Unused Leave Time and the 401(k) or HRA Plan

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Unused Leave Time and the 401(k) or HRA Plan

Do you offer an employer provided 401(k) or HRA (Health Reimbursement Account) plan to your employees as well as offer paid time off?  If so, the IRS has issued a recent private letter ruling (2016) that expands the opportunities for your employees to contribute the cash equivalent of their unused vacation or sick time to their 401(k) or HRA plan, which could save both the employee and employer payroll taxes.

In 2009, the IRS issued a revenue ruling that allowed employers to amend their 401(k) plans to allow or require paid time off balances that would ordinarily be lost in the carryforward to the next year to be contributed, as a non-elective employer contribution (made in cash), to the employee’s account within the plan.

In the 2016 private letter ruling, the IRS expanded this ruling to allow employers to amend their 401(k) and HRA plans to allow employees to contribute unused paid time off balances to the plan(s) during the year.  Under this approved plan, the employee was required to make an annual irrevocable election before the start of the year in which leave is earned to have the dollar equivalent of his or her unused vacation contributed by the employer into the 401(k) plan, HRA, or both.  The contribution would first be made to the employee’s 401(k), but if that contribution exceeded the annual limitations, the remaining contribution would be made to the employee’s HRA.  The arrangement would not provide the employee with any additional taxable compensation for the year, so long as the plan does not allow for the employee to elect to have the contributions paid in cash or as another taxable benefit.  The contributions would still be considered a non-elective employer contribution, not subject to payroll taxes.  The contributions would be considered income to the employee only when the employee distributes the amounts from the 401(k) plan.

If you’re interested in learning more about the IRSrulings in this area, see IRS Rev. Rul. 2009-31 and PLR 201601012 or contact our office to discuss further.