II. GRACE PERIOD NECESSARY FOR TRANSITION FROM PRESENT LAW TO NEW CODE

In the opening general statement of the Committee on Ways and Means in its report on H. R. 8300 there appears the following:

"In general, the purpose of these changes has been to remove inequities, to end harassment of the taxpayer, and to reduce tax barriers to future expansion of production and employment."

I believe that this general purpose has been carried out to a considerable extent in this highly technical section of the code dealing with pension, stock bonus, and profit-sharing plans.

However, the new bill has created new inequities which will take time to clear up-both by changes in the code and by clarification in subsequent new regulations. Meanwhile, current progress in this field is being arrested. Already, taxpayers are saying, "Let's wait and see what happens to the new tax law before we install a new plan-or amend an existing one." Then, when the new tax law becomes a reality they will say, “Let's wait for the new regulations." When the new regulations come out they will say, "Let's study the new regulations and submit our proposed plans or proposed amendments to the Internal Revenue Service." The situation is an echo of the one which prevailed after the enactment of the Revenue Act of 1942 on October 21 of that year. Yet it was not until the summer of 1944 that the Commissioner of Internal Revenue began to pass upon the qualification of plans to any considerable extent. True, the present bill is intended to liberalize the rules for qualification, but taxpayers are averse to parting with their contributions before they have an assurance, by way of a written ruling, as to the qualification of the plan.

Thus, this creeping paralysis can extend over a transition period of years. This stagnation is unhealthy, undesirable, and unnecessary.

It should be observed that the pension and profit-sharing provisions of the code are unique because of the practice and tradition of doing nothing until the Internal Revenue Service issues a favorable ruling.

Recommendation No. 1: Grace period, with taxpayer's choice under present or new law during transition period

Therefore, my first recommendation is that the Congress permit a taxpayer his choice of qualifying his plan under the present code, or the new one for a period of not less than 1 year after the new code becomes effective, or at least until December 31, 1955. Under this proposal a taxpayer can install a new plan or amend an existing one under the present law with the assurance (except for the sections relating to allowable investments, prohibited transactions, and unrelated business income) that he does not need to worry about—or subsequently qualify under the new code as long as his plan remains substantially unchanged after the end of the grace period, for example, December 31, 1955.

Then, meanwhile, if a taxpayer wants to qualify under the new code, if more favorable, he can proceed leisurely to seek an advance approval from the Internal Revenue Service. If the Internal Revenue Service delays such approvals (as I fear it might-pending new regulations)-the taxpayer will not be stagnated. He can still, in the meantime, get approval under the present tax law-and then subsequently amend if the new regulations, when issued, turn out to be more favorable.

This grace period will also allow the Internal Revenue Service more time to make the transition and train its staff to keep pace with the tremendous amount of additional approvals which it will be called upon to issue because of the new code.

This recommendation will, I believe, be a way of minimizing the chaos and stagnation that will exist during this transition period unless the Congress wants to defer making the entire pension and profit-sharing sections of H. R. 8300 operative until, say 1 year after new regulations are issued, based on the new code as adopted.

III. EMPLOYEE COVERAGE UNDER PENSION PLANS ARE TOO RESTRICTIVE FOR LIMITED CLASSIFICATION PLANS

Probably the area of H. R. 8300 which requires the most urgent correction, and about which I believe your committee will be deluged with requests for modification, is that which relates to employee coverage under a qualified plan such as (1) a plan for employees who are not subject to collective bargaining, or (2) a plan for salaried employees only.

A. AUTOMATIC 25 PERCENT (OR 50 PERCENT) CLASSIFICATION IS GENERALLY SATISFACTORY IF ALL REGULAR EMPLOYEES ARE ELIGIBLE

The employee coverage provisions are not all bad by any means. For instance, a tremendous improvement may be expected through the elimination of the high percentage requirements, the 70 and 80 percent provisions, of existing law for employee eligibility and participation. Also, great strides are being made toward a logical and feasible approach by doing away with the haphazard and purely discretionary means of determining whether a classification discriminates in favor of employees who are officers, shareholders, supervisors, or highly compensated. What is a discriminatory classification is a matter of opinion and opinions differ. Not only is there a wide divergence of opinion among the pension trust reviewers in the various field offices throughout the country but different views may be encountered in the same office.

A classification which is automatically acceptable is therefore desirable. The requirements for coverage of 25 percent of all regular1 employees, or 50 percent if there are no more than 20 of such employees, are excellent and will take care of some cases.

