Maybe Not So Definite? IRS Abandons Stance on Definitely Determinable Requirement for Profit Sharing Plans

The IRS has abandoned its two-year old position regarding the "definitely determinable" allocations requirement for profit sharing plans. In a 1994 field directive, the IRS alerted its regional compliance chiefs that an employer could not divide a pool of money set aside for a profit sharing plan into uneven portions and then allocate the resulting portions of the pool to different employee groups. This came to a surprise to many sponsors of profit sharing plans who would commonly divvy up the contributions to their profit sharing plans among their divisions or members of their corporate family according to profitability.

To illustrate, Employer X is made up of DivisionA, Division B, Division C, and Division D. Employer X decides to put $100,000 into its profit sharing plan which covers all four of its divisions. Of the $100,000 profit sharing contributions pool, Employer X designates $10,000, $20,000, $30,000 and $40,000 for employees of Division A, Division B, Division C and Division D, respectively. Employer X has done this because of the profitability of each division (i.e., Division D was more profitable than C, and Division C was more profitable than B and so on and so forth). Employees in each division share the amount designated to their group among themselves pro rata according to compensation.

The 1994 directive stated that this arrangement was a impermissible. Without going into much too detail, it asserted that the arrangement violated the so-called "definitely determinable rule" because the designation of the amount of contributions to each employee group "is at the discretion of the employer and does not provide definitely determinable allocations for each participant."

Probably for this reason (among others), the IRS has disavowed the 1994 directive. According to the new directive, field reviewers and agents overreacted to the 1994 field directive, striking down all sorts of arrangements that the IRS had been approving for years. It appears, then, that plan sponsors may resurrect profit sharing arrangements that had been rejected by the IRS in the determination letter process last year.