PLR 200017054: Government pension contributions picked up by employer avoid current income tax

Plain-English summary

A political subdivision agreed by ordinance to pay mandatory employee contributions to a retirement plan in place of its employees. Employees could not choose to receive the amounts as cash. The IRS ruled that the picked-up contributions would be treated as employer contributions under § 414(h)(2), excluded from employees' income until distribution, and excluded from wages for federal income tax withholding. The ruling does not cover contributions tied to compensation earned before the required pickup arrangement took effect. It also assumes the plan qualifies under § 401(a) and does not decide whether the amounts are subject to Social Security or Medicare taxes.

Ruling snapshot

• Question: Are mandatory retirement plan contributions paid by the government employer excluded from current employee income and federal income tax withholding?
• Outcome: Approved that treatment for qualifying picked-up contributions.
• Key authorities: IRC §§ 414(h)(2), 401(a), and 3401(a)(12)(A); Rev. Ruls. 77-462, 81-35, 81-36, and 87-10.

Full text (IRS public release)

200017054
Internal Revenue Service
Department of the Treasury
Washington, DC 20224

UILC: 414.00-00
Contact Person:
9999.98-00
Telephone Number:

Attn: In Reference to:
T:EP:RA:T3
Date: Feb 3, 2000

Legend:

State A
=
Group B Employees =
Employer M =
Plan X
=
Ordinance C =

Dear Mr.
:

In letters dated June 9 and August 13, 1999, your authorized representative requested a ruling on your behalf concerning the federal income tax treatment of certain contributions to Plan X under section 414(h)(2) of the Internal Revenue Code.

The following facts and representations have been submitted:

Employer M is a political subdivision of State A. Employer M maintains Plan X for the benefit of Group B Employees. It has been represented that Plan X is intended to meet the requirements of section 401(a) of the Code. Plan X requires mandatory employee contributions by Group B Employees.

Ordinance C mandated that Employer M pick up, i.e., assume and pay, the mandatory employee contributions of Group B Employees to Plan X, in lieu of Group B Employees paying such contributions. Group B Employees will have no option to receive
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the picked-up contributions in cash in lieu of having such contributions paid to Plan X.

Based upon the aforementioned facts, you request a ruling that:

1. The mandatory contributions picked up by Employer M on
   behalf of Group B Employees who are participants in Plan X will be treated as employer contributions and will not be included in the eligible participants’ gross income in the year in which such amounts are contributed to Plan X.

2. No part of the contributions of Employer M which
   constitute pick-up contributions shall constitute wages for federal income tax withholding purposes; and

3. The amounts picked up by Employer M on behalf of Group B
   Employees who are participants in Plan X will be excludable from such eligible participants’ gross income until such time as they are distributed from Plan X, as a retirement pension, and thereupon taxed according to the rules governing distributions from qualified retirement plans.

Section 414(h)(2) of the Code provides that contributions, otherwise designated as employee contributions, shall be treated as employer contributions if such contributions are made to a plan described in section 401(a), established by a state government or a political subdivision thereof, and are picked up by the employing unit.

The federal income tax treatment to be accorded contributions which are picked up by the employer within the meaning of section 414(h)(2) of the Code is specified in Revenue Ruling 77-462, 1977-2 C.B. 358. In that revenue ruling, the employer school district agreed to assume and pay the amounts employees were required by state law to contribute to a state pension plan. Revenue Ruling 77-462 concluded that the school district's picked-up contributions to the plan are excluded from the employees' gross income until such time as they are distributed to the employees. The revenue ruling held further that under the provisions of section 3401(a)(12)(A) of the Code, the school district's contributions to the plan are excluded from wages for purposes of the Collection of Income Tax at Source on Wages; therefore, no withholding is required from the employees' salaries with respect to such picked-up contributions.

The issue of whether contributions have been picked up by an employer within the meaning of Code section 414(h)(2) is addressed in Revenue Ruling 81-35, 1981-1 C.B. 255 and Revenue Ruling 81-36, 1981-1 C.B. 255. These revenue rulings established that the following two criteria must be met: (1) the employer must specify that the contributions, although designated as
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200017054

employee contributions, are being paid by the employer in lieu of contributions by the employee; and (2) the employee must not be given the option of choosing to receive the contributed amounts directly instead of having them paid by the employer to the pension plan. Furthermore, it is immaterial, for purposes of the applicability of section 414(h)(2), whether an employer picks up contributions through a reduction in salary, an offset against future salary increases, or a combination of both.

In Revenue Ruling 87-10, 1987-1 C.B. 136, the Internal Revenue Service considered whether contributions designated as employee contributions to a governmental plan are excludable from the gross income of the employee. The Service concluded that to satisfy the criteria set forth in Revenue Rulings 81-35 and 81-36 with respect to particular contributions, the required specification of designated employee contributions must be completed before the period to which such contributions relate.

Pursuant to Ordinance C, criteria set forth in Revenue Ruling 81-35 and Revenue Ruling 81-36 is satisfied by providing, in effect, that Employer M will make contributions in lieu of Group B Employees’ contributions and by providing that Group B Employees shall not be given the option to receive such contributions directly.

Accordingly, with respect to ruling requests 1 and 3, we conclude that the mandatory contributions picked up by Employer M on behalf of Group B Employees who are participants in Plan X will be treated as employer contributions and will not be included in the Employees’ gross income for the year in which such amounts are contributed. These amounts will be includible in the gross income of the Employees or their beneficiaries only in the taxable year in which they are distributed from Plan X.

Because we have determined that the picked-up amounts are to be treated as employer contributions, they are excepted from wages as defined in section 3401(a)(12)(A) of the Code for federal income tax withholding purposes. Therefore, with respect to ruling request 2, we conclude that no withholding of federal income tax is required from Group B Employees’ salaries with respect to such picked-up contributions.

In accordance with Rev. Rul. 87-10, this ruling does not apply to any contribution to the extent it relates to compensation earned before the later of the effective date of the relevant statutes, the date the pick-up election is executed or the date it is put into effect.

No opinion is expressed as to whether the amounts in question are subject to tax under the Federal Insurance Contributions Act. No opinion is expressed as to whether the amounts in question are paid pursuant to a "[illegible]
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agreement" within the meaning of section 3121(v)(1)(B) of the Code.

These rulings are based on the assumption that Plan X will be qualified under section 401(a) of the Code at the time of the proposed contributions and distributions.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

A copy of this letter has been sent to your authorized representative in accordance with a power of attorney on file in this office.

Sincerely yours,

Frances V. Sloan

Frances V. Sloan, Manager
Employee Plans Technical Group 3
Tax Exempt and Government
Entities Division

Enclosures:
Deleted copy of this ruling
Notice 437