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HomeMy WebLinkAboutItem 4.7 Implement Section 414 of IRS Code CITY OF DUBLIN AGENDA STATEMENT CITY COUNCIL MEETING DATE: February 10, 1986 SUBJECT Implementation of Section 414(h) (2) of the Internal Revenue Code EXHIBITS ATTACHED Resolution; PERS Circular No. 161 ; PERS Circular No . 180; PERS Circular No . 100-364 RECOMMENDATION Adopt Resolution and authorize Staff to implement the provisions of Internal Revenue Code Section 414(h) ( 2 ) effective with the payroll period beginning February 15 , 1986 . FINANCIAL STATEMENT: This change will have no financial implication on the City of Dublin. DESCRIPTION PERS has recently advised member agencies of the ability to treat member contributions as tax deferred income . The Federal Internal Revenue Code allows for public employers to treat employee contributions as tax deferred income . Pursuant to the City' s agreement with PERS and personnel rules , all employees except the City Manager contribute 7/ of their gross salary to the retirement plan. For strictly taxing purposes , the employer can adopt a resolution indicating participation in the "Pick-up" program pursuant to Internal Revenue Code Section 414(h) ( 2) . Although the code utilizes the name of employer pick-up, this is treated as such for tax purposes only. The change does not affect the members gross salary, nor the City ' s expense . Under the current program, the employee is taxed on. their gross salary and -then a deduction is made for their contribution to the Public Employees ' Retirement System. The section of the Internal Revenue Code allows the employee to reduce their income by the amount of their contribution to the retirement system and then determine the tax liability. The following is an example of how this would affect an employee whose annual gross wages for the year were $25 , 000. HYPOTHETICAL Current System Annual Gross Earnings PERS Deduction-7l Income Tax-(Assume 13%) Take Home Pay $25 , 000 $1 , 750 (13% of $25 ,000=$3 , 250) $20, 000. 00 Under Section 414(h) ( 2) $25 , 000 $1 , 750 (13% of $23 , 250=$3 , 022. 50) $20, 227. 50 Any actual changes in the employee ' s take home pay would be dependent on their gross earnings and actual tax liability situation. In essence , the employee receives an increase in net pay because income taxation of their contributions are deferred until actual receipt of the money by a refund or through their retirement allowance . The Internal Revenue Service has issued a ruling to PERS which would cover all public agencies which chose to adopt the model resolution. A copy of the IRS ruling is attached. As this adjustment will provide a benefit to the employees of the City of Dublin who are members of the Public Employees' Retirement System without imposing any additional cost to the City of Dublin, it is recommended that the City Council adopt the attached resolution and direct Staff to implement these provisions effective with the payroll beginning February 15 , 1986. ---------------------------------------------------------------------------- COPIES TO : ITEM N0. j RESOLUTION NO . — -86 A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF DUBLIN -------------------------------------- IMPLEMENTING SECTION 414(h) (2) OF THE INTERNAL REVENUE CODE WHEREAS , the City Council has the authority to implement the . provisions of section 414(h) ( 2 ) of the Internal Revenue Code (IRC ) ; and WHEREAS , the Board of Administration of Public Employees ' Retirement System adopted its resolution re section 414(h) ( 2) on September 18 , 1985 ; and WHEREAS , the Internal Revenue Service has stated on December 6, 1985 , that the implementation of the provisions of section 414(h) ( 2 ) IRC pursuant to the Resolution of the Board of Administration would satisfy the legal requirements of section 414(h) (2) IRC ; and WHEREAS , the City Council has determined that even though the implementation of the provisions of section 414(h) ( 2) IRC is not required by law, the tax benefit offered by section 414(h) ( 2 ) IRC should be provided to its employees who are members of the Public Employees ' Retirement System. NOW, THEREFORE , BE IT RESOLVED : I . That the City of Dublin will implement the provisions of section 414(h) (2) Internal Revenue Code by making employee contributions pursuant to California Government Code section 20615 to the Public Employees ' Retirement System on behalf of its employees who are members of the Public Employees ' Retirement System. "Employee contributions" shall mean those contributions to the Public Employees ' Retirement System which are deducted from the salary of employees and are credited to individual employee ' s accounts pursuant to California Government Code section 20615 . II . That. the contributions made by the City of Dublin to the Public Employees ' Retirement System although designated as employee contributions are being paid by the City of Dublin in lieu of contributions by the employees who are members of the Public Employees ' Retirement System. III . That employees will not have the option of choosing to receive the contributed amounts directly instead of having them paid by the City of Dublin to the Public Employees ' Retirement System. IV. That the City of Dublin shall pay to the Public Employees ' Retirement System the contributions designated as