PLR 200029056: Government pension contributions for military service qualify as employer payments

Plain-English summary

A local government proposed allowing employees to buy pension service credit for military service through an irrevocable payroll election. It would pay the elected amounts to its governmental plan in place of direct employee payments. The IRS ruled that the picked-up contributions met section 414(h)(2), so they would be treated as employer contributions and excluded from employees' income when paid. They also would not count as wages for federal income tax withholding. The ruling assumed the plan remained qualified, limited the start date of the arrangement, and left Social Security and Medicare tax questions unresolved.

Ruling snapshot

• Question: Can the government pick up employee contributions to buy military service credit without current income inclusion or federal income tax withholding?
• Outcome: Approved, subject to the stated plan and effective-date conditions.
• Key authorities: IRC §§ 401(a), 414(h)(2), and 3401(a)(12)(A); Rev. Ruls. 77-462, 81-35, 81-36, and 87-10.

Full text (IRS public release)

200029056

Significant Index Number: 414-0900

T:EP:RA:T1

4/25/00

Attn:

Legend:
Employer A =
State B =

Plan X =

Dear

This is in response to a ruling request dated February 9, 2000, concerning the pick
up of certain employee contributions to Plan X under section 414(h)(2) of the Internal
Revenue Code.

The following facts and representations have been submitted:

Employer A, a political subdivision of State B, sponsors Plan X, a governmental plan
under Code section 414(d), for the benefit of its employees. Plan X requires mandatory
employee contributions and is qualified under Code section 401(a). Plan X received a
determination letter from the Internal Revenue Service dated August 26, 1999.

Prior to January 1, 1999, all participant contributions were on an after-tax basis.
Section 9.02(f) of Plan X, adopted on December 17, 1998, provides that participant
contributions required as a condition of employment are picked up under Code section
414(h)(2). In a letter ruling dated October 30, 1998, the Service concluded that

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mandatory employee contributions picked up by Employer A satisfy the requirements of
Code section 414(h)(2) and thus are treated as employer contributions excluded from
employees’ gross income in the year they are made.

Plan X has included certain provisions permitting members to add additional
credited service for periods of military service. Under the Plan, members may purchase
these periods of military service but there is no provision for the pick up of these
contributions. Employer A is now in the process of securing agreements with collective
bargaining representatives to amend the Plan as necessary to permit the pick up of
member contributions for purchases of military service.

Proposed section 9.02(g) of Plan X provides that members may purchase credited
service for periods of military service in a lump sum or in installments or in a combination
of an initial lump sum and subsequent installments in a manner approved by the pension
board. Contributions that are made as a percentage of periodic pay may be made on an
after-tax basis or pre-tax basis which will be picked up by Employer A.

If a member elects to purchase additional service credit on a pre-tax, pick up basis,
the election to do so may not be amended or revoked. The proposed election form,
Military Service Purchase Election and Payroll Deduction Authorization (Pre-tax, Pick —
Up Payment), provides that the election is binding and irrevocable and will remain in
effect until the earlier of the date the payments are completed or termination of
employment. This form further provides that Employer A will make the contributions, in
lieu of contributions by members.

Based on the foregoing facts and representations, you have requested the following
rulings:

1) That the provisions of proposed section 9.02(g) of Plan X satisfy the requirements
of Code section 414(h)(2).

2) That no part of the Plan X contribution amounts picked up by Employer A on
behalf of members of the Plan will be includable as gross income for federal income tax
purposes in the year of contribution with respect to such employees.

3) That contributions of members whether picked up by payroll deduction, offset
against future salary increases or both and though designated as employee
contributions will be treated as employer contributions for Federal income tax purposes.

4) That no part of the contributions of Employer A that are pick up contributions
made by the Employer on behalf of its employees pursuant to proposed section 9.02(g)

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will constitute wages for federal income tax withholding purposes in the taxable year in
which contributed to Plan X.

Code section 414(h)(2) provides that contributions, otherwise designated as
employee contributions, shall be treated as employer contributions if such contributions
are made to a plan described in Code section 401(a), established by a state government
or a political subdivision thereof, or any agency or instrumentality of any one of the
foregoing, 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 Code section 414(h)(2) 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. Rev. Rul. 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 Code section 3401(a)(12)(A), 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 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 Code 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 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 proposed section 9.02(g) of Plan X and the election form described
above, a member may purchase additional credit for military service under Plan X


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pursuant to a binding, irrevocable payroll reduction agreement. These contributions will
be picked up by Employer A, although they are designated as employee contributions.
Members will not have the option to receive the amounts under the agreement directly
instead of having them contributed to Plan X.

Regarding ruling requests (1) through (3), we conclude that the contributions picked
up by Employer A pursuant to proposed section 9.02(g) and proposed payroll reduction
agreement satisfy the requirements of Code section 414(h)(2). The amounts picked up
by Employer A ,whether through pre-tax payroll deduction (as described above) or an
offset against future salary increases, or both, will be treated as employer contributions
and will not be includable in the employees’ gross income for the taxable year in which
such amounts are contributed.

Regarding ruling request (4), because we have determined that the picked up
amounts are to be treated as employer contributions, they are excepted from wages for
federal income tax withholding purposes under section 3401(a)(12)(A). Therefore, no
withholding of federal income tax is required from employees’ salaries with respect to
such picked up amounts.

The effective date for the commencement of the pick up as specified in proposed
section 9.02(g) cannot be any earlier than the later of the date the proposed amendment
is signed or put into effect.

This ruling is based on the assumption that Plan X will be qualified under Code
section 401(a) at the time of the proposed contributions.

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 the whether
the amounts in question are paid pursuant to a “salary reduction agreement” within the
meaning of Code section 3121(v)(1)(B).


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

A copy of this ruling has been sent to your authorized representative pursuant to a
power of attorney on file in this office.

Sincerely yours,

[illegible signature]

Manager, Employee Plans
Technical Group 1

Tax Exempt and Government
Entities Division

Enclosures:
Deleted Copy of the Ruling
Notice 437

CC: