69 T.C. 773">*774 Respondent determined deficiencies in Federal income tax as follows:

One issue in docket No. 9336-74 was conceded by petitioner at trial, and the only issue in docket No. 9347-74 was conceded by respondent on brief. The single issue left to be decided is whether under section 404(a)(3), I.R.C. 1954, ^{11978 U.S. Tax Ct. LEXIS 167">*169} Lansons, Inc., is entitled to deductions for contributions to a "qualified" profit-sharing trust. Respondent determined that the trust was not a qualified trust under section 401 because (1) it did not meet the percentage-of-coverage requirements of section 401(a)(3)(A); and (2) the plan in operation discriminates in favor of employees in the prohibited group. He therefore computed the allowable deductions under section 404(a)(5) as made to a "nonqualified" trust.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

Lansons, Inc. (Lansons), filed its Federal income tax returns for the years in issue with the Southeast Service Center at Chamblee, Ga. Its principal place of business at the time it filed the petition was Miami Beach, Fla.

69 T.C. 773">*775 Lansons was incorporated in 1958 by Louis Levine and his son-in-law, Avram J. Kaiser (also known as Jay Kaiser), to engage in selling men's clothes at retail. Initially Lansons sold only shirts and pants to the tourist trade. In time it began selling high quality men's clothing and expanded its business into several different locations; it became a well recognized outlet for men's clothing in Dade and Broward Counties, Fla. Levine and Kaiser and members of their families were the officers and stockholders of Lansons, and they managed the business. In addition Lansons employed salesmen, clerks, tailors, and pressmen to sell and fit its clothing.

On August 15, 1968, Lansons established Lansons, Inc., Profit-Sharing Trust. The trustees were Louis Levine and Avram J. Kaiser. Lansons adopted the profit-sharing trust 1978 U.S. Tax Ct. LEXIS 167">*170 to help retain its employees; it had difficulty hiring and keeping employees who were willing to work long hours in the type of work required. The owners of Lansons wanted to develop and expand the company and encourage its employees to learn the business and become a part of it.

The profit-sharing trust agreement (profit-sharing plan) as originally adopted by Lansons provided: coverage for all employees earning in excess of $ 400 per month (minimum wage requirement), except part-time employees (who were defined as not working more than 20 hours per week and 5 months per year), and who were not less than 25 years (minimum age requirement) and not more than 65 years of age (maximum age requirement), and had been employed not less than 1 year (service requirement). The agreement provided for 15-percent vesting per year for each 1 year of participation in the plan, with 100-percent vesting in the event of death, or total or permanent disability. Contributions were discretionary with the employer and were allocated to the accounts of the participants based upon the compensation of each. Forfeitures, if any, were to be allocated in the same manner. All amounts in a participant's account 1978 U.S. Tax Ct. LEXIS 167">*171 were distributed to him or his estate upon his death or retirement (normally age 65).

In November 1968, Lansons requested a determination that the profit-sharing trust was a qualified trust within the meaning of section 401(a).

The initial submission to the District Director (Jacksonville, Fla.) showed the following coverage: 69 T.C. 773">*776

Two Schedule 3's (schedules of employees) were submitted, one for the 7 covered employees and the other for 17 nonparticipating employees. J. Herschel Kelley, a representative of the life insurance company which issued policies to the trust, represented Lansons with respect to the submission.

Respondent, through Bernard T. Boyd, a pension trust examiner, advised Kelley of amendments to the profit-sharing plan required for a favorable determination. These included amendments eliminating the minimum wage requirement of $ 400 a month and decreasing the vesting percentage from 15 percent to 10 percent a year. Boyd also had suggested that the minimum and maximum age requirements be eliminated, but he was not dogmatic about 1978 U.S. Tax Ct. LEXIS 167">*172 it.

Accordingly, on January 20, 1969, the plan was amended to eliminate the minimum wage requirement and to change the vesting to 10 percent a year; the minimum and maximum age requirements were not changed.

On January 28, 1969, Lansons submitted the amendments as well as a revised Schedule 3 (Schedule of Covered Employees) for the taxable year ending August 31, 1968. Selected data from the schedule of covered employees follows:

It was understood after submission 1978 U.S. Tax Ct. LEXIS 167">*173 of the amendments that the plan would be approved by the Internal Revenue Service.

69 T.C. 773">*777 Respondent on January 31, 1969, issued a letter approving the profit-sharing trust as a qualified trust under section 401(a) and exempt from income tax under section 501(a).

