On May 20, 2024, the IRS issued private letter ruling (“PLR”) 202434006 (the “2024 PLR”) that permits employees to allocate an employer contribution among various benefits outside of a cafeteria plan. The IRS has previously issued two similar PLRs that permitted the choice between a defined contribution (“DC”) plan contribution and a retiree health reimbursement arrangement (“HRA”) contribution. The 2024 PLR expands on that approach and permits a choice between a DC plan contribution, a retiree HRA contribution, a health savings account (“HSA”) contribution, and a student loan payment under a qualified educational assistance program. Groom Law Group assisted two of these three taxpayers in receiving their PLRs.
Many employers provide employees with nonelective employer contributions to DC plans. These employers also provide other benefits to employees, such as employer contributions to a retiree HRA, employer contributions to an HSA, and benefits under an educational assistance program (educational assistance programs can pay qualified student loan payments through December 31, 2025). (See our prior alert on the student loan provision.)
Recognizing the different ages and goals of their workforce, with many younger employees facing high student loan debt, employers have increasingly wanted to give their employees the choice to allocate these employer contributions to the plan that best addresses their personal situation and needs. However, there was a question whether this choice would raise constructive receipt issues.
Constructive Receipt
If an employer gives an employee the choice between two or more non-taxable benefits, the choice between the benefits does not require income inclusion under the constructive receipt doctrine because there is no taxable benefit to choose from. On the other hand, if an employer gives an employee the choice between a non-taxable benefit (e.g., an HRA contribution) and a taxable benefit (e.g., cash compensation), the employee who elects the non-taxable benefit is treated as if he/she elected the taxable benefit under the constructive receipt doctrine. This tax consequence can generally be avoided only if the choice between the non-taxable benefit and the taxable benefit is offered under a Code section 125 cafeteria plan. However, an HRA is not a permitted cafeteria plan benefit.
While a DC plan contribution is generally non-taxable, DC plan benefits are taxable when distributed. Thus, it was not clear whether the choice between a DC plan contribution and an HRA contribution would result in tax under the constructive receipt doctrine.
2015 PLR
The IRS first ruled favorably on this issue in PLR 201601012, issued December 31, 2015 (the “2015 PLR”). In the 2015 PLR, the employer proposed to amend its DC plan and retiree HRA plan to allow collectively bargained employees to annually and prospectively make an irrevocable election to have the dollar equivalent of up to 21 days of their unused vacation pay, contributed to the DC plan, the retiree HRA plan, or both. The employees did not have an option to receive the vacation pay in cash. The IRS ruled that the proposed arrangement would not impact the tax exclusions for the benefits – i.e., the choice between these benefits would not result in employee income inclusion under the constructive receipt doctrine. Specifically, the IRS ruled that:
- the proposal would not cause the DC plan to offer an additional cash or deferred arrangement pursuant to Code section 401(k); and
- the contributions and payments under the retiree HRA plan that are used to reimburse Code section 213(d) medical expenses are excludable from gross income under Code sections 105(b) and 106.
2020 PLR
In 2020, the IRS again ruled favorably on this issue in PLR 202023001 (the “2020 PLR”). In the 2020 PLR, the collective bargaining agreement provided for a specified level of employer contributions to a DC plan and a retiree HRA on behalf of collectively bargained employees. To give the employees some control over the allocation, the bargaining parties proposed that, before the beginning of each plan year, the employees would be able to designate the allocation of employer contributions above a minimum HRA amount to either the DC plan or the retiree HRA. In no case would an employee be entitled to receive any contributions in cash. The IRS ruled that the proposed arrangement would not impact the tax exclusions for the benefits – i.e., the choice between these benefits would not result in employee income inclusion under the constructive receipt doctrine. Specifically, the IRS ruled that:
- the proposal would not cause the DC plan to offer an additional cash or deferred arrangement pursuant to Code section 401(k); and
- the contributions and payments under the retiree HRA plan that are used to reimburse Code section 213(d) medical expenses are excludable from gross income under Code sections 105(b) and 106.
2024 PLR
The 2024 PLR expands on the plan designs offered in the 2015 PLR and the 2020 PLR by allowing employees to allocate a portion of the discretionary DC plan employer contribution to a retiree HRA, an HSA, or an educational assistance program for student loan payments. Employees would make the annual irrevocable election during open enrollment of year 1. To be eligible for the choice contribution, the employee must have one year of service by December 31st of year 1 and must be employed on January 1 of the subsequent year (year 2). The employer would make the contribution by March 15 of year 2. The election would be available on an annual basis, and the amount available for reallocation could not exceed a specified dollar amount. In no case could the employee receive the amount in cash or another taxable benefit. The IRS ruled that the proposed arrangement would not impact the tax exclusions for the benefits – i.e., that the choice between these benefits would not result in employee income inclusion under the constructive receipt doctrine. Specifically, the IRS ruled that:
- the proposal would not cause the DC plan to offer an additional cash or deferred arrangement pursuant to Code section 401(k);
- the proposal would not affect the treatment of contribution to and payments made from the retiree HRA to pay and reimburse Code section 213(d) medical expenses under Code sections 106(a) and 105(b);
- the allocation of the employer contribution to the employees’ HSAs would be excludible from gross income under Code section 106(d); and
- the proposal would not impact the availability of the $5,250 tax exclusion under the educational assistance program or prevent the educational assistance program from qualifying as an educational assistance program under Code section 127.
Groom Insight: The 2024 PLR provides a mechanism for employers to allow employees some level of choice about how to allocate employer contributions amongst various employee benefits. But, there are considerations to keep in mind to avoid constructive receipt, such as the election timing and irrevocability. As is the case with most benefit changes, this strategy involves considerable communication and additional administrative tasks and may impact nondiscrimination testing. Employers also should keep in mind that PLRs are only binding on the actual recipient.
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