PLR 200308053: State plan contributions excluded from employees' current income

Plain-English summary

A public employer proposed to pay the mandatory employee contributions to a state retirement plan by reducing employees' compensation. Its board resolution would state that the employer paid the amounts in place of employees, and employees could not take the amounts in cash. The IRS ruled that the picked-up contributions would not be taxable to employees in the year paid, although they would enter gross income when distributed. The arrangement could begin no earlier than the later of the dates the final resolution was signed or took effect. The ruling assumed the plan remained qualified under IRC § 401(a) and did not address Social Security and Medicare tax treatment.

Ruling snapshot

• Question: Are mandatory state plan contributions picked up by the employer excluded from employees' current income?
• Outcome: Approved: exclusion in the year of pickup, with inclusion when distributed.
• Key authorities: IRC §§ 401(a), 414(h)(2); Rev. Ruls. 77-462, 81-35, 81-36, 87-10.

Full text (IRS public release)

Uniform Issue List: 414.09-00

200308053

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

GOVERNMENT ENTITIES
DIVISION

NOV 27 2002

Attn:

Legend:
Employer A =
State B =

Statute C =

Plan X =

Dear :

This is in response to a ruling request dated May 1, 2002, as supplemented by additional information submitted September 24, 2002, and October 28, 2002, concerning the pick up of employee contributions to Plan X under section 414(h)(2) of the Internal Revenue Code (“Code”).

The following facts and representations have been submitted:

Participation in Plan X is mandatory by the employees and all eligible employees of Employer A participate in Plan X, a retirement system sponsored by State B. Eligible employees are all employees under authority of Employer A’s Board of Trustees. Plan X requires mandatory employee contributions equal to two per cent of compensation and is qualified under Code section 401(a).

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Employer A’s Board of Trustees has proposed a resolution which provides that Employer A will pick up the mandatory employee contributions within the meaning of Code section 414(h)(2). The resolution states that the contributions, although designated as employee contributions, are being paid by the employer in lieu of contributions by the employee. In addition, the employees will not have the option of receiving the picked-up contributions in cash instead of having the contribution paid by Employer A to Plan X. The proposed resolution also provides that State B has enacted legislation, Statute C, which enables employers that participate in Plan X to pick up and pay the mandatory employee contributions to Plan X.

Statute C provides that a participating employer in Plan X that has received a favorable ruling from the Internal Revenue Service for an employer pick-up program in accordance with Code section 414(h)(2) shall pick up the employee contributions required by Plan X. Statute C also states that the employee contributions to be picked up by the employing unit within the meaning of section 414(h)(2) shall be treated as employer contributions in determining tax treatment under that section, and the employee’s compensation must be reduced by the amount of the mandatory employee contribution.

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

No part of the mandatory employee contributions to Plan X picked up by Employer A on behalf of eligible employees will constitute taxable income to such employees in the year of the pick up.

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

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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.

The proposed resolution of Employer A’s Board of Trustees 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 participating employees. No employee will have the option of receiving the contribution in cash instead of having such contribution paid to Plan X.

Accordingly, based on the above facts and representations, we conclude:

No part of the mandatory employee contributions to Plan X picked up by Employer A on behalf of eligible employees will constitute taxable income to such employees in the year of the pick up but such picked up amounts shall be includable in gross income in the year of distribution.

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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 that requested it. Code section 6110(k) provides that it may not be used or cited by others as precedent.

If you have any questions, please call , T:EP:RA:T1 at .

Sincerely yours,

[illegible signature]

Manager, Employee Plans
Technical Group 1

Enclosures:
Deleted Copy of the Ruling
Notice 437