B. FOR LIMITED CLASSIFICATION PLANS, THE 10-PERCENT KEYMAN RULE IS THE TROUBLE SPOT

However, the difficulty develops where an employer wants to qualify his plan under the proposed limited classifications of some of his employees which would make the plan subject to the new 10-percent keyman rule. This proposed 10percent keyman rule is a new concept and is the greatest obstacle and, in fact, an insurmountable obstacle in many cases involving plans which are otherwise sound.

Thus we have an anomalous situation. The expressed intent of the Congress was to liberalize the pension provisions. Yet we find in this particular area that it is possible for companies to set up limited classification plans and obtain tax approval under the present tax law but which would be impossible of approval if the new bill becomes law.

The simplest solution, obviously, is to remove the 10-percent keyman rule entirely from the proposed law and merely spread the 25 percent (or 50 percent) coverage rule to all limited classification plans as well as to all broad coverage plans. However, such an extension of the 25 percent (or 50 percent) rule, without some restraints, could lead to abuses that could cause discredit on the whole pension movement. This development should be avoided at all costs. Consequently, I have endeavored to spell out the type of cases where the 10 percent rule needs to be eliminated, so that, in the balance of cases, the 10 percent rule, or perhaps the present integration rule, may be utilized.

On the surface, this 10-percent keyman limitation does not appear to be unduly harsh, but let us see what it means in concrete situations.

1. Companies with collective-bargaining units

Let us consider the case of a company which employs 2,000 full-time regular employees. All of the hourly rated employees, 1,800 in number, are already covered under a union-negotiated pension plan which is fully financed by company contributions. The company may desire to set up a plan for the 200 employees who are not subject to the collective-bargaining agreement. This is what it will be faced with:

No more than 20 of the participants in the plan for employees not in the collective-bargaining unit, that is, 10 percent of 200, may be key employees. Key employees are those whose total compensation places them in the highest paid 10 percent of the regular employees, up to a limit of 100 highest paid employees. Many of the non-collective-bargaining employees are frequently higher paid than the employees who are subject to collective bargaining with the result that, say, 100 of the 200 employees not subject to collective bargaining might rank among the highest paid 10 percent of all regular employees. However, only 20 of these 100 higher paid employees may be included in the plan for employees not subject to collective bargaining. Thus, this employer could not establish a practical pension system for his employees not subject to collective bargain

1 Regular employees are those who are employed for more than 20 hours a week, more than 5 months a year, and for more than a minimum period prescribed by the plan, not exceeding 5 years.

ing because 80 out of 100 of them must be left out of that plan. This innocent employer would find himself in this dilemma even though, in fact, he is willing and able to contribute to the cost of 2 pension plans, 1 for all his employees subject to collective bargaining and the other for all his employees who are not members of a collective-bargaining unit. The fact that the 1,800 employees' pension plan was being funded as a result of a collective-bargaining agreement would not in any way help this employer in the straitjacket established by an impractical 10-percent keyman tax test applied in a vacuum only for the employees not subject to collective bargaining. From the standpoint of tax deductions, the anomaly is that the plan for employees not subject to collective bargaining, might well require but a small fraction of the cost for both plans. This unsound situation could not develop under the present tax law. Hence, the 10-percent keyman rule must be eliminated, at least in situations of this type, if the pension movement is to continue to develop.

(a) Recommendation No. 2—25 percent (or 50 percent) rule to apply to a plan for non-collective-bargaining employees if employees in collective-bargaining units have a pension plan.-True, the employer may designate a trust, or two or more trusts, or trust or trusts and annuity plan or plans as constituting parts of a plan intended to qualify. This would be helpful if the plan for the employees subject to collective bargaining could be considered with the plan for the employees not so subject and both held to qualify on an overall basis, as meeting the 25 percent overall test even though the benefits of the two plans are different-which they usually are. It does not appear, however, that the present bill provides this relief. My second recommendation is that the code provide this relief, i. e., that both plans be held to qualify on an overall basis regardless of any divergence in benefits as between the two plans.

(b) Recommendation No. 3-Present 70 percent and 80 percent rule to apply in a plan for non-collective-bargaining employees if collective-bargaining units do not have a pension plan.-Another inequity of H. R. 8300 would be in a case where a company wants to establish a plan for its regular employees who are not subject to collective bargaining (e. g., salaried employees) but does not want to establish a plan for the balance of regular employees (e. g., hourly rated employees), who are subiect to collective bargaining. The union can always demand a pension plan for those members of the collective-bargaining unit which it represents if and when it has exhausted direct wage and other working-condition demands, or when it becomes a top-priority demand at the bargaining table. In addition, most collective-bargaining agreements have a seniority clause which the union might be able to invoke as a deterrent to an employer dismissing long-service members without a pension plan.

