PLR 200204050: Municipality may pick up elected pension contributions

Plain-English summary

A municipality asked whether it could pay mandatory employee contributions to its pension plan for employees who made a one time irrevocable election. It would reduce those employees' current salaries by the contribution amount, and they could not choose to receive the amount as cash. The IRS ruled that the contributions were picked up under IRC § 414(h)(2), so they were excluded from employees' current gross income and from wages for federal income tax withholding. The pick up could not begin before the municipality's final resolution was signed or took effect, whichever was later. The ruling assumed that the plan remained qualified under § 401(a) and did not address Social Security and Medicare tax treatment.

Ruling snapshot

• Question: Are the municipality's elected pension contributions treated as employer contributions and excluded from income tax withholding?
• Outcome: Approved, subject to the timing rule and plan qualification assumption.
• Key authorities: IRC §§ 401(a), 414(h)(2), 3401(a)(12)(A).

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND 200204050

GOVERNMENT ENTITIES
DIVISION

Uniform Issue List: 414.09-00

NOV - 1 2001
T:EP:RA:T1

Attn:

Legend:

Employer A =
State B =
Plan X =

Statute C =

Dear

This is in response to a ruling request dated October 26, 2000, as supplemented by additional correspondence dated October 26, 2001, concerning the pick up of certain employee contributions to Plan X under section 414(h)(2) of the Internal Revenue Code (“Code”).

The following facts and representations have been submitted: Statute C of State B requires Employer A, a municipality of State B, to establish and

maintain a pension plan for the benefit of certain of its employees which complies with the provisions set forth in Statute C. Pursuant to Statute C, Employer A adopted Plan X,

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a defined benefit plan as prescribed in Statute C, for the benefit of certain of its employees. Plan X requires mandatory employee contributions and is qualified under Code section 401(a). Statute C provides that a municipality may pick up the mandatory employee contributions within the meaning of Code section 414(h)(2). If contributions are picked up, Statute C provides that they shall be treated as employer contributions for federal income tax purposes.

Pursuant to a resolution dated October 18, 2000, Employer A has agreed to pick up, i.e., assume and pay, the mandatory employee contributions of those employees (“electing employees”) who have made a one-time irrevocable election to have their contributions picked up and paid to Plan X by Employer A, in lieu of the employees paying such contributions. Employer A shall reduce electing employees’ current salaries by the amount picked up by Employer A. Electing employees do not have the option to receive the picked-up contributions in cash in lieu of having such contributions paid to Plan X.

With respect to employees who wish to participate in the pick up of employee contributions: (1) employees who currently participate in Plan X must execute an irrevocable written election to participate in pick-ups no later than 60 days from the effective date of the pick-up program; and (2) newly hired employees must execute an irrevocable written election requesting to participate in pick-ups no later than 60 days from their date of membership in Plan X. The filing date for these elections may be extended for an additional 30 days if good cause is demonstrated.

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

1) The mandatory employee contributions to Plan X, which are picked up for those employees who so elect in an irrevocable written election, are picked up within the meaning of Code section 414(h)(2), thereby rendering the picked-up contributions excludable from the current gross income of such employees.

2) The picked-up contributions to Plan X are not considered to be wages of employees for federal income tax withholding purposes, and that, as such, federal income taxes need not be withheld on the picked-up contributions.

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.

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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 for federal income tax purposes 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 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.

In this case, the one-time irrevocable election by employees who wish to participate in the pick up of employee contributions under Plan X does not violate Revenue Rulings 81-35 and 81-36 because it does not result in such employees having sufficient control of the contributed amounts to preclude such amounts from being treated as employer contributions.

Employer A’s resolution satisfies the criteria set forth in Revenue Ruling 81-35 and Revenue Ruling 81-36 by providing that Employer A will pick up and make contributions to Plan X in lieu of contributions by electing employees and that no such employee will have the option of receiving the contribution in cash instead of having such contribution paid to Plan X.

200204050

Accordingly, we conclude that:

1) The mandatory employee contributions to Plan X, which are picked up for those employees who so elect in an irrevocable written election, are picked up within the meaning of Code section 414(h)(2), thereby rendering the picked-up contributions excludable from the current gross income of such employees.

2) The picked-up contributions to Plan X are not considered to be wages of employees for federal income tax withholding purposes, and that, as such, federal income taxes need not be withheld on the picked-up contributions.

The effective date for the commencement of any proposed pick up as specified in the final resolution cannot be any earlier than the later of the date the final resolution is signed or put into effect.

This ruling is based on the assumption that Plan X is qualified under Code section 401(a) at all relevant times.

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 “salary reduction agreement” within the meaning of Code section 3121(v)(1)(B).

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.

200204050

A copy of this ruling has been sent to your authorized representative pursuant to a power of attorney on file in this office. If you have any questions, please call ' T:EP:RA:T1 (Badge ), at

Sincerely yours,

John Swieca

Manager, Employee Plans
Technical Group 1

Tax Exempt and Government
Entities Division

Enclosures:
Deleted Copy of the Ruling
Notice 437

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