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Offering choice between employer-paid health insurance or a contributi


Guest geekster
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Guest geekster

I negotiate contracts for employee groups in public schools. One small country CPA has convinced the Board of Education that it is permissable under the Code to give employees the choice between employer-paid health insurance or a contribution by the employer to a 403(B). I don't believe this is permitted; I believe in either the case of the annuity or Section 125 plan cash has to be one of the options.

Where can I find something definitive on this. (The CPA refuses to seek a letter ruling from IRS.)

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Ben

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I agree with you. Cash has to be one of the options. If you have the 2000 edition of Tax Facts 1, look at Q&A 97. In relevant part, it says, "A cafeteria plan generally cannot provide for deferred compensation except that an employee covered by a profit sharing or a stock bonus plan or a rural cooperative plan that has a qualified cash or deferred arrangement may be allowed by the cafeteria plan an election to have the employer contribute on his behalf to the plan." The operative word is "Election."

Also, look at PLR 9104050. While it pertains to a corporate plan, the situation allowed employees to contribute to a health plan or a retirement plan. The Service concluded that because an option existed, employees electing health care would have the contributions included in their gross income.

Hope this is of some help.

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Guest Doug Johnston

Score one for the "country CPA". The plan you are describing in not a cafeteria plan. IRC section 125 applies where at least one of the benefit options the employee is receiving would otherwise be taxable. If the employee cannot choose additional cash compensation in lieu of the employer contributions to the health plan or 403(B), the benefits are tax-free by definition.

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Guest geekster

Here is the root of my question: a 403(B) is a choice between cash or differed compensation, as per the IRC; a Section 125 Plan is a choice between cash or some eligible benefit, as per the IRC.

Nowhere in the IRC is there a provision where an individual gets favorable tax treatment when choosing between deferred compensation and health insurance.

In the situation I originally described, won't individuals be taxed on the value of the health insurance/403(B) option?

Thanks for your time.

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Guest JWBrown

In checking the IRC references, it appears that the cash or deferred arrangement mentioned under section 125 needs to be a 401(k) in order to fall under the 125 exception for profit sharing plans.

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Guest Doug Johnston

Nowhere in the tax code is there a provision that says that employees must pay tax on otherwise purely tax-free benefits simply because they can choose between them. I am referring to employer contributions - not salary reduction elections.

Example: A new employee is given a base salary of $20,000 and a choice between $2,000 toward health insurance premiums or $2,000 in 403(B) contributions. The employee cannot elect to receive cash compensation in lieu of the benefits. Since there is no optional benefit that is otherwise taxable, Section 125 does not apply.

In the situation you described, employees can choose between "employer-paid health insurance" or "contribution by the employer to a 403(B)". If these contributions do not directly decrease the employees' pay, there is no taxable option. Section 125 and the related prohibition on deferred compensation in a 125 plan are irrelevant.

Personally, I would welcome the opportunity to seek a private letter ruling on this issue.

[This message has been edited by Doug Johnston (edited 04-01-2000).]

[This message has been edited by Doug Johnston (edited 04-01-2000).]

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The IRS has taken the position (in at least one PLR)that if an employee is given the choice between health (or presumably some other non-taxable) benefits and a contribution to a 401(a) plan, the employee is taxable under the assignment of income doctrine.

I have no reason to believe that the IRS would take a different position for 403(B) programs.

IMHO the IRS is wrong, and if your client wants to ignore them, it has a defensible position. Do they want to accept the litigation risk?

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Score one for the "country" CPA. You miss his point. The choice that the employee is given is one of method of compensation. You have confused this with the choice between cash and qualified benefit within the 125 plan. This second choice comes AFTER the first and will only exist if the employee decides in favor of the 125 over the 403(B). If the employee decides on the 403(B) there is no 125 choice.Being "country" might not be as bad as you think.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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I'm not certain if the "you" in your message was addressed to me or the original poster.

My comment on the IRS' position was with regard to a choice offered outside of a 125 (or 401(k) or 403(B)) plan (what you would refer to as the first choice).

The country CPA may be correct, but the IRS has issued a nonbinding opinion contrary to what the CPA is recommending. The CPA doesn't score until he discloses the IRS' position, discloses the litigation risks, and gives an explaination as to why the IRS is wrong.

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To IRC401... What PLR and what nonbinding opinion are you referring to?

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Query. (And it's only a query)

Could the recent IRS rulings on arrangements that contribute unused sick pay to a qualified plan have some bearing on what you can or can't do in this situation?

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Guest Harvey Carruth

Since this topic is receiving so much attention on this Bulletin Board, I will submit this contribution, even though Michael Devault provided the correct answer in his contribution on 03-27-2000. The original question posed by geekster on 03-27-2000 is as follows:

"Is it permissible to give employees the choice between employer-paid health insurance (a non-taxable benefit) and a contribution by the employer to a 403(B)?"

