Nor does the plan satisfy the "80 percent of 70 percent" requirement under section 401(a)(3)(A). The crucial second step of this two-phase process focuses on employees eligible under the plan's requirements without regard to statutory exclusions. First, a determination for the percentage of "eligible" to "all" employees should be made to compute the 70-percent test. Then a percentage of "covered" to "eligible" employees must be ascertained to satisfy the 80-percent requirement.

In 1972 Wells is statutorily excluded from the total number of employees due to his lack of service requirement, placing the "all" employee figure at five. Because Wilcox is excluded under the plan for age, the "eligible" employee figure is set at four, providing a four-to-five ratio within the first-step 70-percent test. Using the same reasoning for 1973, there is a six-to-seven ratio, also within the 70-percent guidelines.

The computations for the 80-percent second step determination, however, indicate an insufficient percentage of "covered" to "eligible" employees. The three-to-four and four-to-six ratios for 1972 and 1973, respectively, 1977 U.S. Tax Ct. LEXIS 49">*63 do not meet the 80 percent requirement, and, therefore, the plan provides inadequate coverage under either test to be qualified under section 401(a)(3)(A). ⁵

68 T.C. 881">*890 Respondent further contends that, in addition to not meeting the section 401(a)(3)(B) requirements, petitioner's plan fails to meet the alternative nondiscriminatory requirements with respect to its contributions or benefits under section 401(a)(4). ^{61977 U.S. Tax Ct. LEXIS 49">*64} See secs. 1.401-3(b) and 1.401-4(a)(1)(i), Income Tax Regs.; Loevsky v. Commissioner, 55 T.C. 1144">55 T.C. 1144, 55 T.C. 1144">1149 (1971), affd. 471 F.2d 1178">471 F.2d 1178 (3d Cir. 1973).

The two Code provisions are explained in Babst Services, Inc. v. Commissioner, 67 T.C. 131">67 T.C. 131, 67 T.C. 131">136 (1976):

Section 401(a)(3)(B) deals with coverage, and in effect conditions qualification of the plan upon a finding by the Secretary or his delegate that the classification of employees eligible to participate in the plan is not discriminatory in favor of the prohibited group. Section 401(a)(4), on the other hand, is concerned with the functioning of the plan, and it in substance makes qualification turn upon whether "the contribution or benefits provided under the plan do not discriminate in favor of" the prohibited group.

In deciding whether the contributions and benefits were discriminatory, again all the facts and circumstances of the operation of petitioner's plan must be considered to determine whether the plan was operated for a "fair cross section" of all employees in general, rather than for those employees in the category of the prohibited group. Sec. 1.401-4(a)(2)(iii), Income Tax Regs.

Respondent cites Peter F. Mitchell Corp. v. Commissioner, T.C. Memo. 1968-209, 1977 U.S. Tax Ct. LEXIS 49">*65 which states:

Congress enacted the provisions of section 401(a)(4) "In order to insure that stock bonuses, pension, or profit-sharing plans are operated for the welfare of employees in general, and to prevent the trust device from being used for the benefit of the shareholders, officials, or highly paid employees." H. Rept. No. 2333, 77th Cong., 2d Sess., 1942-2 C.B. 372, 450.

Respondent then concludes that the benefits and contributions received by the high percentage of highly compensated employees were discriminatory under section 401(a)(4).

We agree that petitioner's plan was operated in a discriminatory manner. It is true that the plan is a defined percentage benefit plan without regard to weighted years of service or 68 T.C. 881">*891 forfeiture of benefits, but the exclusion in 1972 of one eligible low compensation employee, Taylor, resulted in coverage only for the high compensation group. Despite Taylor's inclusion in 1973, one low and one middle compensation employee were omitted, thus tipping the coverage scales to imbalance in favor of the prohibited group. The plan, therefore, was not operating for a fair cross section of all the employees in general.

Thus, the central issue in this case 1977 U.S. Tax Ct. LEXIS 49">*66 turns upon whether retroactive relief should be granted for the misinterpretation of the adjustment date. The availability of this type of correction, if successfully pursued, obliterates past coverage difficulties which, in turn, obviates discussion of claims of discrimination. Unfortunately, we find no support for retroactive cure in this case in the Code, regulations, or case law.

