IRS Ruling on Employee Contribution "Pick Ups" by Governmental Employers

On August 28, 2006, the Internal Revenue Service (IRS) published Revenue Ruling 2006-43* providing new documentation requirements for governmental employers that wish to "pick up" employee contributions under Internal Revenue Code (IRC) Section 414(h)(2).

BACKGROUND

As allowed under the IRC, governmental employers may choose to pay (or "pick up") mandatory employee contributions to plans qualified under IRC §401(a) in lieu of direct compensation. This permits the contributions to be treated as pre-tax employer contributions rather than post-tax employee contributions so that the contributions are not taxable income to the employee. However, in some circumstances, the employer's decision to pick up employee contributions is not documented or described in writing to the employee.

Many governmental defined benefit plans require employees to contribute a specified percentage of their salary directly to plans qualified under IRC §401(a). Because salary deferrals are not permitted in a defined benefit plan, these employee contributions must be made on a post-tax basis. However, IRC §414(h) permits governmental employers to elect to pay, or "pick up," these contributions directly. In that case, they are treated as employer contributions and are not taxable income to the employee until they are distributed from the plan. In some cases, the employer's decision to pick up employee contributions in accordance with §414(h) is not documented or described in writing to the employee.

THE NEW GUIDANCE

Revenue Ruling 2006-43 clarifies that the IRS now requires governmental employers that want to pick up employee contributions to take formal action by a "duly authorized person" to provide that contributions on behalf of a specific class of employees will be paid by the employer. This action must be evidenced by a "contemporaneous written document" and applied only to contributions made after the formal action.

TRANSITION RELIEF

Revenue Ruling 2006-43 provides transition relief for pick-up arrangements in place prior to August 28, 2006. Specifically, plans with current pick-up arrangements will not be treated as failing the new requirement described above, provided a participating employer:

• Has taken contemporaneous action evidencing an intent to establish a pick up,
• Has operated the plan according to such pick-up arrangement, and
• Takes appropriate formal action to document the pick-up arrangement, in writing (as described in Revenue Ruling 2006-43) before January 1, 2009.

IMPLICATIONS

In light of Revenue Ruling 2006-43, governmental employers should reexamine their pick-up arrangements to determine whether or not they comply with the new documentation requirements. If they do not comply, they should take corrective action.

In order to satisfy the new documentation requirements under Revenue Ruling 2006-43, governmental employers may need to take formal action in writing to continue to make pick-up contributions that are treated as pre-tax contributions. The IRS indicated that written evidence of a pick-up arrangement may include the following:

• Meeting minutes,
• A resolution,
• An ordinance, or
• A statute.

Segal Company consultants can be retained to work with public sector employers and their attorneys to comply with IRS Revenue Ruling 2006-43.

Compliance Alert, The Segal Company’s periodic electronic newsletter summarizing important developments affecting benefit plan compliance, is for informational purposes only. It is not intended to provide authoritative guidance. On all issues involving the interpretation or application of laws and regulations, plan sponsors should rely on their attorneys for legal advice.

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