Michael Devault gave a definitive cite when he pointed to PLR 9104050, the pertinent paragraphs of which are as follows:

"If an employee elects to have employer contributions made to the Health Care Fund where the option also exists to have those contributions made to the Pension Plan, the employee is forgoing the contributions to the qualified plan. However, contributions to the qualified plan do not constitute a nontaxable benefit. The tax on the contributions is merely deferred until the amounts are distributed to the employee at a future date. When an employee has similar health and medical coverage under another plan but nevertheless elects to have contributions made to the Health Care Fund (by not demonstrating the existence of such similar coverage to the Health Care Fund's trustees), the employee is merely assigning future income (qualified plan distributions) for consideration (Health Care Fund benefits) and thus, is treated as currently receiving the future pension plan distributions for which the accident and health insurance coverage is a mere substitute. Because the recipient of pension plan distributions constitutes a taxable event, analogous to the situations in P.G. Lake and Rev. Rul. 69-471, the employee has converted future income into present income notwithstanding that that income may be used to purchase a nontaxable event."

"Accordingly, we conclude that because the proposed amendments to the Health Care Fund and the Pension Plan and Pension Trust will allow employees who have similar health and medical coverage available under another plan the option of either receiving employer contributions at a future date as qualified plan distributions or immediately as Health Care Fund benefits, such employees, if they elect Health Care Fund coverage (whether or not they are required to establish the availability of other health and medical care coverage), will have contributions to the Health Care Fund includible in their gross incomes in the taxable year in which they are contributed by the employer."

As Michael Devault pointed out, while this opinion deals with a qualified pension plan, the logic applies identically to 403(B) plans/contracts. It is interesting to note that in such an arrangement, 403(B) contributions would not be taxable in the taxable year in which they are contributed by the employer, but health insurance premiums/contributions would be taxable.

Doug Johnston's second contribution (04-01-2000) mentions "choosing between purely tax-free benefits," which is inaccurate in this situation, since contributions to 403(B) plans/contracts are not "tax-free benefits." Seeking a private letter ruling on this issue is almost certain to result in a restatement of PLR 9104050 with "403(B) contract" replacing "qualified pension plan."

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  • 4 weeks later...
Guest Harvey Carruth

One permissible approach is available to allow a qualified employer to offer a choice between employer-paid health insurance and a contribution to a 403(B) contract, but this approach involves a qualified 125 plan in which cash must be an option and an entirely separate 403(B) plan. Basically, the 125 plan may be structured to include two qualified benefits, health insurance coverage and cash. If an employee is eligible to elect cash and decline health insurance coverage based on the 125 plan document rules and decides to do that, then the health insurance premium costs are added to the employee's gross income. At that point, the employee has the option of deferring the additional gross salary via standard 403(B) salary reduction agreement, subject to the usual Internal Revenue Code limitations on 403(B) contributions.

As PLR 9406002 points out, "By enacting section 125 of the Code, Congress set forth a statutory scheme, complete with nondiscrimination requirements, under which employers could offer their employees or prospective employees a choice between cash and certain excludable employer-provided benefits such as accident and health insurance." It is universally accepted that a 403(B) plan cannot be a "qualified benefit" offered within a 125 plan (Treas. Reg. 1.125-2T). Hence, arrangements involving separate 125 and 403(B) plans as described in the previous paragraph are the only ones I know of that satisfy all statutory requirements and meet the goal of the Board of Education and its CPA, as expressed in the original post on this topic by geekster.

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NCompliance Software and Carruth Compliance Consulting

[This message has been edited by Harvey Carruth (edited 05-05-2000).]

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  • 6 years later...

If the choice is health benefit (tax free) or contribution to 401k plan (taxable, albeit later), constructive receipt would make the health benefit taxable by reason of the choice, per constructive receipt. You'd need a 125 plan to keep the health benefit nontaxable, despite having the choice. The problem with a 401k contribution is that it cannot be a 125 plan option because it is deferred compensation (as would be a contribution to a 403b annuity).

From the 401k or 403b side of this situation, those vehicles give an employee choice of when compensation will be taxed, now or later. Not a choice of later or never.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Harvey:

I think your suggestion is a very creative one.

If I understand you correctly, there are 2 section 125 agreements.

The first gives the employee the choice between cash and health insurance premiums.

If the employee chooses cash, the second 125 agreement gives the employee the choice between cash and 403(B) contributions.

Is that correct?

Don Levit

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JS: you have any citation for your statement that the choice between cash & health ins would be constructively received? In Express Oil Change Inc v. IRS, the Ala Fed ct held that the choice between a higher salary and lower salary with health benefits did not result in taxation.

