Employees may allocate employer contributions between an HRA and retirement plan without creating a cash deferral election

Plain-English summary

A union maintained a health reimbursement arrangement and a qualified profit-sharing plan under collective bargaining agreements. The plans proposed allowing employees to make an annual irrevocable choice about how an employer contribution, after a required minimum HRA amount, would be divided between the two plans. Employees could not take the contribution as cash or another taxable benefit. The IRS ruled that this allocation choice would not turn the profit-sharing plan into a section 401(k) cash or deferred arrangement. It also ruled that employer contributions to the HRA and reimbursements for substantiated medical expenses would remain excluded from income under sections 105(b) and 106. The conclusion depended on the HRA being employer-funded and limited to qualified medical reimbursements rather than cash, death benefits, bonuses, separation pay, or other benefits.

Ruling snapshot

• Question: Does an employee's annual allocation of employer contributions between an HRA and a profit-sharing plan create a cash or deferred arrangement or make the HRA benefits taxable?
• Outcome: approved (no section 401(k) arrangement is created, and qualifying HRA contributions and reimbursements remain excluded)
• Key authorities: IRC §§ 105(b), 106, 401(k), 213(d); Treas. Reg. § 1.401(k)-6; Rev. Rul. 2002-41; Notice 2002-45

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202023001                                              Third Party Communication: None
 Release Date: 6/5/2020                                         Date of Communication: Not Applicable
 Index Number: 401.29-00, 105.00-00,
               106.00-00                                        Person To Contact:
                                                                ------------------, ID No. -----------------
 -----------------                                              Telephone Number:
 ----------------------------------------                       --------------------
 ------------------------------------------------------------   Refer Reply To:
 ---------------                                                CC:EEE:EB:QP4
 ----------------------                                         PLR-112964-19
 -----------------------------                                  Date:
 In Re: ----------------------------------------------------    March 03, 2020
 ------------------




Legend

 Taxpayer = ----------------------------------------------------------------------
 HRA Plan = --------------------------------------------------
 DC Plan  = ------------------------------------------------------------------


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

This letter responds to your authorized representative’s letter dated May 29, 2019, and
supplemented on February 21, 2020, requesting a private letter ruling related to the
HRA Plan and the DC Plan.

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

The HRA Plan is a medical expense reimbursement plan, funded through a trust
(“Trust”) that is represented to be a voluntary employees’ beneficiary association
(“VEBA”) as described in section 501(c)(9) of the Internal Revenue Code. Under this
plan each participant has a health reimbursement arrangement (“HRA”). Each HRA may
be used by the participant to provide reimbursement of qualified medical expenses
under section 213(d).

The DC Plan is a qualified profit-sharing plan under section 401(a) with a calendar-year
plan year. Both plans are maintained pursuant to collective bargaining agreements.

Pursuant to the collective bargaining agreements, the HRA Plan and DC Plan require
participating employers to make contributions according to a contribution schedule (the

PLR-112964-19                                  2

total of which is the “employer contribution”). Taxpayer is a union representing
employees of these participating employers. Additionally, Taxpayer, in its capacity as an
employer, contributes to each of the plans on behalf of its own employees (who are not
covered by the collective bargaining agreement), according to a contribution schedule
contained in a separate participation agreement.

Taxpayer, through collective bargaining, is proposing to amend the HRA Plan and the
DC Plan so that, of the employer contribution, there will be a set minimum contributed to
the HRA Plan. The remaining portion of the employer contribution (“the discretionary
contribution”) will be allocated between the DC Plan and the HRA plan pursuant to an
annual election by the employee before the beginning of the plan year. In the absence
of an election, a default uniform fixed contribution will be allocated to the DC Plan and
the remaining portion of the discretionary contribution will be allocated to the HRA Plan.

You request the following rulings:

1. The proposed amendment to the DC Plan will not cause the DC Plan to be treated as
offering a cash or deferred arrangement pursuant to section 401(k).

2. The proposed amendment to the HRA Plan will not affect the treatment of
contributions to and payments made from the Trust to the HRA Plan that are used to
pay and reimburse qualified medical expenses (as defined in section 213(d)) of
employees, retired employees, and their spouses and dependents as amounts
excludable from the gross income of employees, retired employees, and their spouses
and dependents under sections 105(b) and 106.

Ruling Request 1

With respect to the first ruling request, section 401(a) provides that a trust created or
organized in the United States and forming part of a stock bonus, pension, or profit-
sharing plan of an employer for the exclusive benefit of its employees or their
beneficiaries constitutes a qualified trust under that section if a series of conditions are
met.

Section 401(k)(2)(A) provides, in pertinent part, that a qualified cash or deferred
arrangement is any arrangement which is part of a profit sharing plan or stock bonus
plan, a pre-ERISA money purchase plan, or a rural cooperative plan, which meets the
requirements of section 401(a), and under which a covered employee may elect to have
the employer make payments as contributions to a trust under the plan on behalf of the
employee, or to the employee directly in cash.

Section 1.401(k)-6 of the Income Tax Regulations defines non-elective contributions as
employer contributions (other than matching contributions) with respect to which the
employee may not elect to have the contributions paid to the employee in cash or other
benefits instead of being contributed to the plan.

PLR-112964-19                                3


Section 1.401(k)-6 defines elective contributions as contributions made pursuant to a
cash or deferred election under a cash or deferred arrangement.

In the present case, the annual irrevocable election will allow an employee to decide a
participating employer’s contribution rate to both the DC Plan and HRA Plan. While
employees are permitted to make an annual irrevocable election regarding to which
plan the contributions are to be made, they are not permitted to elect to have the
contributions paid in cash or some other taxable benefit. Accordingly, the proposed
amendment to the DC Plan will not cause the plan to be treated as offering a cash or
deferred arrangement pursuant to section 401(k).

