Employee-funded pension contributions remain taxable wages

Plain-English summary

A city and its employees agreed to use part of the employees' fixed salaries to pay a portion of the city's required employer contributions to a governmental retirement plan. The city asked the IRS to treat those amounts as employer contributions that were not currently taxable and were not wages for withholding or FICA purposes. The IRS had already determined that the arrangement did not qualify as an employer pick-up under IRC § 414(h)(2). Applying the rule that compensation is taxed to the person who earns it, the IRS concluded that the amounts were employee contributions included in gross income when contributed. The contributions were also subject to federal income tax withholding and FICA taxes, subject to the applicable wage limit.

Ruling snapshot

• Question: Were salary amounts used to pay the city's pension contribution obligation excluded from employees' income and wages?
• Outcome: Denied
• Key authorities: IRC §§ 61, 3121, 3402, 414(h)(2); Lucas v. Earl, 281 U.S. 111 (1930); Rev. Rul. 67-351

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201551006 [Third Party Communication:
Release Date: 12/18/2015 Date of Communication: Month DD, YYYY]
Index Number: 61.30-03, 3121.01-00,
3402.00-00 Person To Contact:
----------------------
---------------------- Telephone Number:
---------------------------------------------- ---------------------
------------------------------- Refer Reply To:
CC:TEGE:EB:EC
PLR-111250-15
Date:
August 28, 2015

City = ---------------------
Plan = -----------------------------------------------------------------
State X = ------------------------
Date 1 = ----------------------
Year 1 = -------
Agreement = ---------------------------------

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

This is in response to a letter submitted by your authorized representative requesting a
private letter ruling. Specifically, you requested a ruling that certain contributions to
Plan are not income to City employees at the time of contribution under section 61 of
the Internal Revenue Code (Code), and are not wages subject to employment taxes
under sections 3121 and 3402 of the Code.

City contributes amounts to Plan to provide retirement benefits for eligible employees of
City. Plan is a governmental plan as defined in section 414(d) of the Code, and is
qualified under section 401(a).

Under a contract between City and Plan, the City and City’s employees are required to
make contributions to Plan. Since Date 1, City has picked up the employees’ required
contributions pursuant to section 414(h)(2). Beginning in Year 1, City and its employees
entered into Agreement under which a percentage of employees’ statutorily fixed
salaries were to be used to pay a portion of City’s required employer contributions to
Plan. Thus, the City is paying required employee contributions under the pick-up
arrangement, and employees are paying the City’s required contributions from their
salaries pursuant to the Agreement. You request a ruling that contributions made by
the City’s employees under the Agreement are employer contributions, and thus are not
income until distributed to the employees. In addition, you request a ruling that the City
is not required to withhold Federal income taxes from these contributions under section
PLR-111250-15 2

3402 of the Code and that the contributions are not wages under section 3121 of the
Code.

Initially, the City requested a ruling that the employee contributions under the
Agreement were pick-up contributions under section 414(h)(2). Prior to the submission
of this letter ruling request, the Employee Plans Rulings and Agreements group of the
Tax-Exempt and Government Entities Division determined that the contributions made
pursuant to the Agreement do not qualify as employer contributions under section
414(h)(2) of the Code. In response, the City revised its request and now seeks the
ruling described herein.

Section 61(a) of the Code defines “gross income” as income from any source, including
any compensation for services.

Section 402(a) of the Code provides, in general, that an amount actually distributed by
any employees' trust described in section 401(a) that is exempt from tax under section
501(a) is taxable to the distributee in the year it is distributed under section 72 (relating
to annuities).

Section 1.402(a)-1(a)(1)(i) of the Income Tax Regulations provides that an employee is
not required to include in income a contribution made by an employer to a trust
described in section 401(a) of the Code in a year in which the trust is exempt under
section 501(a).

Section 414(h)(1) of the Code provides that any amount contributed to an employees'
trust described in section 401(a) is not treated as having been made by the employer if
it is designated as an employee contribution. Under section 414(h)(2), however, if the
contributions of employing units are designated as employee contributions, but an
employing unit picks up the contributions, the contributions so picked up are treated as
employer contributions.

Sections 3101 and 3111 of the Code impose FICA taxes on “wages.” The term “wages”
is defined in section 3121(a) for FICA purposes as all remuneration for employment,
with certain specific exceptions not relevant here. Section 3121(b) defines
“employment” as any service, of whatever nature, performed by an employee for the
person employing him, with certain specific exceptions not relevant here.

Section 3402(a) of the Code, relating to income tax withholding, generally requires
every employer making a payment of wages to deduct and withhold upon those wages
a tax determined in accordance with prescribed tables or computational procedures.
The term “wages” is defined in section 3401(a) for Federal income tax withholding
purposes as all remuneration for services performed by an employee for his employer,
with certain specific exceptions not relevant here.
PLR-111250-15 3

The Supreme Court has long established the rule that income must be taxed to the
person who earns it. Commissioner v. Culbertson, 337 U.S. 733, 739-40 (1949). In
Lucas v. Earl, 281 U.S. 111 (1930), a husband and wife executed a contract whereby
one-half of the husband's future earnings was assigned to the wife. The Court held that
the husband's entire earnings were includible in his gross income in the year earned
even though there was a valid contract between the husband and wife and the husband
did not physically receive one-half of the earnings in cash. The Court stated:

   There is no doubt that the statute could tax salaries to those who earned
   them and provide that the tax could not be escaped by anticipatory
   arrangements and contracts however skillfully devised to prevent the
   salary when paid from vesting even for a second in the man who earned it.
   That seems to us the import of the statute . . . .

Application of this rule is not limited to cases in which the assignor assigned income to a
closely related party. In United States v. Basye, 410 U.S. 441 (1973), the Court applied
this rule in a case in which a medical partnership elected to have a nonprofit health plan
foundation pay part of the partnership's compensation to a retirement trust.

In Rev. Rul. 67-351, 1967-2 C.B. 86, pursuant to a collective bargaining agreement
between a union and a group of employers, a vacation plan and trust are established for
the benefit of the employees. The agreement provides that the employers will pay into
the trust a specified amount for each hour worked by qualified employees. An individual
account is established for each qualified employee by the trustees of the trust. The
individual employee's interest in the amount in his vacation account is fully vested and
nonforfeitable from the time the money is paid by his employer. The collective
bargaining agreement further states that payments by the employer shall be a part of
the wages due to the employees. The ruling explains that the contributions to the trust
should be regarded as constructive payments of compensation to the employees, and
thus the contributions to the trust are treated as made by the employees rather than by
the employers. The ruling concludes that the payments to the trust are compensation
income to the employees at the time they are made to the trust. Further, the ruling
concludes that the payments to the trust are wages for FICA and Federal income tax
withholding purposes.

Therefore, based solely on the facts presented and the representations made, we
conclude that contributions made to the Plan under the Agreement are employee
contributions and are therefore includable in City employees’ gross incomes under
section 61 of the Code at the time of contribution. Furthermore, as employee
contributions, the payments are subject to Federal income tax withholding at the time of
contribution and are subject to FICA taxes at the time of contribution unless the
maximum wage limitation provided by section 3121(a)(1) applies.

Except as expressly provided herein, no opinion is expressed or implied as to the
PLR-111250-15 4

Federal tax consequences of the facts described above under any other provision of the
Code.

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

The ruling contained in this letter is based upon information and representations
submitted by 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.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                   Sincerely,



                                   John B. Richards
                                   Senior Technical Reviewer, Executive
                                   Compensation (Employee Benefits)
                                   (Tax Exempt & Government Entities)

Enclosures:
Copy of letter
Copy for section 6110 purposes