By the way a 125 plan can allow contributions to a 401k plan. IRC 125©.

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Guest Mpowers

We work with fair amount of school districts nationwide. If cah is an option then there is a problem, there may also me a problem giveg the choice to the employee for tax free vs tax deffered plans.

Mark Powers

PRG

203-453-3151

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JS: you have any citation for your statement that the choice between cash & health ins would be constructively received? In Express Oil Change Inc v. IRS, the Ala Fed ct held that the choice between a higher salary and lower salary with health benefits did not result in taxation.

By the way a 125 plan can allow contributions to a 401k plan. IRC 125©.

Did Express Oil Change go so far as saying that the employee would not be taxable, or did it merely decide that the employer did not have a withholding obligation?

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Since the court ruled that the amounts were not wages how could the amounts be includible in the employee's income? According to the court, if the employee terminated his election he would receive higher wages in the amount that his salary had been reduced. In the court's example if the health ins cost 50 a week and the employee's salary was 300 a week the employee's remumeration is reduced by 50 a week. The employee is paid 250 a week and the employer pays the entire group health ins premium. If the employee chooses not to be covered, the employee is paid 300 a week.

the cite is 1996 WL 679423, 20 employee benefit cases 2184

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The court in Express Oil Change noted that the IRS

argues persuasively that because [Express Oil]'s employees had the choice of accepting a salary reduction in exchange for health insurance coverage or a higher salary, they effectively assigned the amount of the salary reduction to plaintiff, controlling that income. Therefore, pursuant to the assignment of income doctrine, [iRS] asserts that the salary reduction amount constitutes gross income to the employees who entered into a salary reduction agreement. See Caruth Corp. v. United States [89-1 USTC ¶9172 ], 865 F.2d 644, 648 (5th Cir. 1989) ("assignment of income doctrine holds that one who earns income cannot escape tax upon the income by assigning it to another"). The question in this case, however, is not whether the salary reduction amounts constitute gross income to the employees, but rather, whether they constitute "wages" for purposes of income-tax withholding. As [Express Oil] correctly notes, an employee's gross income is not the same as his "wages" for purposes of income-tax withholding, and "many items [that] qualify as income ... are not wages." Central Illinois Pub. Serv. Co. v. United States [78-1 USTC ¶9254 ], 435 U.S. 21, 25 (1978).

The court that found such amounts were not 'wages' for tax withholding and FICA purposes found persuasive the IRS arguments that these amounts would be taxable income to the employees (though that was not the issue before that court).

Treas Reg sec 1.125-1, Q&A-9 includes the following explanation--

Section 125 thus provides an exception to the constructive receipt rules that apply with respect to employee elections among nontaxable and taxable benefits (including cash). These constructive receipt rules generally provide that an individual will be required to include in gross income the taxable benefits that he could have elected to receive if the individual had the opportunity to elect to receive or not to receive the benefits even though both the opportunity to make this election occurs and the actual election is made before the benefits become currently available to the individual. Section 125 does not, however, alter the application of the constructive receipt rules to a situation in which benefits become currently available to an individual even though the individual elects not to receive and does not actually receive the benefits.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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JS:

Is it your opinion that constructive receipt applies, because the health insurance benefits were currently available?

If yes, would constructive receipt apply if the health insurance benefits were available, only after the employee retired or left the employer?

Don Levit

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If the employee may choose to have employer funds applied between deferred taxable income (401k or 403b benefits) and a deferred tax free benefit (say health benefits in retirement), but not cash now or any other current benefit, then I would think the choice should not under constructive receipt cause taxation for the employee now. That's because the employee could not choose to receive anything currently.

The implications for the 401k or 403b plan, however, would probably be true employer contributions (not merely deemed 'employer contributions' the expense of which are actually borne by the employee through salary reduction). This is because of no current "cash" option. Since those employees that would choose the retiree health benefits would not receive the employer contribution to the 401k or 403b plan, you'd likely have some interesting nondiscrimination and perhaps minimum coverage issues to deal with--but they might not be insurmountable.

The choice, albeit now not later, might cause those choosing the retiree health benefits to be taxed on those at the time they could have withdrawn and been taxed on benefits from the 401k or 403b plan. That's because of the choice, and thus constructive receipt. They chose the retiree health benefits, but could have went the other route, a contribution into the 401k or 403b plan that would have been taxable on withdrawal.

If the choice now is couched into the context of a 125 plan attempt, that might not give those that choose the retiree health benefits cover from taxation at the time 401k or 403b plan benefits could have been withdrawn. The reason is that the cafeteria plans have to be primarily for active employees, and only incidentally provide benefits to former employees, and there's the general prohibition against deferral of compensation using a 125 plan.

This is my first time taking an analytical whack at such a choice, so the analysis might not be quite as developed as I would normally like.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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