Governmental plan may pick up mandatory employee contributions

Plain-English summary

A government-owned medical center established a defined contribution plan for senior management employees. The plan required participating employees to contribute a fixed percentage of compensation through salary reduction, while the employer formally agreed to pick up those contributions and gave employees no right to receive the amounts in cash. The IRS ruled that the arrangement satisfied section 414(h)(2), so the mandatory amounts would be treated as employer contributions and excluded from employees’ federal gross income until distributed or made available. The IRS cautioned that salary-reduction pickup contributions generally remain subject to Social Security and Medicare taxes when the employees’ services are covered.

Ruling snapshot

• Question: Whether mandatory salary-reduction contributions were valid employer pickup contributions under section 414(h)(2)
• Outcome: Approved on all three requested rulings
• Key authorities: I.R.C. §§ 402(a), 414(h)(2), 3121(v)(1)(B)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224
Number: 201540014
                                                               Third Party Communication: None
Release Date: 10/2/2015                                        Date of Communication: Not Applicable

414.09-00                                                      Person To Contact:
                                                               --------------------, ID No. ----------------
---------------------------------------                        Telephone Number:
------------------------                                       --------------------
----------------------                                         Refer Reply To:
                                                               CC:TEGE:EB:QP1
------------------------------------------------------------   PLR-T-103159-15
-----------
                                                               Date:
                                                               July 01, 2015




Legend:

Employer A = ---------------------------------------
Plan B     = -------------------------------------------------------
City C     = ---------------


Dear -------------:

This letter is in response to your ruling request, dated April 23, 2010, as supplemented
by correspondence dated April 16, 2015, May 4, 2015, May 7, 2015, June 1, 2015, and
June16, 2015, submitted by your authorized representative, concerning the “pick up” of
certain designated employee contributions to Plan B under section 414(h) of the Internal
Revenue Code (the “Code”).

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

Employer A is a medical center owned by City C. You have represented that Employer
A is a governmental entity.

Employer A adopted Plan B on April 22, 2010, intending it to be effective as of January
1, 2011. However, Employer A did not implement Plan B while it sought this ruling. By
resolution of the Board of Trustees of Employer A (the “Board”), duly adopted by the
Board on June 15, 2015, Plan B was amended and restated, effective as of January 1,
2016.

Plan B is a defined contribution plan, and is represented to be qualified under section
401(a), and a governmental plan under section 414(d). The Plan B document consists
PLR-T-103159-15                              2

of a specimen document and an adoption agreement. The amendment and
restatement of Plan B, effective as of January 1, 2016, was implemented through the
execution of a new adoption agreement. Pursuant to its terms, Plan B will be funded
through a trust (or a custodial account or annuity contract described in section 401(f))
for the exclusive benefit of participants and their beneficiaries. Plan B received a
favorable determination letter from the IRS on March 19, 2012.

Plan B provides that only Senior Management employees of Employer A (Vice
Presidents and President and CEO) (“Eligible Employees”) are eligible to participate in
Plan B. Plan B imposes no age or service requirements.

On March 22, 2010, the Board adopted a resolution authorizing Employer A to pick up
designated contributions made to Plan B by Eligible Employees who are participants.
The resolution also provides that the contributions of Eligible Employees in Plan B that
are picked up by Employer A under section 414(h) will be paid by Employer A on behalf
of the Eligible Employees, and that the Eligible Employees will not have the option of
receiving such picked-up contributions in cash instead of having the contributions made
to Plan B. As noted above, Employer A did not implement Plan B or the associated
pick-up while it sought this ruling.

In connection with the amendment and restatement of Plan B, the Board adopted
resolutions on June 15, 2015, providing that Employer A shall pick up contributions to
Plan B (as amended and restated effective January 1, 2016) that are made pursuant to
salary reduction contributions from Eligible Employees. Moreover, the June 15, 2015
resolutions reiterate that the participants in the amended and restated Plan B will not
have the option of receiving such contributions in cash instead of having them
contributed to the amended and restated Plan B.

The adoption agreement with respect to Plan B, as amended and restated effective
January 1, 2016, states that, for purposes of the designated employee contributions that
will be picked up by Employer A under the terms of Plan B (hereinafter referred to as
“Mandatory Contributions”) an Eligible Employee shall become a participant as of the
first day of the month coinciding with or next following the date on which the Eligible
Employee met all requirements for participation. The amended and restated adoption
agreement additionally provides that for an employee who is an Eligible Employee on
December 31, 2015, participation shall commence on January 1, 2016.

