Rev. Rul. 66-254

Rev. Rul. 66-254

Advice has been requested whether an employer may be considered the purchaser of an annuity contract for an employee under section 403(b) of the Internal Revenue Code of 1954 in the situations described below:

1. An employee of a public school system who performs services for an educational institution described in section 151(e)(4) of the Code purchased an annuity contract. Later, the employer adopted an annuity purchase program under section 403(b) of the Code. May the employer, who agrees with the employee and the insurance company to pay the future premiums on the contract originally purchased by the employee, treat this transaction as part of the annuity purchase program?

2. An employee of a public school system who performs services for an educational institution defined in section 151(e)(4) of the Code has had an annuity contract purchased for him by his employer pursuant to a program established under section 403(b) of the Code. He then terminated his employment with that employer and becomes an employee of an organization which is described in section 501(c)(3) of the Code and exempt from Federal income tax under section 501(a). The new employer has an annuity purchase program under which it plans to purchase annuity contracts referred to in section 403(b). May the employer, who agrees with the employee and the insurance company to pay the future premiums on the annuity contract originally purchased by the former employer, treat such payments as coming within the purview of section 403(b)?

Employer contributions toward the purchase of an annuity contract for an employee are excludable from the employee's gross income to the extent of his applicable exclusion allowance if the requirements of sections 401(g) and 403(b) of the Code are met under the following situations:

A. An employer purchases an annuity contract for an employee.

B. An employee agrees to a salary reduction and, thereafter with the amounts arising therefrom, the employer purchases an annuity contract for him.

C. An employer agrees to pay the annuity premiums on a contract initially purchased by an employee at a time prior to such agreement.

In these three instances the amounts contributed toward the purchase of the annuity contract must be made by the employer because the exclusion allowance under section 403(b) of the Code becomes operative only where the employer makes the premium payments.

If the employer's contributions toward the purchase of the annuity contract for an employee arise by means of an employee's salary reduction, an agreement to that effect is required between the parties. Such an agreement must be legally binding and irrevocable with respect to amounts earned while the agreement is in effect. See section 1.403(b)-1(b)(3) of the Income Tax Regulations. The exclusion allowance under section 403(b) of the Code would only be applicable to those amounts contributed by the employer for the annuity contract which are earned by the employee after such agreement becomes effective.

Accordingly, it is held with respect to situation (1) that the exclusion allowance under section 403(b) of the Code would be applicable when an employer agreed with an employee and the insurance company to pay the future premiums on an annuity contract originally purchased by the employee, if the provisions of sections 401(g) and 403(b) of the Code are otherwise met.

In situation (2), if the present employer agrees to pay the future premiums on an annuity contract originally purchased for such employee by a former employer and the other requirements of sections 401(g) and 403(b) of the Code are met, the exclusion allowance under section 403(b) of the Code is applicable to such payments when such agreement became effective.

The principles set forth in the ruling are also applicable under section 403(b) of the Code to situations involving the purchases of annuity contracts by an employer which is an exempt organization described in section 501(c)(3).

Where a State, a political subdivision of a State, or an agency or instrumentality of either, purchases an annuity under section 403(b) of the Internal Revenue Code of 1954, for an employee of an educational institution, the employer's contributions to a State retirement plan for such employee, which are excludable from the employee's gross income for Federal income tax purposes, may not be added to his "includible compensation" for purposes of computing his applicable exclusion allowance under section 403(b)(2) of the Code. Such employer contributions to a State retirement plan, which were previously excludable from the employee's gross income, serve to reduce the employee's applicable exclusion allowance.

Advice has been requested whether an employer's contributions to a State teacher's retirement plan for an employee, which are excludable from the employee's gross income, may be added to the employee's "includible compensation" in order to increase his applicable exclusion allowance under section 403(b)(2) of the Internal Revenue Code of 1954.

Employees performing services for an educational institution of a certain State participate in two retirement plans. The first is a State teachers' retirement system to which the employer makes contributions in behalf of the employee and to which the employee also makes contributions. The amounts of the employer's contributions are excludable from the employee's gross income for Federal income tax purposes but the employee's own contributions are includible. The second is an annuity purchase program, described in section 403(b) of the Code, where the employer purchases an annuity contract for the employee, pursuant to a valid salary reduction agreement executed by the parties.

An employee computes his exclusion allowance under section 403(b)(2) of the Code and section 1.403(b)-1(d) of the Income Tax Regulations, in the following manner: He determines an amount by multiplying 20 percent of his "includible compensation" by the number of years of his service with the employer who is making the contributions for him. He then subtracts from this product the aggregate contributions made in his behalf by such employer for all prior years which were excludable from his gross income under a plan of deferred compensation. See section 1.403(b)-1(d)(3) of the regulations.

The term "includible compensation" is defined in section 403(b)(3) of the Code as compensation, received from a qualifying employer by an employee, which is includible in the employee's gross income for the most recent period which may be counted as 1 year of service. In this connection, section 1.403(b)-1(e)(1) of the regulations provides that for purposes of computing an employee's exclusion allowance for a taxable year, such employee's includible compensation in respect of such taxable year means the amount of compensation which is includible in his gross income.

The exclusion allowance is to be reduced by any amounts which were contributed to purchase an annuity for the employee and which were excludable from gross income for any taxable year prior to the taxable year for which the exclusion allowance is being computed. Thus, section 1.403(b)-1(d)(3) of the regulations provides that in computing the aggregate of the amounts which have been contributed by an employer for annuity contracts for an employee, and which were excludable from the employee's gross income for any prior taxable year, there shall be included all contributions made by the employer for the benefit of the employee which were excludable from his gross income under a qualified pension, annuity, or bond purchase plan or which were not includible in gross income for the taxable year in which his rights to employer contributions changed from forfeitable to nonforfeitable.

Accordingly, the employer contributions to a State teachers' retirement system for an employee, which are excludable from the employee's gross income for Federal income tax purposes, may not be added to the amount of such employee's "includible compensation" for computation of the applicable exclusion allowance under section 403(b)(2) of the Code. Furthermore such employer contributions made in prior years for the employee fall within the scope of section 403(b)(2)(B) of the Code, and section 1.403(b)-1(d)(3) and (4) of the regulations, and must be used to reduce the employee's applicable exclusion allowance.