IRS Letter Allows Employees to Allocate Discretionary Employer Contributions Among Various Benefits

An IRS private letter ruling (https://www.irs.gov/pub/irs-wd/202434006.pdf) has determined that an employer can permit employees to allocate non-elective, discretionary employer contributions among a 401(k) plan, retiree health reimbursement arrangement (HRA), health savings account (HSA), or Code § 127 educational assistance program (EA Program) without affecting the favorable tax treatment of these programs.

The letter first found that the proposal would not create an additional cash or deferred arrangement under Code § 401(k), as it did not allow employees to choose between receiving the employer contribution in cash (or another taxable benefit) or contributing it to a deferred compensation plan. Consequently, the employer contribution was not classified as an employee pre-tax contribution subject to annual elective deferral limits. The letter also determined that the revised retiree HRA would continue to meet the necessary HRA requirements, with coverage and benefits remaining excludable from gross income. This was due to (1) the prohibition on employees choosing cash or other taxable benefits for employer contributions, (2) the fact that employer contributions were not based on salary reduction elections, (3) the use of contributions solely for reimbursing Code § 213(d) medical expenses (excluding other taxable or nontaxable benefits), and (4) the carry-forward of unused amounts to future periods after retirement.

Furthermore, the letter concluded that if employer contributions to employees' HSAs did not exceed statutory limits and were only available to HSA-eligible employees, these contributions would be excludable from gross income. Additionally, since employees could not choose between educational assistance and other taxable remuneration, the proposal would not alter the status of payments from the EA Program as excludable from gross income, subject to the Code’s statutory limit. Employees’ ability to allocate employer contributions among different programs would not disqualify the EA Program under the Code.

While private letter rulings are specific to the requesting parties and cannot be cited as precedent, they offer valuable insights into IRS interpretations. This ruling may assist employers considering benefit arrangements that allow employees to select among various benefits. A key condition is that employees cannot opt to receive the amounts as cash or taxable benefits.