Bernard T. Boyd, the pension trust examiner, wrote on the back of the revised Schedule 3 this note:

Note - 1/31/69

This annualized compensation permitted a marginally acceptable 401(a)(3)(B) classification, using $ 9,500 as the breaking point between highly and non-highly compensated employees. (Six of 10 deemed not in prohibited group). Letter issued with a caveat, however. (Almost meet 401(a)(3)(A), incidentally).

(S) B T Boyd

1/31/69

However, this $ 9,500 breaking point between highly compensated and nonhighly compensated employees was not discussed with Kelley, petitioner's representative.

The favorable determination letter contained a caveat that it was "effective only for the year or years hereafter in which either the percentage tests of Section 401(a)(3)(A) of the Internal Revenue Code are met, or a non-discriminatory classification within the purview of Section 401(a)(3)(B) of the Internal Revenue Code is maintained."

The revised 1978 U.S. Tax Ct. LEXIS 167">*174 Schedule 3 of covered employees erroneously included Barbara Whitestone as a participating employee. In the original submission, Whitestone had been listed as a nonparticipating employee because of the minimum wage requirement; she earned $ 480 during the fiscal year ending August 31, 1968. However, despite elimination of the minimum wage requirement she still was not covered under the amended plan because of the minimum age requirement. As a result of this mistake, in lieu of having 10 covered employees, there were only 9 covered employees.

Following is a schedule of employees of Lansons, Inc., for 1968 to 1971 indicating those participating in the plan and those excluded from coverage under the plan for failure to meet the service or maximum and minimum age requirements, as well as the compensation received by all employees during those fiscal periods.² Explanatory footnotes appear at the end of the table. 69 T.C. 773">*778

* 1978 U.S. Tax Ct. LEXIS 167">*175 Officer, stockholder and/or supervisor.

** In addition to being excluded by either maximum age requirement or minimum age requirement, individual was also disqualified under the service requirement.

*** Part time.

Reason for exclusion from the plan.

1 Less than 12 months service.

2 Overage (66).

3 Underage (25).

69 T.C. 773">*779 A summary of the coverage of the profit-sharing plan for 1968 to 1971 and the percentage of participating employees in terms of the section 401(a)(3)(A)^{31978 U.S. Tax Ct. LEXIS 167">*176} is as follows:

Of the participating employees in the profit sharing plan for 1968 to 1971, three were stockholders and supervisors, and the remainder were tailors, salesmen, and office clerks. The employees who were excluded because of maximum age generally were retired tailors who supplemented their income by working for Lansons from time to time.

On October 4, 1972, Lansons adopted a second amendment to the profit-sharing trust which removed the age requirements. For fiscal year 1973 Lansons had 34 employees, of whom 20 were 69 T.C. 773">*780 excluded from participation for length of service and the remaining employees were eligible and did participate.

Contributions to the profit-sharing trust were within Lansons' discretion for 1968 to 1971. The contributions were as follows:

For the fiscal years 1970 and 1971 a total of $ 4,314.16 was forfeited by employees leaving Lansons. The contributions and forfeitures were allocated to the participating employees' accounts based on their 1978 U.S. Tax Ct. LEXIS 167">*177 other compensation for the particular fiscal year.

After an audit of petitioner's income tax returns, respondent notified Lansons on December 1, 1972, that the favorable determination letter of January 31, 1969, had been revoked retroactively to all open years. The letter stated these reasons:

Examination of Form 2950 filed with the corporate tax returns for the years ended August 31, 1969, 1970 and 1971 indicate discrimination has occured [sic] by omitting rank and file employees from participation in the plan. Rapid turnover of lower paid employees resulted in contributions inuring to the benefit of the prohibited group.

Section 1.401-1(b)(3) of the Regulations states, "The law is concerned not only with the form of a plan but also with its effects in operation".

Section 1.401(b)(3) of the Regulations states, in part, "a plan is not for the exclusive benefit of employees in general if, by any device whatever, it discriminates either in eligibility requirements, contributions, or benefits in favor of employees who are officers, stockholders, persons whose principal duties consist in supervising the work of other employees or the highly compensated employee.

Under section 401(a)(3)(A)1978 U.S. Tax Ct. LEXIS 167">*178 and 401(a)(3)(B) of the Internal Revenue Code you failed to meet the coverage requirements as defined.

The exclusion of employees for minimum and maximum age as well as the turnover of rank and file employees resulted in the discrimination prohibited under section 401(a)(3)(A) and 401(a)(3)(B).

In addition, incorrect information submitted at the time of qualification resulted in approval of a plan that would not have qualified otherwise.

ULTIMATE FINDINGS OF FACT

The classification set up by Lansons, Inc., in the profit-sharing plan did not discriminate in favor of employees who were officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees for the years 1968 to 1971.

