Contribution to 457 plan in lieu of health insurance

[Guest tws]

Governmental employer offers employees a choice between health insurance or an employer contribution to a 457 plan for the employee. Is a cafeteria plan required?

[Everett Moreland]

A cafeteria plan won't help. See IRC § 125(d)(2). The IRS position is that if an employee has a choice between health insurance and a contribution to a 457 plan, employees who elect health insurance will have taxable income and employees who elect the 457 plan contribution may defer the contribution under the 457 rules.

[Guest tws]

Is the solution to use a cafeteria plan and give the employees the option of choosing cash or health insurance and then those who choose cash can salary defer it into the 457?

[Everett Moreland]

Yes. Seems odd that adding a cash election would solve the problem, but I think it does.

[mbozek]

I thought that to have a cafeteria plan the employee must be offered a choice between cash and a tax deferred benefit, e.g health ins. IRC 125(d)(1)(B). Offering a choice between two non taxable options does not create a taxable event because there is no cash is available. This no different than offering the ee a choice between a 403(b) annuity contribution and health care. Everett do you have a ruling for your position since neither benefit is currently taxable to the employee.

[Guest tws]

Because the 457 contributions (as well as the 403(b) contributions) are taxable when eventually distributed to the employee, they are treated as taxable benefits (same as cash) for cafeteria plan purposes.

[mbozek]

We are not talking about a cafeteria plan where the ee has a choice between cash and a non taxable benefit. The question is whether there is any income tax due if the only choice an employee has is between two non taxable benefits, e.g., deferral under a 457 plan or health ins. Since neither benefit is included in the employee's income there is no constructive receipt which requires the amount to be included in income under IRC 451. Amounts which are contributed by an employer to a 403(b) plan are not include in an employees income. IRC 403(b)(1). They are not the same as cash.

[Everett Moreland]

mbozek: "Everett do you have a ruling for your position since neither benefit is currently taxable to the employee." I researched this several years ago and so far haven't found my research memo. What I found in the research is (1) a congressional committee report on § 125 (it might be a senate report) suggests you are right and (2) several PLRs or TAMs state that a benefit that is eventually taxable (such as a 457 plan contribution) is treated as a taxable benefit, and so a choice between deferred compensation and health benefits makes the health benefits taxable. Most of these PLRs cite Lucas v. Earl.

[mbozek]

I thought that Lucas v. Earl had to do with assignment of income, eg. person who earns income cannot assign it to another person, not CR by a person who earns income. Anyway IRS has issued several rulings which allow the transfer of accumulated vacation pay or disability pay from an employer to a qualified plan upon the consent of employee of without CR as long as ee has no right to receive the benefits as cash because cash would trigger CR.

[Everett Moreland]

mbozek: I finally found one of the PLRs, 9104050:

"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 receipt 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 benefit.

"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 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."

[jstorch]

It might be a little late to chime in, but Everett Morland's last post nails the right PLR. I have found very little commentary on PLR 9104050; anyone have any reason to believe the IRS has changed position or the law affecting has changed since it was issued?

I found the following thread which also covers the issue, which may be of interest:

http://benefitslink.com/boards/index.php?s...st=0entry7743

125 plans offer a choice between cash and certain nontaxable benefits ("qualified benefits" under § 125(f)). The key is in realizing 457/403(b)/401(k) contributions are not nontaxable, but merely tax-deferred--they are taxable in the future.

(The reason 401(k) deferrals may be offered in a 125 plan is because it is specifically provided for in Section 125(d)(2)(B).)

[mbozek]

I think that that subsequent IRS rulings have undercut the rationale of 9104050.

RR 200311043 permits the employer to contribute excess vacation pay as an employer contribution to a qualified plan as long as the employee does not have the option to elect to recieve the vacation time in cash. The employees only choices are to take vacation pay during the year, forfeit the excess vacation pay or have the employer contribute the excess vacation pay to a qualified plan. Under the ruling there is no constructive receipt of the excess vacation time because the employees cash compensation is not affected by his her choice. (" ...Because the employee did not have the option to receive cash or any other taxable benefit in lieu of the employer vacation pay contribution he/she is not in constructive receipt of income").

Further the holding in RR 9104050 can be distinguished from a qual. retirement plan which provides an additional contribution to employees who are not covered by the health care plan since the employee's cash compensation is not effected by the choice because the employee has no right to chose between taxable and non taxable options in the same plan.

[mbozek]

Finally the rationale of the 91 ruling is suspect because it treats the employee as assigning future retirement benefits in return for health care benefits without knowing what the future value of the pension contribution will be at distribution. This makes no sense economically because the value of the future benefits paid to the employee may be less than the value of the present value of the cost of health care benefits.