employee contributions from the same source of funds as used in paying salary. V. That the amount of the contributions designated as employee contributions and paid by the City of Dublin to the Public Employees ' Retirement System on behalf of an employee shall be the entire contribution required of the employee by the Public Employee ' s Retirement Law ( California Government Code sections 20000, et , seq. ) . VI . That the contributions designated as employee contributions made by the City of Dublin to the Public Employees ' Retirement System shall be treated for all purposes, other than taxation, in the same way that member contributions are treated by the Public Employees ' Retirement System. PASSED, APPROVED AND ADOPTED this th day of 1986. AYES : NOES : ABSENT: Mayor ATTEST: City Clerk , �" / Document No. _PERS Date: December 18, 1985 Circular Letter _ - File No.: Index No.: California Public Employees' Retirement System Distribution: I, IIA, VI, XII & SPECIAL P.O. BOX 90103 Sacramento. CA 95809-0103 Circular Letter No.: 100-161 (916) 445-6476 Telecommunications Device For The Deaf— (916) 445-8155 r To: PUBLIC AGENCIES, COUNTY SUPERINTENDENT OF SCHOOLS, SCHOOL DISTRICTS, `1AI'.l i BOARD MEMBERS, DIVISION & OFFICE HEADS Subject EMPLOYER "PICK UP" FOR SCHOOLS AND LOCAL AGENCIES At the September 18 meeting, the PERS Board of Administration adopted a resolution which was necessary in order to obtain a single group private letter ruling from IRS regarding the establishment of a "pick-up" program by PERS school and other local public agency employers for required member contributions. Attached is a copy of the appropriate Agenda Item. Included in the Agenda Item was a form resolution which could be used by any school or local public agency employer and is also attached. Although PERS' request for a single ruling was sent to IRS on October 5, a written response has not been received. We have, however, been notified by the IRS by telephone that they signed the private letter ruling on December 6, 1985 and that it was being prepared for transmission. Any agency can use this date for their resolution purposes. We will forward a copy of the ruling to all agencies once it has been received. Please contact me at the above number if you have any questions. j� ROBERT D. WALTON, CHIEF ACCOUNTING DIVISION RDW/pm Attachments PERS-ADM-69 (Rev. 5/85) r STATE OF CALIFOriN1A PUBLIC EMPLOYEES' RETIREMENT SYSTEM _ 1416 NINTH STREET.P.0. BOX 1953 SACRAMENTO.CALIFORNIA 95809 ' Telephone (916) , September 18 , 19E5 AGENDA ITEM. 16 TO: MEMBERS OF THE BOARD OF ADMINISTRATION SUBJECT: Employer Pick-Up for Schools and Local Agtncies The In,tern,al Revenue Service, at the request of the State Controller for a private letter ruling , on December 18 , 1984 rulea that the state, as the employer, could "pick-up" state member contributions to the Public Employees ' Retirement System for income taxation, purposes. Under the ruling, members car, actually continue to pay their required percentages of gross income to PERS , however, their contributions are considered to be "picked up" by the employer for federal income taxation purposes, and gross salary and related retirement benefits are not affected. The Governor subsequently issued an Executive Order which made the ruling effective with the February pay period for state employees, and they received an increase in net pay because income taxation of the contributions was deferred t; until actual receipt by refund or retirement allowance. The Internal Revenue Service has informed staff that the Board of Administration, as the retirement plan administrator , can submit a request for a similar ruling affecting the school and local public agency members of the System, and that a single group request was preferable to separate requests by each employer. The request procedure is contained in Revenue Procedure section 83-36 , and requires the Board of Administration to adopt the resolution, contained in Attachment A , and to provide a form resolution, for adoption, by each school and local public agency employer which is contained i-r, Attachment B. Staff requests adoption, of the resolution., and is available for any questions. er G 055 Adams, nief Couns-el enr,eth homason Chief Assistant -Executive Officer Attachments Document No. Date: January 22, 1986 Letter File No.: o.: Corcular� Index N California Public Employees' Retirement System Distribution: I,IIA, VI, XII & SPECIAL P.D. Box 90103 Circular Letter No.: 100-180 Sacramento, CA 95809-0103 (916) 322-0245 The Deaf ern (9 6) Telecommunications Device 81 S or To: PUBLIC AGENCIES, COUNTY SUPERINTENDENT OF SCHOOLS, SCHOOL DISTRICTS, BOARD MEMBERS, DIVISION & OFFICE HEADS -Subject: EMPLOYER "PICK-UP" FOR SCHOOLS AND LOCAL AGENCIES The "private letter ruling" referred to in Circular Letter #100-161, dated December 18, 1985, has now been received and is attached. This ruling officially affirms the ability for any PERS school or local employer to participate in the "pick-up" program. Based on recent inquiries-there still appears to be many questions or misunderstandings about the "pick-up" program. The following will hopefully clarify many of these issues: What is the "pick-Up" Program? Basically, the Internal Revenue Code (IRC) Section 414 (h) (2) allows public employers to designate required employee contributions as being "picked-up by the employer and treated as employer contributions for Federal and State tax purposes only. The term "pick-up" is a misnomer. to Actually the member contributions continustub.be deducted from the actual gross salary reflected on a member's pay Is the "Pick-Up" Program the Same as Employer Paid Member Contributions (EPMC) ? No! Under EPMC the employer actually pays the member contributions and the member's pay stub does not reflect a deduction from gross salary for retirement contributions. When Does the Employer Need to Adopt the "Resolution"? The employer should only adopt the resolution when they want to ram, implement the "pick-up" program. If the employer is under the EPMC program, the IRS required resolution is not necessary. Does PERS Need a Copy Of the Resolution if we Implement the "Pick-Up" Program? No! All PERS needs is a letter from the employer stating that they are implementing the "pick-up" program and indicating the first pay period that member contributions will be reported as being "picked-up" . PERS-ADM-69 (Rev.5/85) -2- Are State Taxes Covered by the "Pick-Up" Program? Yes! The State Taxation and .Revenue Code Section 17501 provides that State taxes follow the provisions of IRC Section 414 (h) (2) . Is "Special Compensation" Covered by the "Pick-Up" Program? Yes! Any compensation which is reportable to PERS under the Retirement Law, Government Code Section 20022 (a) and, therefore, subject to retirement contributions is covered by the "pick-up" program. If you have any further questions, please contact Rich Anderson at (916) 322-0245. ROBERT D. WALTON, CHIEF ACCOUNTING DIVISION RDW/pm Attachment .......... Internal Revenue Service Department of the Tre&.. y Washington. DC 20224 Person to Contact: State of California Ms. N.J. Provenzano Public Employees' Telephone Number: Retirement System (202) 566-4925 1416 Ninth Street Refer Reply to: P.O. Box 90101 OP:E:EP:RQ:2:5 Sacramento, CA 95809-0101 Date: Attn: Mr. Sidney C. McCausland 6 DEC 1995 Executive Officer Legend: State A = California Plan X = Public Employees' Retirement System Gentlemen: This letter is in response to your ruling request, dated October 4, 1985, concerning the federal" income tax treatment, under section 414(h)(2) of the Internal Revenue Code, of certain contributions to Plan X. State A established Plan X for the benefit of its officers, employees, and their beneficiaries. Employees of local public agencies in State A whose appointing powers have contracted with Plan X are participants as well. You state that Plan X meets the qualification requirements of Code section, 401(a). As far as the vast majority of school and local public agency employees are concerned, participation in Plan X is compulsory, pursuant to State A statute. However, certain school and local public agency officers, employees and others (including elected officers, and certain persons employed on a part-time, seasonal, or other irregular basis) are either not permitted or not required to be members. Employee participant contribution rates are determined by the nature of the service performed, and whether the employee is a participant under the "Federal-State Agreement" entered into pursuant to section 218 of Title 11 of the Social Security Act, 42 U.S.C. Section 218. Employee contributions of up to 8 percent of the employee's salary are required, depending on the following membership categories, established in the State A Code: "school," "local miscellaneous," and "local safety." The managing body of Plan X ("Board") is requesting this ruling on behalf of the 1253. school employers and 1201 other local public agencies which directly employ the school and other local public agency participants in Plan X. Those employers have been authorized by section 20615 of the State A Government Code to pay all or a portion of the normal contributions required to be paid by a participant on the participant's behalf. - 2 - State of California The Board adopted a resolution on September 18, 1985, effective upon receipt of a favorable ruling, whereby it will accept employee contri- butions paid by a school or a local agency employer which has implemented Code section 414(h)(2) pursuant to State A Government Code section 20615. The resolution states that, if an employer does choose to implement Code section 414(h)(2), the employer must (1) specify that the contributions, although designated as employee contributions, are being paid by the employer in lieu of employee contributions, (2) not give the employees the option of receiving the contributed amounts directly instead..of having them paid by the employer, (3) pay the contributions, from the same source of funds as used in paying salary, and (4) satisfy administrative procedures as set forth by the Board. You have included with your ruling request a model resolution, set forth in Appendix A of this private letter ruling, that must be adopted by all employers choosing to implement a pick up plan pursuant to the September 18, 1985, Board resolution. Based on the foregoing facts, you request the following rulings: 1. That gross income of a member for a tax year does not include any part of the amount of the member's contribution to Plan x which is "picked up" in the tax year by an employing school or other local public agency pursuant to the Resolution adopted by the Board of Administration on September 18, 1985. 