Section 401(b) authorizes a taxpayer to retroactively correct a disqualifying provision ⁷ on the face of a plan. ⁸ FESPA is thus precluded from relief under this provision since its defect was one of operation and not form. It is to this method that the court in Myron v. United States, 382 F. Supp. 590 (C.D. Cal. 1974), affd. 550 F.2d 1145">550 F.2d 1145 (9th Cir. 1977), was referring when it denied retroactive relief for a profit-sharing plan. The court noted that:

plaintiff is attempting to elevate form over substance. * * * There was a benefit enjoyed by not covering those employees -- unfortunately for them, however, it inured only to Myron and her sole-owned corporations. [Myron v. United States, supra at 598.]

Petitioner argues that the operation of its plan in variance with its terms should be viewed as harmless 1977 U.S. Tax Ct. LEXIS 49">*67 error, rather than a fatal error causing its plan to be disqualified. There is no allowance in section 401(a) for an excuse to be offered to neutralize the effect of the objectionable operation, irrespective of whether the cause resulted from an honest mistake, inadvertence, erroneous advice of counsel, or intentional misdirection. See Myron v. United States, supra.

Nor can petitioner obtain relief under applicable case law for the simple reason that those cases permitting retroactive cure were not discriminatory in operation. To the contrary, 68 T.C. 881">*892 petitioner maintains that Myron v. United States, supra, leaves the door ajar on the degree of discrimination to permit courts to decide how wide to open it on the degree of mistake that would be tolerated in allowing retroactive corrections. Petitioner further cites Aero Rental v. Commissioner, 64 T.C. 331">64 T.C. 331 (1975), as support for permitting retroactive cure for harmless error.

With respect to the discretion petitioner claims courts have to grant retroactive relief, this Court would like to stress that the lines of demarcation 1977 U.S. Tax Ct. LEXIS 49">*68 for deciding whether to grant this type of cure are well defined when concerned with operational rather than form disqualification. Relief was granted in Aero Rental when we decided that the taxpayer had timely amended "the objectionable provisions, and no one benefited by reason of the temporary existence of those provisions." 64 T.C. 331">Aero Rental v. Commissioner, supra at 342. See also Mendenhall Corp. v. Commissioner, 68 T.C. 676">68 T.C. 676 (1977). A deciding factor that cannot be ignored is that the objectionable provisions were on the face of the plan and were not involved in the operation of the plan. Unlike the instant case, the plan in Aero Rental was not discriminatory in operation. This crucial difference was expressly noted in the concurring opinion as being persuasive for the majority result. The same conviction was reiterated in the concurring opinion of Myron.

Petitioner also cites Ray Cleaners Inc. v. Commissioner, T.C. Memo. 1968-6, as support for retroactive cure. In that case the taxpayer failed to invite several employees to be plan participants in one of the years in issue. The holding results from a finding that the plan was nondiscriminatory with respect to those employees covered 1977 U.S. Tax Ct. LEXIS 49">*69 by the plan (before considering the effect of the excluded employees). The opinion is based on this distinguishing factor:

While only three employees were participants, four others were invited to participate and declined to do so. * * * It follows that only one of the three participants was in the prohibited group. We do not think this renders the plan discriminatory in operation. Finally, it is true that in 1964, petitioner inadvertantly failed to invite three eligible employees to participate. We do not think, however, that an inadvertent omission disqualifies a plan. Although there is language to the effect that inadvertent omission will not disqualify a plan, it is written in the context based upon the narrow confines of a finding that this plan did not violate section 401(a), irrespective of its objectionable 68 T.C. 881">*893 operation. This was due to the fact that the plan was properly operated prior to the error, that the eligible employees had been initially offered coverage, and that employees who were participants included those not in the prohibited group -- all facts not applicable to the instant case. That holding, however, is not a blanket suggestion that operational violation 1977 U.S. Tax Ct. LEXIS 49">*70 of section 401(a) may be excused on grounds of inadvertent omission and we expressly reject such a broad interpretation.

Petitioner's administrative mistakes are analogous to the discriminatory operation of the plan in Myron v. United States, supra. Both taxpayers argued justifiable excuse for the disqualification in operation because those defects derived from honest mistakes. In countering that contention, the Court of Appeals for the Ninth Circuit said:

While it might seem harsh to deny retroactive qualification of any plan where a claim of innocence has been accepted, this Court is not prepared to say that consideration of the degree of failure, even innocent failure in coverage is an improper basis for denying qualification.

