[Federal Register Volume 69, Number 220 (Tuesday, November 16, 2004)]
[Rules and Regulations]
[Pages 67054-67055]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-25236]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 31

[TD 9159]
RIN 1545-BD50


Payments Made by Reason of a Salary Reduction Agreement

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulation.

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SUMMARY: This document contains a temporary regulation that defines the 
term ``salary reduction agreement'' for purposes of section 
3121(a)(5)(D) of the Internal Revenue Code (Code). The temporary 
regulation provides guidance to employers (public educational 
institutions and section 501(c)(3) organizations) purchasing annuity 
contracts described in section 403(b) on behalf of their employees. The 
text of the temporary regulation also serves as the text of the 
proposed regulation set forth in the notice of proposed rulemaking on 
this subject in the Proposed Rules section in this issue of the Federal 
Register.

DATES: Effective Date: This regulation is effective on November 16, 
2004.
    Applicability Date: For dates of applicability, see Sec.  
31.3121(a)(5)-2T(b).

FOR FURTHER INFORMATION CONTACT: Neil D. Shepherd, (202) 622-6040 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This temporary regulation (REG-155608-02) amends the Employment Tax 
Regulations (26 CFR part 31) by providing guidance relating to section 
3121(a)(5)(D). The Federal Insurance Contributions Act (FICA) imposes 
taxes on employees and employers equal to a percentage of the wages 
received with respect to employment. Code section 3121(a) defines wages 
for FICA tax purposes as all remuneration for employment unless 
otherwise excepted. Code section 3121(a)(5)(D), added by the Social 
Security Amendments of 1983 (Public Law 98-21 (97 Stat. 65)), generally 
excepts from wages payments made by an employer for the purchase of an 
annuity contract described in section 403(b). In a codification of 
long-standing administrative practice, however, section 3121(a)(5)(D) 
expressly excludes from the exception payments made by reason of a 
salary reduction agreement (whether evidenced by a written instrument 
or otherwise). See Rev. Rul. 65-208, 1965-2 C.B. 383, and S. Rep. No. 
98-23, at 41, 98th Cong., 1st Sess. (1983). This temporary regulation 
defines the term ``salary reduction agreement'' for purposes of section 
3121(a)(5)(D).

Explanation of Provisions

    The FICA taxation of payments made by an employer for the purchase 
of annuity contracts described in section 403(b) has been shaped by a 
congressional concern for the social security revenue base and for 
employees' social security benefits. In the context of contributions 
for the purchase of such annuity contracts, Congress has interpreted 
the term ``wages'' for FICA tax purposes more broadly than the term 
``gross income'' for income tax purposes. See S. Rep. No. 98-23, at 39, 
98th Cong., 1st Sess. (1983) relating to the Social Security Amendments 
of 1983 (Public Law 98-21 (97 Stat. 65)).
    An amount is generally includible in wages for FICA tax purposes at 
the time it is actually or constructively paid by the employer and 
received by the employee. Additionally, wages generally include an 
amount that an employer contributes to a plan only if the employee 
agrees to reduce his or her compensation. For income tax purposes, 
however, section 403(b) provides an exclusion from gross income for 
contributions made by an employer, including contributions made 
pursuant to a cash or deferred election or other salary reduction 
agreement. See section 1450(a) of the Small Business Job Protection Act 
of 1996 (Public Law 104-188 (110 Stat. 1755)). Conversely, for FICA tax 
purposes, wages include contributions made by an employer to a section 
403(b) contract pursuant to a cash or deferred election or other salary 
reduction agreement. See S. Rep. No. 98-23, at 40-41, 98th Cong., 1st 
Sess. (1983). Thus, while section 403(b) excludes from gross income 
contributions made pursuant to certain cash or deferred elections, such 
contributions are made by reason of a salary reduction agreement under 
section 3121(a)(5)(D) and are included in wages for FICA tax purposes. 
Consequently, this temporary regulation explicitly provides that the 
term ``salary reduction agreement'' includes a plan or arrangement 
whereby a payment will be made if the employee elects to reduce his or 
her compensation pursuant to a cash or deferred election as defined at 
Sec.  1.401(k)-1(a)(3) of the Income Tax Regulations.
    Pursuant to regulation Sec.  1.401(k)-1(a)(3)(iv) of this chapter, 
a cash or deferred election does not include a one-time irrevocable 
election made upon an employee's commencement of employment with the 
employer. Similarly, pursuant to section 402(g)(3), while the term 
``elective deferrals'' generally includes any employer contribution to 
purchase an annuity contract under section 403(b) under a salary 
reduction agreement (within the meaning of section 3121(a)(5)(D)), an 
employer contribution made pursuant to a one-time irrevocable election 
is not treated as an elective deferral. See H.R. Rep. No. 100-795, at 
145, 100th Cong., 2d Sess. (1988) and S. Rep. No. 100-445, at 151, 
100th Cong., 2d Sess. (1988) relating to the amendment of section 
402(g)(3) by the Technical and Miscellaneous Revenue Act of 1988 
(Public Law 100-647 (102 Stat. 3342)). Notwithstanding that section 
403(b) contributions made pursuant to a one-time irrevocable election 
are excluded from cash or deferred elections under section 401(k) and 
from elective deferrals under section 402(g)(3), such contributions are 
made pursuant to a salary reduction agreement. If the employee had not 
made a one-time irrevocable election, the employer's cash payment to 
the employee would be includible in the employee's gross income and in 
wages for FICA tax purposes. Consequently, this temporary regulation 
explicitly provides that the term ``salary reduction agreement'' 
includes a plan or arrangement whereby a payment will be made if the 
employee elects to reduce his or her compensation pursuant to a one-
time irrevocable election made at or before the time of

