Rev. Rul. 81-35

Advice has been requested whether, pursuant to section 414(h)(2) of the Internal Revenue Code, an employee may exclude from current gross income, for federal income tax purposes, contributions made by the employing governmental unit to a pension plan qualified under section 401(a) under the circumstances described below.

A is employed by a school district within a state whose statutes require that employees contribute 7 percent of gross salary to the state's pension plan. The plan is qualified under section 401(a) of the Code, and its trust is exempt from federal income tax under section 501(a).

A entered into an agreement with the school district in 1977 pursuant to which the school district contributed 7 percent of A's salary, on A's behalf, to the state's qualified pension plan. The agreement designated these amounts as employee contributions and provided that amounts paid by the school district were to satisfy A's obligation to contribute 7 percent of salary to the state's pension plan. The agreement in question was voluntary and was not entered into as a condition of A's employment.

Section 414(h)(1) of the Code states that amounts contributed to a plan qualified under section 401(a) may not, for tax purposes, be treated as employer contributions if they are designated as employee contributions. Section 414(h)(2) provides an exception to this rule, however, by allowing contributions (otherwise designated as employee contributions) to government plans to be treated as employer contributions if the employer "picks up" the contributions.

Rev. Rul. 77-462, 1977-2 C.B. 358, specifies the federal income tax treatment to be accorded contributions "picked-up," within the meaning of section 414(h)(2) of the Code, by a governmental unit and paid to a plan qualified under section 401(a). It concludes that such "picked-up" contributions are not includible in the gross income of the employees until these amounts are distributed or made available to the employees.

Contributions are considered "picked-up" by the employer, for purposes of section 414(h)(2) of the Code, if two criteria are satisfied. First, 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. Second, the employee must not have the option of choosing to receive the contributed amounts directly instead of having them paid by the employer to the pension plan.

Rev. Rul. 81-36, this page, this Bulletin, concludes that certain amounts contributed by the employer were considered to be "picked-up," within the meaning of section 414(h)(2) of the Code, because (1) the employer specified that the contributions were paid by the employer in lieu of contributions by the employee, and (2) the employee, pursuant to a union-negotiated agreement, had no option to receive the contributed amounts directly instead of having them paid by the employer to the pension plan.

The employer in the above example did specify that the contributions, designated as employee contributions, were paid by the employer in lieu of contributions by the employee. A, however, voluntarily entered into an agreement with A's employer to have these contributions made to the state's pension plan. Thus, A did exercise an option to have these contributions made to the pension plan rather than receiving the amounts directly and, therefore, such amounts are not considered "picked-up," within the meaning of section 414(h)(2), because they fail to satisfy the criteria stated above.

Accordingly, A may not, pursuant to section 414(h)(2) of the Code, exclude from gross income, for federal income tax purposes, contributions made by the employing governmental unit to its qualified pension plan.

The circumstances outlined here are distinguished from those presented in Rev. Rul. 77-462. That ruling applies only to government "pick-up" plans which meet the requirements of section 414(h)(2) of the Code.

Rev. Rul. 81-36 is also distinguished.