PLR 1340026: IRS approves picked-up pension contributions as employer contributions

Plain-English summary

The IRS ruled that mandatory pension contributions deducted from certain public employees' salaries and paid to a state retirement plan by participating employers would be treated as employer contributions for federal income tax purposes. The contributions would not be currently included in the employees' gross income and would not be wages subject to federal income tax withholding. The ruling relied on the plan's prospective employer pick-up arrangement, the employees' lack of an option to receive the amounts directly, and the assumption that the plan qualified under section 401(a). The ruling applies to the specific taxpayer and facts submitted.

Ruling snapshot

• Question: Would mandatory employee contributions picked up by participating governmental employers be treated as employer contributions and excluded from current income and wage withholding?
• Outcome: Approved
• Key authorities: IRC §§ 401(a), 414(h)(2), 3401(a)(12)(A), and 6110(k)(3); Treas. Reg. § 1.401(k)-1(a)(3); Rev. Ruls. 77-462, 81-35, 81-36, 87-10, and 2006-43

Full text (IRS public release)

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

XXX
XXX
XXX
XXX
XXX
Legend:
Employer A
State X
Plan Y
System Z
Statute M
Statute N

Section P

Date 1

Dear XXX:

XXX

XXX
XXX
XXX
XXX
XXX

XXX

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

201340026

JUL 0 9 2013

Uniform Issue List: 414.00-00, 414.09-00

T:EP:RA:T3

This letter is in response to your ruling request, dated December 8, 2011, submitted by
your authorized representative, as supplemented by correspondence dated April 24,
2013, May 23, 2013, and June 26, 2013, with respect to the federal income tax
treatment of certain contributions to a retirement plan pursuant to section 414(h) of the
Internal Revenue Code (“Code”).

The following facts and representations are submitted under penalties of perjury in
support of your request:

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State X has established and maintains Plan Y pursuant to Statute M, for the benefit of
certain police officers and firefighters employed by a city, county, town, village or police
or fire district of State X who are not eligible to participate in a local pension plan. Plan Y
is one of the plans offered under System Z, the State X retirement plan system for its
employees. Plan Y is intended to qualify under section 401(a) of the Code.

On Date 1, the Governor of State X signed into law, as enacted by the State X
legislature, Statute N. Statute N amended Statute M relating to Plan Y to provide that
mandatory employee contributions currently being made to the Plan by certain
employees will be picked up by participating employers (hereinafter referred to as
“Participating Employers”) and treated as employer contributions.

Section P of Statute N provides that each Participating Employer shall pick up member
contributions that are required under Section P by its employees and shall do so by
reducing the salary of those employees by the amount that each such employee is
required to contribute. Further, Section P provides that a Participating Employer pays
for pick up contributions in lieu of the member contributions and that these pick up
contributions shall be treated as employer contributions in determining income tax
treatment under section 414(h) of the Code. Section P additionally provides that for all
other purposes, including the computation of retirement benefits and contributions by
employers and employees, such pick-up contributions shall be deemed employee
salary. Further, Section P states that the pick-up will not become effective until 60 days
after System Z receives a favorable ruling.

For purposes of Section P, the term “member” means a person who is employed as a
police officer or firefighter by any employer who first joins System Z on or after January
1,20 . Section P requires each member to contribute three percent of annual wages
to the Plan.

Based on the above facts and representations, you request a ruling that for federal
income tax purposes, mandatory contributions, deducted from employees’ salaries and
contributed by the employer to Plan Y will be considered picked up by Participating
Employers, and will not be currently included in the gross income of the participants on
whose behalf the pick-up is made and will not constitute wages subject to federal
income tax withholding.

Section 414(h)(2) of the Code provides that contributions, otherwise designated as
employee contributions, shall be treated as employer contributions if such contributions
are made to a plan determined to be qualified under section 401(a) of the Code,
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 afforded contributions that are picked up by the
employer within the meaning of section 414(h)(2) of the Code has been developed in a
series of revenue rulings. In Revenue Ruling 77-462, 1977-2 C.B. 358, the employer
school district agreed to assume and pay the amounts employees were required by

" XXX

Page 3 of 5 201340026

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 were excluded from the
employees’ gross income until such time as they were distributed to the employees.
The revenue ruling further held that, under the provisions of section 3401(a)(12)(A) of
the Code, the school district’s contributions to the plan were excluded from wages for
purposes of the collection of income tax at the source on wages. Therefore, no
withholding was required for federal income tax purposes from the employees’ salaries
with respect to such picked-up contributions.