[[Page 67055]]

initial eligibility to participate in such plan or arrangement (or 
pursuant to a similar arrangement involving a one-time irrevocable 
election).
    A contribution that is made as a condition of employment and that 
reduces an employee's compensation generally constitutes an employee 
contribution includible in wages for FICA tax purposes. See section 
1015 of the Employee Retirement Income Security Act of 1974 (Public Law 
93-406 (88 Stat. 829)) relating to amounts designated as employee 
contributions under section 414(h) of the Code; see also H.R. Rep. No. 
93-807, at 145, 93d Cong., 2d Sess. (1974) wherein Congress stated that 
``[u]nder present law, contributions which are designated as employee 
contributions are generally treated as employee contributions for 
purposes of the Federal tax law.'' Code section 414(h)(1) merely 
codified the existing administrative and judicial treatment of amounts 
designated as employee contributions. See, for example, Howell v. 
United States, 775 F.2d 887 (7th Cir. 1985) holding that mandatory 
contributions to a state retirement plan of amounts designated as 
employee contributions and withheld from the employee's salary are 
employee contributions includible in the employee's gross income. Thus, 
as with employer contributions made pursuant to cash or deferred 
elections and one-time irrevocable elections, employer contributions 
that are made as a condition of employment and in lieu of mandatory 
employee contributions and that reduce an employee's compensation are 
amounts otherwise includible in wages for FICA tax purposes.
    Whether a contribution that reduces an employee's compensation is 
required by statute, contract, or otherwise, an employee implicitly 
agrees to the contribution as a condition of employment. The acceptance 
of employment and the subsequent performance of services manifests the 
employee's agreement to the contribution. See H.R. Conf. Rep. No. 98-
861, at 1415, 98th Cong., 2d Sess. (1984) relating to the amendment of 
section 3121(v)(1)(B), wherein Congress stated that ``[t]he conferees 
intend that the term salary reduction agreement also includes any 
salary reduction arrangement, regardless of whether there is approval 
or choice of participation by individual employees or whether such 
approval or choice is mandated by State statute.'' In Public Employees' 
Retirement Board v. Shalala, 153 F.3rd 1160, at 1166 (10th Cir. 1998), 
the court noted that ``an employee's decision to go to work or continue 
to work * * * constitutes conduct manifesting assent to a salary 
reduction.'' Accordingly, the court held that a designated employee 
contribution picked up by an employer with a corresponding reduction in 
the employee's gross salary constitutes a contribution made pursuant to 
a salary reduction agreement. Similarly, this temporary regulation 
explicitly provides that the term ``salary reduction agreement'' 
includes a plan or arrangement whereby a payment will be made if the 
employee agrees as a condition of employment (whether such condition is 
set by statute, contract, or otherwise) to make a contribution that 
reduces the employee's compensation.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) and (d) of the Administrative Procedure 
Act (5 U.S.C. chapter 5) do not apply to this regulation. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), 
refer to the Special Analyses section in the preamble to the notice of 
proposed rule making published in the Proposed Rules section in this 
issue of the Federal Register. Pursuant to section 7805(f) of the Code, 
this temporary regulation will be submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small businesses.

Drafting Information

    The principal author of this regulation is Neil D. Shepherd, Office 
of Division Counsel/Associate Chief Counsel (Tax Exempt and Government 
Entities). However, other personnel from the IRS and Treasury 
Department participated in its development.

List of Subjects in 26 CFR Part 31

    Employment taxes, Income taxes, Penalties, Pensions, Railroad 
retirement, Reporting and recordkeeping requirements, Social security, 
Unemployment compensation.

Amendments to the Regulations

0
Accordingly, 26 CFR part 31 is amended as follows:

PART 31--EMPLOYMENT TAXES

0
Paragraph 1. The authority citation for part 31 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 31.3121(a)(5)-2T is added to read as follows:


Sec.  31.3121(a)(5)-2T  Payments under or to an annuity contract 
described in section 403(b) (temporary).

    (a) Salary reduction agreement defined. For purposes of section 
3121(a)(5)(D), the term salary reduction agreement means a plan or 
arrangement (whether evidenced by a written instrument or otherwise) 
whereby payment will be made by an employer, on behalf of an employee 
or his or her beneficiary, under or to an annuity contract described in 
section 403(b)--
    (1) If the employee elects to reduce his or her compensation 
pursuant to a cash or deferred election as defined at Sec.  1.401(k)-
1(a)(3) of this chapter;
    (2) If the employee elects to reduce his or her compensation 
pursuant to a one-time irrevocable election made at or before the time 
of initial eligibility to participate in such plan or arrangement (or 
pursuant to a similar arrangement involving a one-time irrevocable 
election); or
    (3) If the employee agrees as a condition of employment (whether 
such condition is set by statute, contract, or otherwise) to make a 
contribution that reduces his or her compensation.
    (b) Effective date.
    (1) This section is applicable November 16, 2004.
    (2) The applicability of this section expires on or before November 
15, 2007.

    Approved: November 1, 2004.
Nancy Jardini,
Acting Deputy Commissioner for Services and Enforcement.

Gregory Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04-25236 Filed 11-15-04; 8:45 am]
BILLING CODE 4830-01-P