Besides, it must be remembered that even though an employer is perfectly willing to have an identical plan for his employees who are subiect to collective bargaining and for those not subject to collective bargaining there is the fact that some unions insist on having their own type of plan covering their union members only-often on an area wide, or industrywide basis. Consequently, it would be impractical in such a situation for an employer to negotiate a pension plan for his employees subject to collective bargaining that would be identical with his plan for the employees not subject to collective bargaining. Yet, unless he did this under H. R. 8300, it would be impossible for him to start with a plan for his employees not subject to collective bargaining alone without meeting the impractical 10 percent keyman test (unless there are at least 1,000 salaried employees not subject to collective bargaining).

My recommendation is that where an employer is subject to collective bargaining of some of his regular employees, even though these employees do not have a pension plan, the employer should be permitted to offer a plan to these employees who are not subject to collective bargaining. In such cases, the present tax-law rules as to coverage might be applied, i. e., the plan for employees not subject to collective bargaining may qualify if it covers at least 70 percent of all such regular employees or, if at least 70 percent of them are eligible, at least 80 percent of those who are eligible must participate in the plan.

Similarly, if some of the employer's salaried or hourly rated employees are members of a collective-bargaining unit, while others are not, the 70-percent and 80-percent coverage rules should apply as to these nonmember employees. Recommendation No. 4-70-percent and 80-percent rule for salaried employees only plan where nonsalaried employees have no plan

Thus far, I have addressed myself solely to the critical situations where, for practical purposes, an employer would be prevented from establishing a plan for

his employees not subject to collective bargaining if he had some employees who are subject to collective bargaining.

However, there are other areas which I believe should be opened up to the possibility of establishing a limited classification plan, particularly salaried employees' classification, even though the nonsalaried, e. g., hourly employees, are not subject to collective bargaining.

Again the 10-percent keyman rule under H. R. 8300 makes such salaried plans hopeless except for very large companies which can cover 1,000 or more salaried employees. Thus, smaller companies could not establish a practical salariedemployees-only-classification type of plan if the 10-percent keyman rule becomes the law. This would discriminate against the small employer in his efforts to attract and hold desirable salaried employees. No such restriction applies under the present tax law. The remedy lies in eliminating the 10-percent keyman rule for the salaried-employees-only type of plans.

If the Congress continues-as I believe it should-the possibility of a salariedonly classification, it would mean that the Congress was reaffirming the policy of permitting companies to start first with a salaried-only-type plan and relying on the general impact of employer and employee relations to encourage these employers to ultimately broaden their plans to cover their nonsalaried employees instead of trying to force this issue through tax encouragement or tax penalty. It is possible that there may develop some abuses. However, the fact that contributions or benefits have to be nondiscriminatory within the group covered in a salaried plan will be a restraint. In addition, the basic restraint will be the fact that, whatever benefits an employer provides for his salaried employees will make him vulnerable to similar request from the excluded nonsalaried employees. Fundamentally, if an employer's nonsalaried (hourly) employees are not subject to collective bargaining and he elects to give pensions to his salaried employees only, he may be treating employees unequally and causing probable friction among them. This would be poor employee relations and adversely affect plant efficiency and operation and this will be a constant reminder to an employer who establishes a salaried-only plan. This basic restraint will cause pension plans to expand and cover all regular employees with the Government merely providing the initial impetus by encouraging a company to start a plan, even if on a salaried-employees-only basis.

My recommendation No. 4 is identical to my recommendation No. 3; namely, that the 70 percent and 80 percent rule for salaried only plan eligibility rules be applied to all regular salaried employees-where nonsalaried (e. g., hourly) employees are excluded from eligibility under the plan, or have a separate plan of their own-with different benefits.

3. Remedy for possible abuses under recommendation No. 4 is to retain integration However, if this 70 percent and 80 percent rule is not deemed an adequate control for salaried employees only type of plans (where nonsalaried employees have no plan or one with different benefits), then it would seem that retention of the integration rules under the present tax law is preferable to the 10 percent keyman rule for this type of salaried employees only plan.

4. All other more limited classifications must meet the 10 percent keyman or integration rules

Any other classification, beyond those I have described above, such as those for employees earning in excess of a specified amount, or those employed in a designated plant, division, department, or other operating unit of the employer could be required to meet either the 10 percent keyman rule, or, if deemed necessary the present integration rules, as a basis for qualification.