69 T.C. 773">*781 Respondent abused his discretion in retroactively revoking his ruling that the trust was a qualified trust under section 401(a).

OPINION

Petitioner seeks deductions for its 1969, 1970, and 1971 fiscal years for amounts it contributed to its profit-sharing trust. The parties agree that these deductions are allowed under section 404(a)(3) if the trust is exempt under section 501(a), and that exemption in turn depends upon whether the trust was a 1978 U.S. Tax Ct. LEXIS 167">*179 "qualified trust" within the meaning of section 401(a). At issue is section 401(a)(3), which provides:

(a) Requirements for Qualification. -- A trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exlusive benefit of his employees or their beneficiaries shall constitute a qualified trust under this section --

* * * *

(3) if the trust, or two or more trusts, or the trust or trusts and annuity plan or plans are designated by the employer as constituting parts of a plan intended to qualify under this subsection which benefits either --

Simpson, J., dissenting: In my judgment, the majority has embraced conclusions which are out of step with the decisions of this and other courts. It is well settled that although a formula for determining eligibility to participate in an employee plan may not be discriminatory on its face, it must be tested in operation, and if in operation the formula results in the prohibited discrimination, the plan does not qualify. Here, substantially all of the benefits accrued 1978 U.S. Tax Ct. LEXIS 167">*195 to members of the prohibited group; nevertheless, the Court has held the plan to be qualified, and I must dissent from that conclusion.

The predecessor of section 401(a) was first enacted in 1942. Sec. 162(a), Revenue Act of 1942, ch. 619, 56 Stat. 862. This provision was designed to correct prior abuses by insuring that employee plans were operated for the welfare of the employees in general, rather than for the benefit of shareholders, officers, or highly compensated employees. H. Rept. 2333, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 372, 413, 450-451; S. Rept. 1631, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 504, 541, 606-607. In addition to providing automatic qualification for plans which satisfied the mechanical percentage of coverage test, Congress provided that more restrictive plans might also qualify, if the Commissioner found that the plan did not discriminate in favor of the prohibited group. Significantly, the report of the Senate Finance Committee provided:

If a plan fails to qualify under the * * * percentage requirements it may still qualify under section * * * [401(a)(3)(B)], provided always that (as required by paragraphs (3) and (4)) the plans eligibility conditions, 1978 U.S. Tax Ct. LEXIS 167">*196 benefits, and contributions do not discriminate in favor of employees who are officers, shareholders, supervisory employees, or highly compensated employees. * * * [S. Rept. 1631, supra, 1942-2 C.B. at 606; emphasis supplied.]

69 T.C. 773">*789 Since the enactment of this provision, the regulations have always provided that the law is concerned not only with whether a plan is discriminatory in form, but also with its effects in operation. Sec. 1.401-1(b)(3), Income Tax Regs.; sec. 39.165-1(a)(3), Regs. 118; sec. 29.165-1(a), Regs. 111. For example, section 401(a)(5) makes clear that a plan limited to salaried employees may qualify; that is, the use of a salaried-only classification is not inherently discriminatory. Yet, the courts have consistently held that when a plan is limited to salaried employees, its operation must be examined, and the courts have uniformly struck down such plans when discrimination in operation was found. Commissioner v. Pepsi-Cola Niagara Bottling Corp., 399 F.2d 390">399 F.2d 390 (2d Cir. 1968), revg. 48 T.C. 75">48 T.C. 75 (1967); Wisconsin Nipple & Fabricating Corp. v. Commissioner, 67 T.C. 490">67 T.C. 490 (1976), on appeal (7th Cir., June 27, 1977); Babst Services, Inc. v. Commissioner, 67 T.C. 131">67 T.C. 131 (1976); 1978 U.S. Tax Ct. LEXIS 167">*197 Liberty Machine Works, Inc. v. Commissioner, 62 T.C. 621">62 T.C. 621 (1974), affd. per curiam 518 F.2d 554">518 F.2d 554 (8th Cir. 1975), Loevsky v. Commissioner, 55 T.C. 1144">55 T.C. 1144 (1971), affd. per curiam 471 F.2d 1178">471 F.2d 1178 (3d Cir. 1973), cert. denied 412 U.S. 919">412 U.S. 919 (1973); Ed & Jim Fleitz, Inc. v. Commissioner, 50 T.C. 384">50 T.C. 384 (1968).