2. That member contributions "picked up" by the employing school or other local public agency pursuant to the Resolution adopted by the Board of Administration on September 18, 1985, will be credited to the member's account but will be treated as employer contributions for tax purposes; that such contri- butions are exempted from the definition of wages set forth in section 3401(a)(12)(A) of the Code; and that no part of the amount of the "pick up" by the employing school or other local public agency constitutes wages for federal income tax withholding purposes in the tax year in which they are contributed. 3. That amounts "picked up" by the employing school or other local public agency pursuant to the Resolution adopted by the Board of Administration on September 18, 1985 will be taxable to the recipient upon their distribution either through a retirement benefit, disability benefit, or a lump sum payment. 4. That, for purposes of the application of section 414(h)(2) of the Code, it is immaterial whether an employer "picks up" contri- butions through a reduction in salary, or offset against future salary increases, or a combination of both. 3 - State of California Section 414(h)(2) of the Internal Revenue Code provides that contri- butions, ot`ierwise designated as employee contributions, shall be treated as employer contributions if such contributions are made to a plan estab- lished by a state government or a political subdivision thereof, which is described in section 401(a), and are picked up by the employing unit. The federal income tax treatment to be accorded contributions which are picked up by the employer within the meaning of section 414(h)(2) of the Code is specified in Revenue Ruling 77-462, I977-2 C.B. 358. In that revenue ruling, the employer school district agreed to assume and pay the amounts employees were required by state law to contribute to a state pension plan. Revenue Ruling 77-462 concluded that the school district's picked-up contributions to the plan are excluded from the employees' income until such time as they are distributed to the employees. The revenue ruling held further that under the provisions of section 3401(a)(12)(A) of the Code, the school district's contributions to the , plan are excluded from wages for purposes of the Collection of Income Tax at Source on Wages; therefore, no withholding is required from the employees' salaries with respect to such picked-up contributions. The issue of whether contributions have been picked up by an employer within the meaning of Code section 414(h)(2) is addressed in Revenue Ruling 81-35, 1981-I C.B. 255 and Revenue Ruling 81-36, 1981-1 C.B. 255. These revenue rulings established that the following two criteria must be met: (1) the employer must specify that the contributions, although designated as employee contributions, are being paid by .the employer in lieu of contributions by the employee; and (2) the employee must not be given the option of choosing to receive amounts directly instead of having them paid by the employer to the pension plan. Furthermore, it is immaterial whether an employer picks up contributions through a reduction in salary, an offset against future salary increases, or a combination of both. The resolution adopted by the Board and the model resolution satisfy the criteria set forth in Rev. Rul. 81-_`5 and Rev. Rut. 81-36 by prcyviding that adopting employers will make contributions in lieu of the employees' contributions and that the employees may not elect to receive such' contri- butions directly. ✓ Accordingly, we conclude that the amounts picked up by an employer on behalf of those employees who participate in Plan X shall be treated as employer contributions and will not be includible in the employees' gross income in the year in which such amounts are contributed. These amounts will be includible in the gross income of the employees or their beneficiaries only in the taxable year. in which they are distributed, to the extent that the amounts represent contributions made by the employer. - 4 - State of California Because we have determined that the picked-up amounts are to be treated as employer contributions, they are excepted from wages under section 3401(a)(I2)(A) of the Code. In addition, no part of the amounts that are picked up by an employer will constitute wages for federal income tax withholding purposes in the taxable year in which they are contributed to Plan X. For purposes of the application of section 4I4(h)(2) of the Code, it is immaterial whether an employer picks up contributions through a reduction in salary, an offset against future salary increases, or a combination of both. In order to rely on this private letter ruling, a participating school or local public employer must adopt the model resolution contained in Appendix A as written and without change. If an adopting employer modifies the model resolution in any way, this ruling will be null and void with respect to the noncomplying employer. The effective date for the commencement of any proposed pick-up as specified in the final resolution adopted by a school or local public employer cannot be any earlier than the later of the date the final resolution is signed or the date it is put into effect. These rulings are based on the assumption that Plan X will be qualified under