PLR 200241055: City pension pickups excluded from employees' current income and withholding wages

Plain-English summary

A city amended its charter to pick up mandatory employee contributions to a defined benefit pension plan. The city would pay the contributions instead of the employees, who could not choose to receive the amounts in cash. The IRS ruled that the picked up amounts are employer contributions under § 414(h)(2), excluded from employees' current gross income and federal income tax withholding wages. The treatment applies whether the city funds them through salary reduction, an offset against future raises, or both. The ruling assumes the plan remains qualified under § 401(a) and applies only to contributions after the charter authorization's effective date. It gives no opinion on FICA taxes or the salary reduction agreement rule in § 3121(v)(1)(B).

Ruling snapshot

• Question: Are the city's mandatory pension contribution pickups excluded from employees' current gross income and federal income tax withholding wages?
• Outcome: Approved, subject to the plan qualification and effective date limits.
• Key authorities: IRC §§ 401(a), 414(h)(2), 3401(a)(12)(A); Rev. Ruls. 77-462, 81-35, 81-36, 87-10.

Full text (IRS public release)

200241055

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Uniform Issue List No.: 414.09-00

PERSON TO CONTACT
TELEPHONE NUMBER

OFFICE SYMBOLS
T:EP:RA:T1

DATE
JUL 19 2002

LEGEND:

Employer A =
City Charter D =

Plan X =

Ordinance P =
Employees C =

Ladies and Gentlemen:

Employer A requests a ruling concerning the pick-
up of certain employee contributions under its
qualified retirement plan pursuant to section 414(h) of
the Internal Revenue Code ("Code") .

Plan X is a defined benefit plan, the terms of
which are set forth in the provisions of City Charter
D, which provides retirement income to qualifying
employees and former employees of Employer A, and
survivor income to their qualifying beneficiaries. In
the case of Employees C, Plan X requires annual
employee contributions, the amount of which is
determined as a percentage of compensation. City
Charter D states that Plan X is intended to be a
qualified pension plan under section 401 of the
Internal Revenue Code.

200241055

Employer A adopted Ordinance P, which provides in part
as follows:

Section 1.

[City Charter D] is hereby amended to read as

follows:

Section 2.405 Member Contributions-Amounts

(a) Effective as of January 1, - , member
contributions to the retirement system shall be
deducted from each member's paychecks at the
following rates:

Benefit Group % of Annual Compensation

General
Public Safety non-command
Public Safety command

Continuation of employment by a member shall
constitute consent and agreement to the
deduction of applicable member contributions.

(b) The Employer shall pick-up the member
contributions required by this Section for all
compensation earned after the effective date of
this subsection. The contributions so picked up
shall be treated as employer contributions in
determining tax treatment under the United
States Internal Revenue Code. The Employer
shall pick-up the member contributions from
funds established and available in the salaries
account, which funds would otherwise have been
designated as member contributions and paid to

200241055

the retirement system. Member contributions
picked up by the Employer pursuant to this
subsection shall be treated for all other
purposes of this and other laws of the Employer
in the same manner and to the same extent as
member contributions made prior to the effective
date of this subsection. The member does not
have the option of receiving the picked-up member
contributions in cash instead of having it paid
into the Retirement Systems.

Employer A requests three rulings as follows:

1. That no part of the mandatory contribution
   picked up by Employer A be constituted as gross income
   to Employees C for federal income tax treatment for the
   taxable year in which the pick-up is made.

2. That the contribution, whether picked up by
   salary reduction, offset against future salary
   increases, or both, and, though designated as employee
   contributions, will be treated as employer
   contributions for federal income tax purposes.

3. That the contribution picked up by Employer A
   will not constitute wages from which federal income tax
   will be withheld.

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 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

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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.

Employer A’s Ordinance P 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.

Accordingly, we conclude (1) that no part of the
mandatory contribution picked up by Employer A will be
constituted as gross income to Employees C for federal
income tax treatment for the taxable year in which the
pick-up is made, (2) that the contribution, whether
picked up by salary reduction, offset against future
salary increases, or both, and, though designated as
employee contributions, will be treated as employer
contributions for federal income tax purposes, and (3)
that the contribution picked up by the employer will
not constitute wages from which federal income tax will
be withheld.

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 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 who
requested it. Section 6110(k) (3) of the Code provides
that it may not be used or cited by others as
precedent.

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These rulings express no opinion as to the impact
of these proposed transactions upon the qualified, nor
the continuing qualified status of the plan involved.
These rulings are based on the assumption that Plan X
will be qualified under section 401(a) of the Code at
all relevant times.

In accordance with Revenue Ruling 87-10, this
ruling does not apply to any contribution before

January 1, , the effective date of the City Charter
D authorization.

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,

[signature]

Andrew E. Zuckerman, Manager
Employee Plans Technical Group 1
Tax Exempt and Government
Entities Division

Enclosures:

Deleted copy of letter ruling
Form 437