Under Plan B, Mandatory Contributions are mandatory contributions that all Eligible
Employees must make if required under the adoption agreement. Plan B further
provides that Mandatory Contributions are picked up by Employer A in accordance with
section 414(h)(2) and are treated as employer contributions for federal income tax
purposes, but are considered wages for purposes of FICA.
PLR-T-103159-15                             3

The adoption agreement with respect to Plan B, as amended and restated effective
January 1, 2016, provides that, as of the effective date of an Eligible Employee
becoming a participant in Plan B, Mandatory Contributions will be made to Plan B at a
fixed rate of 7.5% of compensation. The amended and restated adoption agreement
also states that the fixed percentage shall be applied only to the compensation earned
during an Eligible Employee’s period of participation. Furthermore, the adoption
agreement mandates that the Mandatory Contribution will remain in effect for the
duration of that participant’s employment with Employer A as an Eligible Employee.

The adoption agreement with respect to Plan B additionally provides that, for each plan
year, each Eligible Employee may elect to make Voluntary Contributions. Plan B
defines Voluntary Contribution as a contribution made to Plan B by an Eligible
Employee on an after-tax basis pursuant to the election of the Eligible Employee. An
Eligible Employee’s election to make Voluntary Contributions remains in effect until
revoked or completion of a superseding Voluntary Contribution election.

You request the following rulings:

      (1)    The provisions of Plan B regarding the pick-up of Mandatory Contributions
             satisfy the requirements of section 414(h)(2).
      (2)    The Mandatory Contributions made by Eligible Employees pursuant to
             salary reduction and picked up by Employer A in accordance with section
             414(h)(2) will be treated as employer contributions for federal income tax
             purposes.
      (3)    No part of the Mandatory Contributions picked up by Employer A in
             accordance with section 414(h)(2) will be includible by Eligible Employees
             as gross income for federal income tax purposes in the year of
             contribution.

With respect to your first and second requested rulings, section 414(h)(1) provides that
any amount contributed to an employees’ trust described in section 401(a) shall not be
treated as having been made by the employer if it is designated as an employee
contribution.

Section 414(h)(2) provides that, for purposes of section 414(h)(1), in the case of any
plan established by the government of any State or political subdivision thereof, or by
any agency or instrumentality of any of the foregoing, or a governmental plan described
in the last sentence of section 414(d) (relating to plans of Indian tribal governments),
where the contributions of employing units are designated as employee contributions
but where any employing unit picks up the contributions, the contributions so picked up
shall be treated as employer contributions.

The federal income tax treatment to be afforded contributions that are picked up by the
employer (within the meaning of section 414(h)(2)) has been described in a series of
PLR-T-103159-15                                4

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 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. Revenue Ruling
77-462 further held that, under the provisions of section 3401(a)(12)(A), 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, 1981-1 C.B. 255, and Revenue Ruling 81-36, 1981-1 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). 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.

Section 1.401(k)-1(a)(3)(i) of the Income Tax Regulations defines a cash or deferred
election as any direct or indirect election (or modification of an earlier election) by an
employee to have the employer either: (A) provide an amount to the employee in the
form of cash (or some other taxable benefit) that is not currently available, or (B)
contribute an amount to a trust, or provide an accrual or other benefit under, a plan
deferring the receipt of compensation.

Revenue Ruling 2006-43, 2006-35 I.R.B. 329, amplifying and modifying Revenue Ruling
81-35, Revenue Ruling 81-36, and Revenue Ruling 87-10, describes the actions
required for a state or political subdivision of a state, or an agency or instrumentality of
either, to pick up employee contributions to a plan qualified under section 401(a) so that
the contributions are treated as employer contributions pursuant to section 414(h)(2).
PLR-T-103159-15                              5

Specifically, Revenue Ruling 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) if certain conditions are
satisfied, including that 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 §1.401(k)-1(a)(3) with respect to designated
employee contributions.

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

Summarizing the requirements of Revenue Ruling 81-35, Revenue Ruling 81-36,
Revenue Ruling 87-10, and Revenue Ruling 2006-43, in order to have a valid pick up
arrangement:

      (1)    Employer A must specify that the contributions, although designated as
             employee contributions, are being paid by the employer in lieu of
             contributions by the employee and the required specification of designated
             employee contributions must be completed before the period to which
             such contributions relate.
      (2)    Employer A must take formal action, through a person duly authorized to
             do so, 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. The action must apply only prospectively and be evidenced
             by a contemporaneous written document.
      (3)    An employee must not be given the option of choosing to receive the
             contributed amounts directly instead of having them paid by Employer A to
             the pension plan. Further, 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 §1.401(k)-
             1(a)(3) with respect to designated employee contributions.