Revenue Ruling 81-35, 1981 C.B. 255, and Revenue Ruling 81-36, 1981 C.B. 255,
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.

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 paid by the employer
are actually employee contributions paid by the employee and recharacterized at a later
date. 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. Thus,
employees may not exclude from current gross income designated employee
contributions to a qualified plan that relate to compensation earned for services
rendered prior to the date of the last governmental action necessary to effect the pick-
up.

Rev. Rul. 2006-43, 2006-35 I.R.B. 329, amplifying and modifying Rev. Rul. 81-35, 1981-
1 C.B. 255, Rev. Rul. 81-36, 1981-1 C.B. 255, and Rev. Rul. 87-10, 1987-1 C.B. 136,
describes the actions required for a state or political subdivision thereof, or an agency or
instrumentality of any of the foregoing, to “pick-up” employee contributions to a plan
qualified under section 401(a) of the Code so that the contributions are treated as
employer contributions pursuant to section 414(h)(2) of the Code. Specifically, Rev.

Rul. 2006-43 provides that a contribution to a qualified plan established by an eligible
employer (i.e., a governmental employer) will be treated as picked-up by the employing
unit under section 414(h)(2) of the Code if two conditions are satisfied:

1) First, the employing unit must specify that the contributions, although
designated as employee contributions, are being paid by the employer. For this
purpose, the employing unit must take formal action to provide that the
contributions on behalf of a specific class of employees of the employing unit,
although designated as employee contributions, will be paid by the employing
unit in lieu of employee contributions. A person duly authorized to take such
action with respect to the employing unit must take such action. The action must

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apply only prospectively and be evidenced by a contemporaneous written
document (e.g., minutes of a meeting, a resolution, or ordinance).

2) Second, the pick-up arrangement must not permit a participating employee
from and after the effective date of the “pick-up” to have a cash or deferred
election right within the meaning of section 1.401(k)-1(a)(3) of the Income Tax
Regulations (“Regulations”) with respect to designated employee contributions.
Thus, for example, no participating employee may be given the right to opt out of
the pick-up arrangement described in section 414(h)(2) of the Code, or to receive
the contributed amounts directly instead of having them paid by the employing
unit to the plan.

Rev. Rul. 2006-43 states that the pick-up rules expressed in Rev. Rul. 81-35 and Rev.
Rul. 81-36 apply whether the employer picks up contributions through a reduction in
salary or through an offset against future salary increases.

In this case, Plan Y satisfies the criteria set forth in Rev. Rul. 81-35, Rev. Rul. 81-36,
and Rev. Rul. 2006-43, by specifically providing that Employer A shall pick up the
mandatory contributions deducted from employees’ salaries and contributed by the
employer to Plan Y. Section P of Statute M specifies that the contributions, although
designated as employee contributions, will be picked up by Employer A. Employer A
took formal action by enacting Section P of Statute M, and the pick-up applies
prospectively from the date 60 days after the date that Employer A receives this ruling.
In addition, it has been represented that employees are required to participate in Plan Y,
do not have the option of choosing to receive the contributed amounts directly instead of
having them paid by Employer A to Plan Y, and may not make a cash or deferred
election with respect to the contributions.

Accordingly, we conclude that for federal income tax purposes, mandatory
contributions, deducted from employees’ salaries and contributed by the employer to
Plan Y, will be considered picked up by participating employers. In addition, we
conclude that such mandatory contributions will not be currently included in the gross
income of the participants on whose behalf the pick-up is made and will not constitute
wages subject to federal income tax withholding.

No opinion is expressed as to the federal tax consequences of the transaction
described above under any other provisions of the Code.

This ruling is based on the assumption that Plan Y is qualified under section 401(a) of
the Code.

This ruling is directed only to the specific taxpayer that requested it. Section 6110(k)(3)
of the Code provides that it may not be used or cited by others as precedent.

• XXX”

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Pursuant to a power of attorney on file with this office, a copy of this letter ruling is being
sent to your authorized representative. Should you have any questions or concerns
regarding this ruling, please contact XXX at (XXX) XXX-XXXX. Please address all
correspondence to SE:T:EP:RA:T2.

Sincerely yours,

Enclosures:
Deleted copy of this letter
Notice of Intention to Disclose