The Commission has not and need not set any inflexible standard for determining the degree of inadvertent error required for disqualification. * * * [Myron v. United States, 550 F.2d 1145">550 F2d 1145, 550 F.2d 1145">1146 (9th Cir. 1977.]

Moreover, the concurring opinion by Judge Sneed distinguished Ray Cleaners from Myron on the same ground Ray Cleaners is not applicable here -- because the pension plan was discriminatory in operation.

Petitioner has attempted to distinguish its case on 1977 U.S. Tax Ct. LEXIS 49">*71 the basis that its plan, unlike the one in Myron, operated properly during its first 2 years of operation. That position is without legal significance, for as stated in Central Motor Co. v. United States, an unreported case ( D. N.M. 1976, 37 AFTR 2d 76-1001, 76-1003, 76-1 USTC par. 9245, p. 83,524):

A plan declared qualified by the Commissioner at its inception may lose its qualification if it is administered or operated in a way that violates the fundamental purpose of section 401. * * * (Citations omitted.)

The fact that a plan discriminated in operation was decisive in denying retroactive relief in Quality Brands, Inc. v. Commissioner, 67 T.C. 167">67 T.C. 167, 67 T.C. 167">175 (1976). There this Court stressed:

petitioners suggest that they are willing to reconstruct the accounts * * * to eliminate the prohibited discrimination * * * They argue that such actions 68 T.C. 881">*894 should be given retroactive effect, and they claim that Aero Rental, 64 T.C. 331">64 T.C. 331 (1975), supports their position. However, this situation is altogether different from that in Aero Rental, in which there had been no discrimination in the operation of the plan * * * here, the plans have been operated in a manner so as to discriminate in favor of 1977 U.S. Tax Ct. LEXIS 49">*72 a prohibited group. Under these circumstances, there is no authority for permitting the petitioners to change retroactively what has been done in order to qualify the plan. See also Myron v. United States, supra; cf. sec. 401(b). [Emphasis added.]

Petitioner seeks to distinguish Quality Brands from its case on factual grounds that are immaterial to the outcome. In both cases the discriminatory effect resulted from improper operation of the plan, and it is immaterial that the causes to that end differed as a result of discretionary, as opposed to nondiscretionary, acts. Denial of retroactive cure applies to both acts, as the holding in Quality Brands indicates.

Petitioner also cites Time Oil Co. v. Commissioner, 258 F.2d 237">258 F.2d 237 (9th Cir. 1958), remanded 26 T.C. 1061">26 T.C. 1061 (1956), for the proposition that operational variances can be deemed too "slight" to disqualify the plan, based on whether those variances prejudiced the benefits to be received by the beneficiaries and improved the benefits to the employer. The issue in Time Oil was whether the plan was operated for other than the exclusive benefit of its employees.

We agree with respondent that Time Oil was based on different issues of 1977 U.S. Tax Ct. LEXIS 49">*73 fact and results and, therefore, is not the proper criterion to apply in determining if petitioner's plan satisfies the percentage and nondiscriminatory requirements of section 401(a). There is no authority in that case to justify retroactive cure for inadvertence. Furthermore, in Wisconsin Nipple & Fabricating Corp. v. Commissioner, 67 T.C. 490">67 T.C. 490, 67 T.C. 490">498 (1976), when distinguishing Time Oil, we reiterated the criterion of improper operation on which cases turn:

In Time Oil Co. v. Commissioner, * * * also relied upon by the petitioner, it was found that the profit-sharing plan was not disqualified because of its operation. Here, such a finding has not been made. [Citations omitted.]

Accordingly, we hold that petitioner's plan did not fulfill the eligibility requirements under section 401(a)(3). Because the plan operated improperly, petitioner is not permitted to cure that discriminatory operation retroactively for the years 1972 and 1973. See and compare Ludden v. Commissioner, 68 T.C. 826">68 T.C. 826 (1977).

68 T.C. 881">*895 In view of concessions made by the parties and our conclusions on the disputed issues,

Decision will be entered under Rule 155.