There is no reason to apply different legal principles to plans in which eligibility depends upon length of service, a minimum age, or a maximum age. Indeed, the Senate Finance Committee report stated with respect to the predecessor of section 401(a)(5):

The acceptable provisions mentioned in the law are not intended to be exclusive; for example, there would also be permitted to qualify under section * * * [401(a)(3)(B)] plans limited to employees who have reached a designated age or have been in the employer's employment for a designated number of years or are employed in certain designated departments or are in other classifications, provided that the effect of covering only such employees does not discriminate in favor of officers, shareholders, supervisory employees, or highly compensated employees. [S. Rept. 1631, supra, 1942-2 C.B. at 606; emphasis supplied.]

See also sec. 1.401-3(d), Income Tax Regs.1978 U.S. Tax Ct. LEXIS 167">*198 There may be reasons for limiting a plan to salaried employees, such as the fact that other plans have been created for nonsalaried employees; yet, it has been held that the existence of such justification does not relieve the plan of the requirement of operating in a nondiscriminatory manner. 67 T.C. 131">Babst Services, Inc. v. Commissioner, supra at 140-141; Loevsky v. Commissioner, 55 T.C. 1144">55 T.C. 1151; but see sec. 410(b)(2)(A) (added by sec. 1011, Employee Retirement Income 69 T.C. 773">*790 Security Act of 1974, Pub. L. 93-406, 88 Stat. 900). In like manner, there may be reasons to include minimum age or service requirements as conditions of eligibility or to exclude employees who have passed a maximum age. Yet, the use of such conditions -- singularly or in combination -- may cause the benefits of the plan to flow to the prohibited group, and when that is the result, the plan has failed to meet the essential condition of qualification, that is, it has failed to benefit employees generally.

The majority places great reliance on Ryan School Retirement Trust v. Commissioner, 24 T.C. 127">24 T.C. 127 (1955). However, that case involved unusual facts, and it has been limited to its facts. McMenamy v. Commissioner, 54 T.C. 1057">54 T.C. 1057 (1970), 1978 U.S. Tax Ct. LEXIS 167">*199 affd. 442 F.2d 359">442 F.2d 359 (8th Cir. 1971); 50 T.C. 384">Ed & Jim Fleitz, Inc. v. Commissioner, supra;John Duguid & Sons, Inc. v. United States, 278 F. Supp. 101">278 F. Supp. 101 (N.D. N.Y. 1967). In the Ryan School Retirement Trust case, the drastic reduction in employment was not foreseeable; whereas, here, the effect of the eligibility requirements was to be anticipated.

Finally, the fact that the Commissioner initially approved of this plan does not entitle it to qualification for the years at issue. The information submitted to the Commissioner in connection with the request for qualification showed that the plan was on the borderline of qualification. That information contained an error, which was slight, but in view of the marginal nature of the plan, we cannot assume that such error was insigifnicant. Thus, the ruling was based upon information which never did exist in fact. The U.S. District Court for the Eastern District of Louisiana recently had occasion to consider a somewhat similar situation in the case of Pittman Construction Co. v. United States, 436 F. Supp. 1215">436 F. Supp. 1215 (E.D. La. 1977). In that case, the taxpayer inadvertently misrepresented the age of its president and 50-percent shareholder. An initial 1978 U.S. Tax Ct. LEXIS 167">*200 favorable determination letter was revoked when the misrepresentation was discovered. The court found that the Commissioner's initial approval of the plan did not preclude its later disqualification, for the ruling was valid "only if the facts presented by the taxpayer at the time the ruling was requested were accurate." 436 F. Supp. 1215">436 F. Supp. at 1218.

Moreover, the efficacy of a ruling continues only so long as there are no material changes in the facts upon which it is based. Wisconsin Nipple & Fabricating Corp. v. Commissioner, 67 T.C. 490">67 T.C. 69 T.C. 773">*791 at 496 and cases cited therein. Here, the facts did change -- coverage of the prohibited group increased year by year. Of the participating employees, 67 percent were in the prohibited group the first year, 75 percent the second year, and 83.3 percent the third year.

Under section 7805(b), revocation of a ruling is applicable retroactively, unless the Commissioner provides otherwise, and his failure to make the revocation prospective only must be sustained unless he acts arbitrarily. Automobile Club of Michigan v. Commissioner, 353 U.S. 180">353 U.S. 180 (1957); see Dixon v. United States, 381 U.S. 68">381 U.S. 68 (1965). Under the circumstances of this case, it was surely not arbitrary 1978 U.S. Tax Ct. LEXIS 167">*201 for the Commissioner to revoke his ruling. Were we to hold that a taxpayer acquires an irrevocable right to a favorable ruling issued without knowledge of what facts may develop, the Commissioner might well conclude that it would be inadvisable for him to issue rulings in such a situation.