Ruling Request 2

With respect to the second ruling request, section 61(a)(1) and section 1.61-21(a)(3)
provide that, except as otherwise provided in Subtitle A, gross income includes
compensation for services, including fees, commissions, fringe benefits, and similar
items.

Section 106 provides that gross income of an employee does not include employer-
provided coverage under an accident or health plan. Section 1.106-1 provides that the
gross income of an employee does not include contributions which the employee’s
employer makes to an accident or health plan for compensation (through insurance or
otherwise) to the employee for personal injuries or sickness incurred by the employee or
the employee’s spouse or dependents (as defined in section 152). The employer may
contribute to an accident or health plan either by paying the premium on a policy of
accident or health insurance covering one or more of the employees, or by contributing
to a separate trust or fund which provides accident or health benefits directly or through
insurance to one or more of the employees. However, if the insurance policy, trust, or
fund provides other benefits in addition to accident or health, section 106 applies only to
the portion of the contributions allocable to accident or health benefits.

Section 105(b) states that except in the case of amounts attributable to (and not in
excess of) deductions allowed under section 213 (relating to medical expenses) for any
prior taxable year, gross income does not include amounts attributable to employer-
provided coverage (1) if such amounts are paid, directly or indirectly, to the taxpayer to
reimburse the taxpayer for expenses incurred by the taxpayer for the medical care (as
defined in section 213(d)) of the taxpayer or the taxpayer’s spouse or dependents (as
defined in section 152, determined without regard to subsections (b)(1), (b)(2), and
(d)(1)(B)) and any child (as defined in section 152(f)(1)) who has not attained age 27 as
of the end of the taxable year. Section 1.105-2 provides that only amounts that are paid
specifically to reimburse the taxpayer for expenses incurred by the taxpayer for the
prescribed medical care are excludable from gross income. Thus, section 105(b) does
not apply to amounts that the taxpayer would be entitled to receive irrespective of
whether the taxpayer incurs expenses for medical care.

PLR-112964-19                               4


In Rev. Rul. 2002-41, 2002-2 C.B. 75, an employer sponsors an HRA that is paid for
solely by the employer and not through salary reduction contributions. The HRA
reimburses substantiated medical care expenses (as defined in section 213(d)) of
participating employees and their spouses and dependents (as defined in section 152)
up to a maximum annual reimbursement amount. Unused amounts from one coverage
period are carried forward to subsequent coverage periods. Participating employees
have no right to receive cash or any other benefit in lieu of medical expense
reimbursements. In Situation 2 of Rev. Rul. 2002-41, the maximum reimbursement
amount under the HRA that is not applied to reimburse medical care expenses before
an employee retires or otherwise terminates employment continues to be available after
retirement or termination for any medical care expense under section 213(d) incurred by
the former employee or the former employee’s spouse and dependents. The ruling
concludes that coverage and reimbursements made under the HRA are excludable from
the gross income of participating employees under sections 106 and 105.

Notice 2002-45, 2002-2 C.B. 93, provides that an HRA is an arrangement that: (1) is
paid for solely by the employer and not pursuant to salary reduction; (2) reimburses the
employee for medical care expenses (as defined in section 213(d)) incurred by the
employee and the employee’s spouse and dependents (as defined in section 152); and
(3) provides that any unused portion of the maximum dollar amount available during the
coverage period is carried forward to subsequent periods. Notice 2002-45 also provides
that benefits under an HRA must be limited to reimbursements of section 213(d)
expenses and that all such expense reimbursements must be substantiated to be
excludable under section 105. Notice 2002-45 further provides that medical care
expense reimbursements under an HRA are excludable under section 105(b) if the
reimbursements are provided to the following individuals: current and former employees
(including retired employees), their spouses and dependents (as defined in section 152
as modified by the last sentence of section 152(b)), and the spouses and dependents of
deceased employees.

Under the HRA Plan, if the employee timely makes an irrevocable annual election to
have an employer contribute amounts to the HRA Plan in lieu of the DC Plan, such
amounts are paid solely by the participating employers and not pursuant to salary
reduction elections or otherwise. The amounts may be used to provide benefits that
reimburse qualified eligible medical expenses and will not be used to provide for the
payment of death benefits, bonuses, or separation pay. In addition, amounts may not be
used to provide other taxable or nontaxable benefits. Thus, the HRA Plan meets the
requirements of Rev. Rul. 2002-41 and Notice 2002-45, and the amounts are
excludable from the gross income of employees, retired employees, and their spouses
and dependents under sections 105(b) and 106.

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, as specified in Rev. Proc. 2020-1, 2020-1 I.R.B. 1,

PLR-112964-19                                  5

section 7.01(16)(b). This office has not verified any of the material submitted in support
of the request for ruling, and such material is subject to verification on examination. The
Associate office will revoke or modify a letter ruling and apply the revocation
retroactively if there has been a misstatement or omission of controlling facts; the facts
at the time of the transaction are materially different from the controlling facts on which
the ruling was based; or, in the case of a transaction involving a continuing action or
series of actions, the controlling facts change during the course of the transaction. See
Rev. Proc. 2020-1, section 11.05.

Except as specifically set forth above, no opinion is expressed or implied concerning the
federal tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. This letter expresses no opinion as to whether the DC Plan
satisfies the requirements to be qualified under section 401(a), including, but not limited
to, the eligibility, vesting, and distribution rules, contribution limits, and coverage and
nondiscrimination testing.

This letter ruling is directed only to the taxpayer who requested 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.



                                              Sincerely,




                                              Joyce Kahn, Branch Chief
                                              Qualified Plans Branch 4
                                              Office of Associate Chief Counsel
                                              (Employee Benefits, Exempt Organizations,
                                              and Employment Taxes)


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