In the present case, the facts represented state that the written provisions of Plan B and
the adoption agreement explicitly mandate that the Mandatory Contributions be picked
up by Employer A in accordance with section 414(h)(2), and that the Mandatory
Contributions, although required to be made under the terms of Plan B by each Eligible
Employee, will be paid (i.e., picked up) by Employer A. In addition, the Board formally
adopted a resolution on June 15, 2015, authorizing Employer A to pick up the
Mandatory Contributions under Plan B, as amended and restated effective January 1,
2016. Thus, the arrangement satisfies the first two requirements above.
PLR-T-103159-15                              6

With respect to the third requirement, pursuant to the Plan B adoption agreement, as
amended and restated effective January 1, 2016, Mandatory Contributions to Plan B
equal to 7.5% of compensation will be picked up by Employer A on behalf of every
Eligible Employee, effective as of the date of the Eligible Employee’s participation in
Plan B. Therefore, because the Mandatory Contributions are designated, mandatory
employee contributions, Eligible Employees are not given the option of choosing to
receive the contributed amounts directly instead of having them paid by Employer A to
Plan B. Moreover, because the Mandatory Contributions are non-elective, the pick-up
arrangement under Plan B does not permit Eligible Employees from and after the
effective date of the pick-up to have a cash or deferred election right within the meaning
of §1.401(k)-1(a)(3) with respect to the designated employee contributions.

In addition, in accordance with Revenue Ruling 2006-43, the pick-up arrangement
under Plan B does not fail to satisfy the requirements of section 414(h)(2) merely
because the Mandatory Contributions are made by Employer A to Plan B on behalf of
the Eligible Employees through a reduction in salary.

Consequently, based on the foregoing, we conclude that the provisions of Plan B, as
amended and restated effective January 1, 2016, regarding the pick-up of Mandatory
Contributions satisfy the requirements of section 414(h)(2); and, therefore, the
Mandatory Contributions made by Eligible Employees pursuant to salary reduction and
picked up by Employer A in accordance with section 414(h)(2) will be treated as
employer contributions for federal income tax purposes.

With respect to your third requested ruling, section 402(a) generally provides that any
amount actually distributed to any recipient by any employees’ trust described in section
401(a), which is exempt from tax under section 501(a), shall be taxable to the recipient
in the taxable year of the distribution under section 72 (relating to annuities).

Section 1.402(a)-1(a)(1)(i) provides that if an employer makes a contribution for the
benefit of an employee to a trust described in section 401(a) for the taxable year of the
employer which ends within or with a taxable year of the trust for which the trust is
exempt under section 501(a), the employee is not required to include such contribution
in his income except with respect to the year or years in which such contribution is
distributed or made available to him.

As stated above, we have concluded, with respect to your second ruling request, that
the Mandatory Contributions that are picked up by Employer A under Plan B, as
amended and restated effective January 1, 2016, on behalf of Eligible Employees in
accordance with section 414(h)(2) will be treated as employer contributions for federal
income tax purposes. Accordingly, we further conclude, with respect to your third ruling
request, that, pursuant to section 402(a), §1.402(a)-1(a)(1)(i), and Revenue Ruling 77-
462, such Mandatory Contributions picked up by Employer A in accordance with section
PLR-T-103159-15                                7

414(h)(2) will not be includible by Eligible Employees as gross income for federal
income tax purposes until these amounts are distributed or made available to them.

Notwithstanding the foregoing, all payments of remuneration by an employer for
services performed by an employee are generally subject to taxes under the Federal
Insurance Contributions Act (FICA) unless the payments are specifically excepted from
the term “wages” or the services are specifically excepted from the term “employment.”
FICA taxes include social security and Medicare taxes. Section 3121(v)(1)(B) provides
that, other than the social security tax wage base limitation, nothing in section 3121(a)
excludes from the term “wages” any amount picked up as an employer contribution
under section 414(h)(2) if the pick-up is pursuant to a salary reduction agreement
(whether evidenced by a written instrument or otherwise). For these purposes, the term
“salary reduction agreement” includes any salary reduction arrangement, regardless of
whether there is approval or choice of participation by individual employees or whether
such approval or choice is mandated by State statute. H.R. Conf. Rep. No. 861, 98th
Cong. 2d Sess. 1415 (1984); see also Public Employees’ Retirement Board v. Shalala,
153 F.3rd 1160 (10th Cir. 1998).

Therefore, under section 3121(v)(1)(B), if an employee’s services are covered (included
in employment) for social security tax purposes, pick-up contributions under section
414(h)(2) that are made pursuant to a salary reduction agreement are generally subject
to social security taxes (unless the maximum wage base exception applies). Also,
under section 3121(v)(1)(B), if an employee’s services are covered (included in
employment) for Medicare tax purposes, pick-up contributions under section 414(h)(2)
that are made pursuant to a salary reduction agreement are subject to Medicare taxes
(without any limit based on the amount of wages). This does not constitute a ruling on
whether the pick-up contributions under Plan B are made pursuant to a salary reduction
agreement for FICA tax purposes.

This ruling is based on the assumptions that Employer A is a governmental entity and
that Plan B satisfies the qualification requirements set forth in section 401(a) and
constitutes a governmental plan within the meaning of section 414(d), at all relevant
times.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.
PLR-T-103159-15                             8


The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                     Sincerely,



                                     Laura B. Warshawsky
                                     Senior Tax Law Specialist
                                     Qualified Plans Branch 2
                                     (Tax Exempt and Government Entities)



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