section 40I(a) of the Code at the time of the proposed contributions and distributions. Sincerely yours, John J. Swieca Chief, Employee Plans Rulings and Qualifications Branch Enclosures: Deleted copy Notice 437 J. PUBLIC EMPLOYEES' RETIREMENT SYS. _d P. 0. Box.1953 (1416 - 9th Street) MAR 281985 Sacramento, CA 9809 Date: Telephone: 445-6476 CITY OF DUBLIN March 19, 1985 TO: CIRCULAR BOARD MEMBERS & RELATED LETTER NUMBER: - MANAGERS 100-364 PUBLIC AGENCIES Distribution: COUNTY SUPERINTENDENT OF SCHOOLS I, IIB, VI and XII Subject: EMPLOYER "PICK-UP"; INTERNAL REVENUE CODE 414 (h)(2) The State of California recently implemented an Internal Revenue Service ruling which will permit postponement of income taxes on State employee retirement contributions to PERS. This notice will provide direction to any PERS employer who wishes to implement such a program. Basically, the Internal Revenue Code (IRC) Section 414 (h)(2) allows public employers to designate required employee contributions as being "picked-up" by the employer and treated as employee contributions for tax purposes only. At the direction of the PERS Board of Administration, staff made a presentation at the February 20 Board meeting which outlined how the "pick-up" ruling could be applied to PERS public agencies and school employers. A copy of this agenda item is attached, Exhibit I. The employer "pick-up" of member contributions under IRC 414 (h)(2) provides for the "pick-up" of employee retirement contributions through either a salary reduction or in lieu of a salary increase. The state implemented the program through a salary reduction. This reduction was only for the purposes of computing federal and state taxes and did not affect the actual gross salary reflected on a member 's pay .stub or other payments or benefits. In implementing the "pick-up" program for state employees, the State Controller prepared a summary on the impact of this program. The following outlines this summary. For the purposes of this summary, "old" gross refers to the gross salary before the "pick-up" program and "reduced gross" refers to the gross salary after implementation of this program. Federal Taxes - Under the "pick-up" plan, the employee's gross salary will be reduced by the amount of the employee's retirement compensation. Pursuant to IRC Section 414 (h)(2), Federal taxes will be computed based upon the reduced gross. State Taxes - State Taxation and Revenue Code Section 17501 provides that State taxes follow provisions of IRC Section 414 (h)(2). As a result, State taxes are also computed based upon the employees reduced gross. Social Security - Computation of Social Security payments will continue to be based upon the employee 's old gross. Supplemental Pay - All supplemental pays that are based upon the employee's salary, such as overtime, will be computed on the employee's old gross. .- _--_--_ _--__-_ .........._-- ........... ____--_-....... ........... __--__'_-__-^ . -2- - , ' Disability - All disability pay, i.e. , Industrial Disability Leave, m000iaau1lity luour000e and Labor Code 4800' will be computed from the employee's old gross. Since Industrial Disability Leave and Labor Code 4800 payments are not taxable income, they will not be affected by the employer "pick-up" program. However, application of the retirement exclusion amount to an employee who receives regular pay and Industrial Disability Leave or Labor Code 4800 pay in the same month will affect the amount of taxable income. PC83 Member Contributions - The PC8S member contribution amount will continue to be computed based on the employee's old gross. The payment will be mode into the employee's account, and will be paid to the employee upon separation if he/she requests a refund. Upon retiremen't' benefits will be computed based upon the employee's old gross. Payments from the "pick-up" account due to separation or retirement will be considered taxable income. Earning Statement - The employee's earning statement attached to the payroll warrant will not be changed. In the Gross Pay field, you should continue to print the old gross, and the field titled Retirement Comtri- botioo will be the payment "picked-up" by the employer. Because of the "pick-up." amount, the employees taxes and net pay should change. W-2 - The field titled 'Wages, Tips, Other Compensation" on the employees W-2 Wage and Tax Statement will reflect taxable gross income. The amount "picked-up" by 'the employer will not be included on the V{-2. Retroactivity - Under the "pick-up" program, the employer .is making the retirement contribution for the employee. As a result, the money is not taxable income until paid by the retirement system to the employees. The ruling cannot be applied to retirement contributions previously paid by the employee. In addition, the IBS ruling requires that "pick-up" programs be implemented prospectively. NOTE: It is important to separate the employer "pick-up" program which in the subject of this Circular Letter and the Employer Payment of Member Contributions {E9MC} which was the subject of previous Circular Letters. Under the CPMC program, the employer actually pays the member contribution and the member's pay stub does not reflect a deduction from gross salary for retirement coutribotlorrm. Both programs result in the deferral of income taxes on the member's pCBS contributions.