The Internal Revenue Service (IRS) recently issued a private letter ruling concluding that employers may permit employees to allocate non-elective, discretionary employer contributions among various employee benefit programs without endangering the tax advantages of those programs. The affected employee benefit programs include 401(k) plans, retiree health reimbursement arrangements (HRAs), health savings accounts (HSAs), and Code §127 educational assistance (EA) programs. While IRS private letter rulings apply only to the parties requesting them, they can provide helpful insights into the IRS’s point of view on various benefits-related topics.
The Employer’s Proposal
The employer inquiry that led to the IRS private letter ruling involved a proposal to reduce its discretionary 401(k) contributions and instead allow eligible employees to make annual irrevocable elections during open enrollment to allocate those contributions among other employee benefit programs. More specifically, employees could choose to allocate an additional employer contribution to the 401(k) plan, the retiree HRA (for eligible employees), the EA program, or their HSA. Employees making no election would receive the employer contribution in their 401(k) plans, and no employee would receive the contribution in cash or as a taxable benefit.
Furthermore, the employer contribution would occur on or about March 15 of the following year and be treated as a contribution in the year it occurred. The only exception would be that retiree HRA contributions would be treated as notional contributions on December 31 in the year of election or the date used to credit interest in that program. Additionally, employees who elected to direct the employer contribution to the EA program or their HSA would be ineligible for other 127 plan benefits or pre-tax HSA benefits until after March 15 to avoid exceeding benefit limits.
The IRS Private Ruling
The IRS private ruling drew several conclusions concerning how this employer’s proposed benefit arrangement would impact the tax benefits derived from the different employee benefits programs, as follows:
- 401(k) Plans – The proposal would not create an additional cash or deferred arrangement under Code §401(k) since receiving the contribution in cash or another taxable benefit is not an option. As a result, the employer contribution is not a pre-tax contribution subject to the annual elective deferral limitation.
- Retiree HRAs – The proposal provides that employees cannot receive cash or another taxable benefit, employer reductions cannot be made from salary reduction elections, contributions only can be used to reimburse Code §213(d) medical expenses and unused benefits could be carried forward to subsequent periods after retirement. Therefore, the proposal would still meet applicable HRA requirements, with coverage and benefits under the HRA would remain excludable from gross income.
- HSAs – Under the proposal, as long as employer contributions did not exceed statutory limitations and only HSA-eligible employees could make this election, the employer contributions to HSAs would remain excludable from the employees’ gross incomes.
- EA Program – Since employees cannot choose between educational assistance and other taxable income or benefits, the proposal would not affect payments from the EA program as excludable from gross income. Likewise, the ability of employees to choose how to allocate employer contributions among various benefit programs did not disqualify the EA program under the Code.
HBL has experience in all areas of benefits and employment law, offering a comprehensive solution to all your business benefits and H.R./employment needs. We help ensure you are in compliance with the complex requirements of ERISA and the IRS code, as well as those laws that impact you and your employees. Together, we reduce your exposure to potential legal or financial penalties. Learn more by calling 470-571-1007.
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