IV. VESTING WHERE COLLECTIVELY BARGAINED PLAN REPLACES EMPLOYER'S PLAN It may also be observed that employees now covered under an existing qualified plan may, pursuant to collective bargaining negotiations, subsequently become participants in a separate plan for the collective bargaining unit but which is financed in whole or in part by the employer. Obviously, in most instances, the employer cannot afford to contribute both to his own and the plan for the collective bargaining unit. Provision is therefore usually made that upon becoming participants in a negotiated plan to which the employer contributes the employees shall not be entitled to benefits under the employer's plan established for his regular employees who are not in the collective bargaining unit. If this materializes, the position currently taken by the Internal Revenue Service is that the employer's plan has been terminated or, at least, terminated with respect to those employees who go over to the plan for the collective bargaining unit. In such 45994-54-pt. 3-20

event, it is required under Revenue Ruling No. 33 "At such time the rights of all participants should be fully vested."

This is an unfair and costly requirement which the employer must meet, especially in view of the fact that the situation was not of his choosing. Also, it should be remembered that if this relief is not granted it would discourage employers generally from covering any employees who might some day be covered by a collectively bargained pension plan. This would be just the opposite to the sound trend of encouraging an employer to cover all his regular employees. Recommendation No. 5-No vesting to be required

It is therefore recommended that the situation should be remedied by an explicit provision to the effect that no vesting is required as to benefits funded by employer contributions made on behalf of employees who subsequently become participants in a separate plan for the collective bargaining unit to which the employer is required to make contributions.

V. 30 PERCENT SHAREHOLDERS' RULE IS TOO SEVERE

Thus far, I have deliberately separated the 10 percent keyman rule from the 30 percent shareholders' rule because each rule has a different impact.

The 30 percent shareholder rule can be lived with-but I believe it is unnecessarily harsh and will discourage establishment of plans by smaller businesses. Obviously, the 30 percent shareholder rule does not bother a large or sometimes even medium-sized company. It only limits small companies but yet this, in point of numbers, is the area for greatest potential growth of the pension and profit-sharing movement in the future. Therefore, to impose too confining a limitation here can slow down the establishment of these types of plans. This is not good for our economy as employees would have one less reason to want to work for small companies if they do not have the same opportunity for security under a pension plan as if they worked for big business. The practical solution is to try to prevent undue tax advantage to shareholder-employees and still en-courage these smaller plans.

A. RECOMMENDATION NO. 6-CHANGE 30 PERCENT RULE TO A 50 PERCENT RULE A more reasonable and logical rule, for plans that do not meet the 25 percent (or 50 percent) coverage test, would be a 50 percent shareholders' rule. Thus, a limited classification type of plan, e. g. salaried employees only, meeting the tests indicated in my recommendations 2, 3, or 4, would be deemed to be prima facie acceptable if up to, but not exceeding, 50 percent of the employer's contributions were used to provide benefits for shareholder-employees. This would indicate that at least one-half of the employer's contributions were for the benefit of nonshareholders (as defined) and hence for the exclusive benefit of the employees. However, if the employer's contributions for shareholder-employees (as defined) exceeded 50 percent, it would be deemed prima facie as a taxdeductible dividend device and should be prohibited.

Some views have been expressed that in a case of two shareholders, husband and wife, who are the only employees, the plan could meet the 50 percent rule and hence concentrate all of the benefits for the two shareholder-employees. This example is correct in theory but in practice it would be an insignificant aspect of the whole weight of tax-deductible contributions for pension plans. After all, corporations do not establish themselves or stay in business merely to set up tax-deductible pension funds. As they grow they have to add employees and they certainly want to grow. So the pension plan is merely incidental. As the organization grows the portion that the shareholders get would keep on shrinking, and if the organization does not grow the impact on revenue can be disregarded as being insignificant. Meanwhile, it is the lesser price to pay to encourage small- and medium-sized employers to establish these plans particularly if there is incorporated some reasonable shareholder rule such as herein suggested.

B. ALTERNATE RECOMMENDATION NO. 7-CHANGE FIXED 30 PERCENT RULE TO A FLEXIBLE PERCENTAGE RULE

If a liberalized percentage, such as 50 percent, is not acceptable, I would suggest a new approach to a flexible yardstick as the complement of the top corporate tax bracket that is in the code as it may exist from time to time.