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"Condition of employment" contributions to 403(b)


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Is anyone familiar with so-called "condition of employment" employee contributions to 403(B) plans? I'm seeing these for the first time. The proposed employee contribution is mandatory and is pre-tax. I found the following reference in the audit guidelines, which suggests they're permissible but I don't understand on what basis the contributions are pre-tax. ("Elective deferrals do not include elective contributions made pursuant to a one-time irrevocable election that is made at initial eligibility to participate in the salary reduction agreement, or pursuant to certain other one-time irrevocable elections to be specified in regulations, or pre-tax contributions made as a condition of employment.") It should be noted that this is NOT a governmental employer, so even if 414(h)(2) applies to 403(B) arrangements, it wouldn't apply to this employer.

Assuming we can get past state wage withholding statutes, what are the tax issues? I understand that these are not salary reduction contributions, but on what basis are they pre-tax? General constructive receipt principles (i.e., no opportunity to receive as cash)? If there are two different levels of employee contributions based on employment classification, how do you test for nondiscrimination? What if there is an employer "match"? Do you use Notice 89-23?

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I haven't seen the actual plan documents to which you refer. However, I would suspect that the plan documents in some way refer to these as being employer contributions for tax purposes, even though they are being referred to as mandatory employee contributions for other purposes. Thus, they would be pretax in the same way as other employer contributions would be pretax.

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The opinions of my postings are my own and do not necessarily represent my law firm's position, strategies, or opinions. The contents of my postings are offered for informational purposes only and should not be construed as legal advice. A visit to this board or an exchange of information through this board does not create an attorney-client relationship. You should consult directly with an attorney for individual advice regarding your particular situation. I am not your lawyer under any circumstances.

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  • 2 weeks later...
Guest Brent Rowell

My understanding of these plans is as follows:

Objective:

Allow employees to exceed elective limitation

Method:

Make a portion of employee salary reduction mandatory by making it a condition of employment

Result: Mandatory SALARY REDUCTION counts as employer contribution for purpose of calculating elective limitation since it is non elective (My understanding is that in all other respects it is treated as normal salary reduction)

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Thanks, Brent and Carol.

Carol, I put some language in the plan document along the lines of Rev. Ruls. 81-35 and 81-36 (while recognizing these aren't "pick ups," the same sort of tax rationale applies).

Brent, I think you're right--one reason an employer might adopt this structure is to avoid the 402(g) limit, and, as long as the contribution really is a condition of employment and there isn't an opportunity for the employee to select or change the amount of the election, apparently this works.

An interesting related question is whether the employer contribution that "matches" the condition of employment contribution should be tested under the ACP test or under the disparity safe harbors in Notice 89-23. I'd argue that the employer contribution isn't a matching contribution as defined for purposes of the ACP test, so the disparity safe harbors should apply. But I haven't found anything definitive on this.

Thanks again for your responses.

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  • 11 months later...

somewhat related question I have: is there any authority that 414(h)(2) picked-up contributions are not subject to ADP testing and/or that the plan document does not need ADP testing provisions? The plan does not have a determination letter covering the 414(h)(2) provisions yet. Testing would always be passed since the contributions are the same for everyone. I have a TPA's attorney telling me these are subject to ADP testing since they are pre-tax and that the document should say so. This doesn't make sense to me; I'd like to point to some definitive authority on the issue. Thanks.

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It seems to me that ADP testing applies only to elective deferrals under a cash or deferred arrangement described under 401(k). A one-time irrevocable election to contribute is, by definition, not a cash or deferred election for 401(k) purposes and therefore, I don't see how the ADP test could apply.

Moreover, pick-up contributions being unique to governmental employers, isn't it likely that the plan sponsor is not subject to ADP testing even if it has a grandfathered 401(k) plan?

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If you are advising a client on the tax treatment of the contributions, make certain that the "mandatory" contributions are truly mandatory. I've seen plans with "mandatory" contributions that weren't enforced. I've also seen plans in which employees were required to make contributions but had their choce of pre-tax or after-tax (which would make the mandatory contributions elective deferrals).

PS: I've also seen an SPD that told employees that they had to make "mandatory voluntary" contributions.

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Beth, I suspect that the TPA's attorney is not familiar with governmental plans, and is therefore unaware that governmental plans have a way (Code section 414(h)(2)) to permit pretax contributions that is not available to private plans. ADP testing is mandated only under 401(k), and therefore is not applicable to a plan that is not a 401(k) plan.

IRC401, I'm still pondering those "mandatory voluntary" contributions! :rolleyes:

Employee benefits legal resource site

The opinions of my postings are my own and do not necessarily represent my law firm's position, strategies, or opinions. The contents of my postings are offered for informational purposes only and should not be construed as legal advice. A visit to this board or an exchange of information through this board does not create an attorney-client relationship. You should consult directly with an attorney for individual advice regarding your particular situation. I am not your lawyer under any circumstances.

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