Getting 401(k) contributions for unused vacation days

[Guest r. d. olney]

Can anyone shed any light on the subject of getting 401(k) contributions for unused vacation days. I have a few clients who are interested. An article about this topic first appeared in the Wall St. Journal back in late 1996/early 1997. A company had put this provision in their plan. They received a private letter ruling on it though, which as I understand, does not give other plan sponsors the green light to install this provision. Have there been any recent developments?

[Guest jdw]

The WSJ article was printed on 12/10/96. It apparently refers to PLR 9635002. You may also want to check TAM 9635002, which discusses a related topic.

I haven't seen any recent discussion threads about this on this site, but there are some in the archives. You can find them by using the search feature.

[Dave Baker]

Here's the TAM: http://www.benefitslink.com/IRS/9635002.shtml

Strangely, I'm having very little luck finding out more about it, by searching these message boards or by searching BenefitsLink (http://www.benefitslink.com/search) ... as I recall, the consensus was that discrimination-in-favor-of-highly-compensated-employees problems were likely to cause difficulty.

[david shipp]

Try this link to an interesting analysis of the vacation pay issue.

http://www.the401k.com/news/quarter41996/vacation.html

[Guest Brenda Thompson]

The IRS has once again spoken on this issue in yet another PLR -- it's PLR 199940043, issued, I believe, in mid-October of this year. Although I haven't looked at the PLR itself, from the discussion I've seen, it doesn't appear to be any different from the 1996 PLR. Does anyone else know anything about this latest PLR?

[Alonzo]

There really is not too much to say. The IRS rulings provide that the value of sick days can be contributed to a plan by an employer, if the employee is not choosing between the contribution or receiving the value of the sick days in cash. (There can't be any election by the employee to defer income. Otherwise, you have a 401(k) plan.)

I am finding that this approach is becoming very popular among government employers, who often have employees who have accumulated an enormous amount of sick days. The nondiscrimination rules don't apply to those employers. This could also be an interesting kind of negotiated benefit.

[Felicia]

Have not been able to find a copy of the 1999 PLR. Does anyone have a cite for this?

[BeckyMiller]

Member Alonzo hit the nail on the head in his comment. The contribution of the value of these days is treated as an employer contribution and must be tested for discrimination. In our middle market practice, we find that most unused vacation time comes from high paid. As such, it was a nifty idea with no benefit.

Also, I have been told (but can't prove or give authority for this statement)that these arrangements may be futile in states such as California which have specific rules vesting all vacation pay. I would check that out before pursuing.

[401 Chaos]

Anybody have any recent experience with this. We have come across a plan that has had a provision permitting contribution of up to 2 weeks of unused / forfeited vacation benefits for NHCEs only. The provision has been in the plan for 10 years+ (??) and the plan last received a determination letter dating back to 2002 with the provision intact. The plan was submitted for a determination letter last year and the IRS has now come back questioning the provision and told the plan that they have to have a PLR in order to include that provsion. Without a PLR the plan will need to be amended to delete the provision (although the IRS seems unsure as of when the deletion would take effect or what to do about prior application of the provision). When asked why they did not object to this in 2002 review, they indicated the national office had since provided more / better guidance on how to react to these vacation / leave contribution provisions.

Anybody have a similar experience or suggestion on how to handle.

[QDROphile]

Since IRS reviewers are sometimes confused, one must try to get the reason for the resistance. For example, the agent may think the arrangement is a CODA, and the agent could be correct depending on the nature of the vacation pay terms. Or the agent may think the arranagement violates the requirement for allocation terms. Or the agent may simply be taking a negative view without understanding how the arrangement works because a lot of arrangements don't work. You may have to press to a higher level if it is important, and be prepared to show that you know what will work and the plan fits.

[401 Chaos]

Thanks QDROphile. We had a somewhat frustrating discussion with the the agent and then the agent's supervisor. As best we can tell, the thrust of their concern / comments seems to be that they really don't have the authority to consider the specifics of the company's vacation plan to analyze whether it is a CODA or nonelective contribution, or comes within 9635002. They did not argue that the arrangement might work given the fact that the company's vacation plan follows the use it or lose it rule type policy addressed in TAM 9635002. Their main point seemed to be that analysis / determination of the vacation policy was outside their jurisdiction and they needed some other Service review / determination of proper classification of the vacation plan before they could pass on its inclusion in the plan. They did not share with us whatever guidance or directive they presumably received from the national office on this but suggested they were following higher instructions. Not sure we really have the whole story but was hoping others might have experienced something similar.

[401 Chaos]

Just wanted to bump this up a last time to see if anybody has had a similar experience.

Not clear exactly where the document with the questionable provision came from but client believes it came from one they were steered to by their TPA (currently Principal) so seems like a fair bet there may have been others out there with similar provisions dating back several years.

Thanks

[TheRestatement3dOfTed]

In August 2009, the IRS issued Rev. Rul. 2009-31, which addresses contributions of the dollar value of unused time off to profit-sharing and 401(k) plans.

From the EBIA weekly newsletter, 09/10/2009:

"This guidance illustrates two situations in which the dollar equivalent of unused paid time off (PTO) can be contributed to an employer's profit-sharing plan without adversely affecting the plan's qualified status. In one scenario, the plan required the value of unused PTO, up to applicable Code Section 415 limits, to be contributed as of December 31 (i.e., a nonelective contribution), with any remainder being paid to the employee in cash the following year. In the second scenario, participants could elect to have all or a portion of the value of unused PTO (up to applicable Code Section 415 and 401(a)(30) limits) contributed to the plan in the following year (i.e., an elective contribution), with the remainder paid in cash. In both scenarios, IRS concluded that PTO contributions that were made as described and satisfied the applicable nondiscrimination requirements would not be included in an employee's income until distributed. Any amounts paid in cash instead of being contributed would be income in the year paid."

A companion ruling, Rev. Rul. 2009-32, addresses amendments involving mandatory or elective contributions of unused time off to profit-sharing plans upon termination of employment.

Rev. Rul. 2009-31 available at: http://www.irs.gov/pub/irs-drop/rr-09-31.pdf

Rev. Rul. 2009-32 available at: http://www.irs.gov/pub/irs-drop/rr-09-32.pdf

Cheers!

(E: edited for correct links)

[fiona1]

So if an employee can take unused PTO as cash, then it can be deferred into a 401(k) plan as an elective deferral. Does anyone know if a plan document need to be amended in order for an employee to do this? The cash rec'd as unused PTO fits under the definition of compensation as far as I can tell. The Rev Ruling states that the 401(k) has to be amended to allow these contributions - but that doesn't make sense to me.

I can understand the need for the plan to be amended if the PTO is "use it or lose it" - and the contribution to the plan is made as a non-elective. But I'm struggling on the deferral part.

[Bird]

I think you are right; if it is available as cash it can be deferred and no amendment is needed.

[fiona1]

Thanks for the response. After looking into it a little more, I think if the participant defers on the cash-out from the PTO plan under their current election - then no amendment is necessary. If they want to defer a different amount - say 100% - then the plan would need to allow that ability. Hence a possible amendment.