PLR 9933048: Employer may pick up mandatory pension contributions

Plain-English summary

A political subdivision adopted an ordinance to pay mandatory employee contributions to its defined benefit pension plan. Employees could not choose to receive those amounts directly. The IRS ruled that the payments qualify as employer contributions under section 414(h)(2), so employees exclude them from income until distribution and the employer need not withhold federal income tax on them. The pickup cannot begin before the later of the ordinance's signing or implementation. The ruling assumes the plan qualifies under section 401(a) and does not decide whether the payments are subject to FICA tax.

Ruling snapshot

• Question: Can a political subdivision pick up mandatory employee pension contributions under section 414(h)(2)?
• Outcome: Approved, subject to the ordinance's effective date and the plan's qualification.
• Key authorities: IRC §§ 401(a), 414(h)(2), 3401(a)(12)(A); Rev. Ruls. 77-462, 81-35, 81-36.

Full text (IRS public release)

Uniform Issue List: 414.09-00

199933048

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Person to Contact:
Telephone Number:

Refer Reply to:
OP:E:EP:T:4
Date:
MAY 24 1999

Attn:

Legend:
State A =

Employer M =

Plan X =

Group B Employees =

Ordinance R =

Ladies and Gentlemen:

This letter is in response to a request for a private letter ruling dated January 22, 1999, submitted on your behalf by your authorized representative, regarding the federal income tax treatment of certain contributions to Plan X under section 414(h)(2) of the Internal Revenue Code (the “Code”).

The following facts and representations have been submitted:

Employer M, a political subdivision of State A, has established Plan X. Plan X is a defined benefit plan that

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provides for mandatory employee contributions. Plan X has previously received a favorable determination letter from the Internal Revenue Service with respect to its qualified status under section 401(a) of the Code.

Pursuant to Ordinance R, which was adopted by Employer M on January 5, 1999, Employer M will pick up (assume and pay) the mandatory employee contributions of Group B Employees to Plan X in lieu of Group B Employees paying such contributions. In addition, Group B Employees will not have the option of receiving the contributed amounts directly instead of having such contributions paid by Employer M to Plan X.

Based on the aforementioned facts and representations, you have requested the following rulings:

1. That no part of the mandatory contributions “picked
   up” by Employer M as the employer of Group B Employees will constitute gross income to Group B Employees for federal income tax purposes.

2. That the contributions that are “picked up” will be
   treated as employer contributions for federal income tax purposes.

3. That the contributions “picked up” by Employer M
   will not constitute wages from which taxes must be withheld.

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 described in section 401(a), established by a state government or a political subdivision thereof, 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 section 414(h)(2) of the Code 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. Revenue Ruling 77-462 concluded that the school district's picked-up contributions to the plan are excluded from the employees' gross income until such time as they are distributed to the employees. The revenue ruling held further that under the provisions of section 3401(a)(12)(A) of the Code, the school district's contributions to the plan are excluded from wages for

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purposes of the Collection of Income Tax at Source on Wages; therefore, no withholding 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 section 414(h)(2) of the Code 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 whether an employer picks up contributions through a reduction in salary, an offset against future salary increases, or a combination of both.

Ordinance R satisfies the criteria set forth in Revenue Ruling 81-35 and Revenue Ruling 81-36 because it specifies that Employer M will assume and pay mandatory employee contributions to Plan X in lieu of contributions by Group B Employees and that Group B Employees may not elect to receive such contributions directly instead of having such contributions paid by Employer M to Plan X.

Accordingly, we conclude that the amounts picked up by Employer M on behalf of Group B Employees shall be treated as employer contributions and will not be includible in Group B Employees' gross income in the year which such amounts are contributed. These amounts will be includible in the gross income of Group B Employees or their beneficiaries only in the taxable year in which they are distributed, to the extent that the amounts represent contributions made by Employer M.

Because we have determined that the picked-up amounts are to be treated as employer contributions, such amounts are excepted from wages as defined in section 3401(a)(12)(A) of the Code for federal income tax withholding purposes. Therefore, no withholding of federal income tax is required from Group B Employees' salaries with respect to such picked-up contributions. For purposes of the application of section 414(h)(2) of the Code, it is immaterial whether Employer M picks up contributions through a reduction in salary, an offset against future salary increases, or a combination of both.

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The effective date for the commencement of the pick-up as specified in the ordinance cannot be any earlier than the later of the date the ordinance is signed or the date it is put into effect.

These rulings are based on the assumption that Plan X satisfies the requirements for qualification under section 401(a) of the Code at the time of the proposed contributions and distributions.

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 section 3121(v)(1)(B) of the Code.

A copy of this letter is being sent to your authorized representative in accordance with a power of attorney on file in this office.

Sincerely yours,

John G. Riddle, Jr.
Chief, Employee Plans
Technical Branch 4

Enclosures:
Deleted copy of letter ruling
Notice 437

cc: