IRS Technical Advice Memorandum 9635002

National Office Technical Advice Memorandum

Qualified pension, profit-sharing, and stock bonus plan; Cash or deferred arrangements.

ISSUE

Whether contributions made by Company A to Plan X, of an employee's "vacation pay benefit", are includable in that employee's gross wages for purposes of the Federal Insurance Contributions Act (FICA).

FACTS

Company A established Plan X on July 1, 1959. Plan X is a stock purchase plan with profit sharing features and cash or deferred arrangements. It has been determined to be qualified under section 401(a) of the Internal Revenue Code, most recently in a determination letter issued on February 4, 1986.

Company A employees are entitled to a certain amount of paid annual leave based on years of service. This paid vacation time is earned on a calendar basis and must be used during the same calendar year, otherwise it is forfeited. Under Article 6 of Plan X, in effect from December 31, 1979 through November 1, 1991, participants who did not use all of their paid vacation time during a calendar year were able to elect to have some or all of this vacation time, in excess of two weeks, converted to its equivalent in pay (referred to in Plan X as the vacation pay benefit) and contributed to Plan X by Company A on the employee's behalf.

LAW AND RATIONALE

Section 1.401(k)-1(a)(3) of the Income Tax Regulations states that a cash or deferred election is any election (or modification of an earlier election) by an employee to have the employer either provide an amount to the employee in the form of cash or some other taxable benefit that is not currently available, or contribute an amount to a trust, or provide an accrual or benefit, under a plan deferring the receipt of compensation. In this case, an employee's only options with respect to vacation time entitlement over two weeks per year were (1) to take the vacation time; (2) to have Company A contribute the value of the time to Plan X; or (3) to forfeit the vacation time. The employee's cash compensation was not affected by his or her choice. In effect, an employee was able to earn Plan X contributions by working additional weeks. Because the employee did not have the option to receive cash or any other taxable benefit in lieu of the additional employer contribution to Plan X, we do not believe that the employee's choice among the above options was a cash or deferred arrangement. The contribution of the vacation pay benefit was simply a nonelective employer contribution to a qualified plan.

Section 1.451-2(a) of the Income Tax Regulations states, in part, that income, although not actually reduced to the taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayers's control of its receipt is subject to substantial limitations or restrictions. Since the employee in this case cannot receive the benefit in any other form during the year, he or she is not in constructive receipt of income. Therefore, the vacation pay benefit is not includable in the employee's gross income until distributed from Plan X.

Code section 3121(a)(5)(A) provides, in general, that a payment on behalf of an employee to a qualified trust is not included in wages for purposes of FICA. Section 3121(v)(1)(A) provides that an employer contribution under a qualified cash or deferred arrangement under section 401(k) is included in wages. We have already determined that the vacation pay benefit is not part of a cash or deferred arrangement. Since it is, however, a non-elective employer contribution to a qualified trust, the general rule of section 3121(a)(5)(A) excludes it from wages for purposes of FICA.

CONCLUSION

The contributions made by Company A to Plan X of an employee's vacation pay benefit are excludable from the employee's gross wages for purposes of FICA.