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IRS Issues Guidance for Employee's Contributions of Paid Time-Off

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October 9, 2009

The IRS recently issued two rulings providing guidance for qualified retirement plans to allow participants to contribute the value of their accrued but unused paid time-off (e.g., vacation pay, sick pay, etc.) to their plan accounts. Plans that will allow for any such contributions must be amended.  These two rulings are:

  • Revenue Ruling 2009-31 allowing qualified retirement plans to permit or require contributions on an annual basis of paid time-off that would otherwise be forfeited at the end of the year.
  • Revenue Ruling 2009-32 allowing qualified retirement plans to permit or require participants to contribute paid time-off at termination of employment.

The value of the paid time-off contributed to the plan is taken into account for purposes of the annual contribution limitations. In the case of paid time-off contributed at termination of employment, the tax year in which the contribution is made determines the limitation year (even if the contribution year is different from the tax year in which the termination occurred).

Further, the rules applicable to distributions of other types of contributions apply to these contributions in the same manner. Consequently, the value of the unused paid time off is includable in gross taxable income at the time such contributions are distributed from the plan.

In addition to the standard limitations applicable to all contributions to the plan, plan administrators must be mindful of state wage laws which require the payment of unused paid time-off following an employee’s termination of employment.

All plans must perform discrimination testing with respect to these contributions, including those which have adopted the design-based safe harbor rules of Section 401(a) of the Internal Revenue Code.

These rulings do not specifically state whether such contributions arrangements are available under Section 403(b) of the Internal Revenue Code, tax-sheltered annuity plans. Neither do they address whether these types of contributions will be subject to FICA taxes.

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