so contributed.

The trust agreement contains no expression of intent contrary to the declaration of establishing thereby a separate and individual trust for each employee eligible to participate in the Plan. Therefore, it is held that a separate trust was created for each employee by the said agreement.

If any of the trusts so created has for a taxable year any taxable income, or gross income of $600 or more, regardless of the amount of taxable income, or has a nonresident alien beneficiary, the trustee will be required to make a Fiduciary Income Tax Return, Form 1041, for each such trust.

The consolidated funds will qualify as common trust funds under section 584 of the Code, provided the funds are maintained in accordance with section 584(a)(2) of the Code in conformity with the rules and regulations, prevailing from time to time, of the Board of Governors of the Federal Reserve System partaining to the collective investment of trust funds by national banks. If the provisions of section 584(a)(2) are complied with, the consolidated funds will not be subject to Federal income tax. However, for information purposes only, the trustee should file a Partnership Return, Form 1065, for the consolidated funds.