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CCH® PENSION AND BENEFITS — 12/5/07

IRS issues final regs on 403(b) salary reduction agreements subject to FICA tax

The IRS has issued final regulations that define salary reduction agreements subject to Social Security (FICA) taxes. The final regulations adopt without change temporary and proposed rules issued in November 2004 that apply to agreements requiring employers to reduce employee salaries and make contributions to a 403(b) tax-sheltered annuity.

For income tax purposes, employer contributions to a tax-sheltered annuity are excluded from a participant’s income. Such contributions are subject to FICA taxes, however, if they are made under a salary reduction agreement.

Salary reduction agreement defined

The final regulations define a salary reduction agreement to include:

• An arrangement requiring a payment if the employee elects to reduce compensation under a cash or deferred election as defined in Reg. §1.401(k)-1(a)(3);
• An arrangement requiring a payment if the employee elects to reduce compensation under a one-time irrevocable election made when or before the employee is initially eligible to participate in the arrangement (or a similar one); and
• An arrangement requiring a payment if the employee agrees as a condition of employment to make a contribution that reduces the employee’s compensation. The condition may be set by statute, contract, or on some other basis.

Therefore, a salary reduction agreement includes both voluntary reductions in salary and salary reductions required as a condition of employment. The final regulations apply to contributions made to 403(b) plans on or after November 15, 2007. The temporary regulations, which were prospective only, apply to contributions made on or after November 16, 2004.

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