PLR 200130052: Government pension pickup contributions excluded from current income and withholding

Plain-English summary

A local government adopted a resolution to pay mandatory employee contributions to two state retirement plans in place of its employees. Employees could not take the contribution amounts as cash. The IRS ruled that, under § 414(h)(2), the picked up amounts would be treated as employer contributions and excluded from employees' current federal gross income. They would also be excluded from wages for federal income tax withholding. The ruling applies only from the resolution's effective date, which cannot precede its execution, and assumes both plans remain qualified. The IRS gave no opinion on Social Security tax or whether a salary reduction agreement exists.

Ruling snapshot

• Question: May a local government pick up mandatory pension contributions without current income inclusion or federal income tax withholding?
• Outcome: Approved, subject to prospective timing and plan qualification.
• Key authorities: IRC §§ 401(a), 414(h)(2), 3401(a)(12)(A); Rev. Rul. 77-462, 81-35, 81-36, 87-10.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
200130052
Uniform Issue List No: 414.09-00
Washington, DC 20224

Person to Contact:
Telephone Number:
Refer Reply to:
T:EP:RA:T2
Date: MAY 2 2001

Atten:

Legend:
State A =
Employer M =
Plan N =
Plan O =
Statute X =
Resolution Y =

Dear

This is in response to a request for a private letter ruling submitted on behalf of Employer M on September 5, 2000, as supplemented by additional correspondence dated October 30, 2000 and November 16, 2000 concerning the federal income tax treatment of certain contributions to Plan N and Plan O under section 414(h)(2) of the Internal Revenue Code (“Code”).

The following facts and representations have been submitted:

Employer M is a political subdivision of State A. Pursuant to Statute X, counties and other eligible local governmental units may participate in State A’s retirement and pension system. Employer M has elected to provide pension benefits to its employees by participating in Plan N and Plan O. Employer M became a participating employer in State A’s retirement and pension system on April 1, 1953. It is represented that Plan N and Plan O are qualified plans under section 401(a) of the Code.

Both Plan N and Plan O require mandatory membership for all permanent employees of Employer M hired prior to January 1, 1980, except elected and appointed officials who have an option to participate. In addition, both Plan N and Plan O require employees to make mandatory contributions to the Plans. Furthermore, Plan N and Plan O permit Employer M, as a participating governmental unit, to pick up, within the meaning of section 414(h)(2) of the Code, the mandatory employee contributions made to Plan N and Plan O.

On June 2, 1999, Employer M adopted Resolution Y, which provides that Employer M will “pick up” (within the meaning of section 414(h)(2) of the Code) the mandatory employee contributions required under Plan N and Plan O. Resolution Y specifies that such picked-up contributions, although designated as employee contributions, are being paid by the employer in lieu of contributions by the employee and the employee will not have the option of choosing to receive the contributed amount directly instead of having them paid by the employer to the retirement plans.

Based on the foregoing, the following rulings are requested:

(1)That no part of the mandatory employee contributions picked up by Employer M will be included in the gross income of the employees for federal income tax purposes in the taxable year in which they are contributed to Plan N and Plan O pursuant to section 414(h)(2) of the Code.

(2)That the mandatory employee contributions picked up by Employer M will be treated as employer contributions for federal income tax purposes.

(3)That the mandatory employee contributions picked up by Employer M will not constitute wages from which taxes must be withheld under section 3401(a)(12)(A) of the Code, in the taxable year in which they are contributed to Plan N and Plan O.

Section 414(h)(2) of the Code provides that contributions, otherwise designated as employee contributions, shall be treated as employer contributions if: (1) such contributions are made to a plan determined to be qualified under section 401(a) of the Code; (2) the plan is established by a state government or political subdivision thereof; and (3) the contributions are picked up by the governmental employer.

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’ income until such time as they are distributed to the employees. The revenue ruling held further that under 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 the source of 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 section 414(h)(2) of the Code 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 employees must not be given the option of choosing to receive amounts directly instead of having them paid by the employer to the pension plan. Furthermore, it is immaterial whether an employer picks up contributions through a reduction in salary, an offset against future salary increases, or a combination of both.

In order to satisfy Revenue Ruling 81-35 and 81-36 with respect to particular contributions, Revenue Ruling 87-10, 1987-1 C.B. 136 provides that the required specification of designated employee contributions must be completed before the period to which such contributions relate. If not, the designated employee contributions being paid by the employer are actually employee contributions paid by the employee and recharacterized at a later date. Thus, the retroactive specification of designated employee contributions as paid by the employing unit, i.e., the retroactive “pick-up” of designated employee contributions by a governmental employer, is not permitted under section 414(h)(2) of the Code.

Resolution Y executed by Employer M satisfies the criteria set forth in Revenue Rulings 81-35 and 81-36 because it specifies: (1) that the contributions, although designated as employee contributions, are to be made by Employer M for its employees and (2) that the employees may not elect to receive such contribution amounts directly.

Accordingly, we conclude that:

In regard to ruling request number one, the employee contributions picked up by Employer M and contributed to Plan N and Plan O on behalf of its employees will not be includible in the employees’ gross income for federal income tax purposes in the taxable year in which such amounts are contributed.

In regard to ruling request number two, the employee contributions picked up by Employer M and contributed to Plan N and Plan O shall be treated as employer contributions within the meaning of section 414(h)(2) of the Code.

In regard to ruling request number three, because we have determined that the picked-up employee contributions 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, in the taxable year in which they are contributed to Plan N and Plan O.

These rulings apply only if the effective date for the commencement of any proposed pick-up as specified in Resolution Y, cannot be any earlier than the later of the date Resolution Y is executed or the date it is put into effect.

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

No opinion is expressed as to whether the amounts in question are subject to tax under the Federal Insurance Contribution Act. No opinion is expressed as to whether the amounts in question are being paid pursuant to a “salary reduction agreement” within the meaning of section 3121(v)(1)(B) of the Code.

This ruling is directed only to the taxpayer that requested it and applies only with respect to Plan N and Plan O. Section 6110(k)(3) of the Code provides that this private letter ruling may not be used or cited by others as precedent.

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

Sincerely Yours,

(signed) JOYCE E. FLOYD

Joyce E. Floyd, Manager
Employee Plans Technical Group 2
Tax Exempt and Government Entities Division

Enclosures:

Deleted Copy of Letter
Notice of Intention to Disclose