rr-00-35.pdf

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Part I
Section 403. -- Taxation of Employee Annuities.
26 CFR 1.403(b)-1: Taxability of beneficiary under annuity contract
purchased by a section 501(c)(3) organization or public school.
Rev. Rul. 2000-35
ISSUE
Will employer contributions to an annuity contract described in
§ 403(b) of the Internal Revenue Code (the "Code") fail to be
considered to be made under a salary reduction agreement merely
because they are made pursuant to an arrangement under which a fixed
percentage of an employee’s compensation is contributed to the
annuity contract unless the employee affirmatively elects to receive
the amount in cash?
FACTS
Employer X, an organization described in § 501(c)(3) which is
exempt from tax under § 501(a), maintains Plan A, a plan described in
§ 403(b) of the Code and § 3(2) of the Employee Retirement Income
Security Act of 1974 ("ERISA"). Under Plan A, any employee of
Employer X, including a newly hired employee, may elect to have
Employer X make contributions on the employee's behalf towards the
purchase of an annuity contract in lieu of receiving that amount as
cash compensation that would otherwise be payable to the employee.
The employee may designate the amount of these compensation reduction
contributions as a percentage of the employee’s compensation, subject
to certain limitations set forth in the plan. These compensation
reduction contributions satisfy the § 403(b) requirements applicable
to contributions made pursuant to a salary reduction agreement, and
are treated for all purposes as made pursuant to a salary reduction
agreement under the plan.
Plan A also provides that Employer X will make matching
contributions on account of an employee’s compensation reduction
contributions up to a specified percentage of the employee’s
compensation. Plan A does not permit any other contributions.
Plan A is amended, effective the next January 1, to add an
automatic compensation reduction election feature. Under this
feature, each employee's compensation will automatically be reduced
by 4 percent and this amount will be contributed towards the purchase
of an annuity contract under Plan A unless the employee affirmatively
elects to receive cash or have a different percentage contributed.

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Both before and after the amendment, the employee is not able to
receive, prior to a distributable event described in § 403(b)(11),
amounts contributed towards the purchase of an annuity contract.
Both before and after the amendment, Plan A and the annuity contracts
purchased thereunder satisfy the requirements of § 403(b). An
election not to make compensation reduction contributions or to
contribute a different percentage of compensation can be made at any
time.
Under Plan A as amended, in the case of a newly hired employee,
an election not to make compensation reduction contributions or to
contribute a different percentage is effective for the first pay
period and for subsequent pay periods (until superseded by a
subsequent election) if filed when the employee is hired or if filed
within a reasonable period thereafter ending before the compensation
for the first pay period is currently available. Thus, if a newly
hired employee files an election to receive cash in lieu of
compensation reduction contributions and the election is filed when
the employee is hired or within a reasonable period thereafter ending
before the compensation is currently available, then no compensation
reduction contributions for the first pay period or subsequent pay
period are made on the employee’s behalf to Plan A until the employee
makes a subsequent affirmative election to reduce his or her
compensation. Elections filed at a later date are effective for
payroll periods beginning in the month next following the date the
election is filed.
At the time an employee is hired, the employee will receive a
notice that explains the automatic compensation reduction election
and the employee’s right to elect to have no such compensation
reduction contributions made to the plan or to alter the amount of
those contributions, including the procedure for exercising that
right and the timing for implementation of any such election.
In the case of an employee hired before the January 1 effective
date who has not elected compensation reduction contributions of at
least 4 percent, Plan A as amended provides that the automatic
election will become effective on the first pay period beginning on
or after January 1 unless the employee elects during a specified
reasonable period ending on January 1 to receive cash or have a
different amount contributed to Plan A. Thus, if a current employee
files an election to receive cash in lieu of compensation reduction
contributions and the election is filed during the reasonable period
ending on the January 1 effective date, then no compensation
reduction contributions for the first pay period beginning on or
after the January 1 effective date or for subsequent pay periods are
made on the employee’s behalf to Plan A until the employee makes a
subsequent affirmative election to reduce his or her compensation.
In the case of a current employee who has a compensation reduction
contribution election in effect for less than 4 percent, who does not
make a new compensation reduction contribution election during the
reasonable period ending on the January 1 effective date, and whose
compensation is therefore automatically reduced by 4 percent, if that
employee thereafter makes an affirmative election to reduce his or

The Department of Labor has advised Treasury and the Service that, under
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Title I of the Employee Retirement Income Security Act of 1974 (ERISA),
fiduciaries of a plan must ensure that the plan is administered prudently and
solely in the interest of plan participants and beneficiaries. While ERISA
§ 404(c) may serve to relieve certain fiduciaries from liability when
participants or beneficiaries exercise control over the assets in their
individual accounts, the Department of Labor has taken the position that a
participant or beneficiary will not be considered to have exercised control
when the participant or beneficiary is merely apprised of investments that
will be made on his or her behalf in the absence of instructions to the
contrary. See 29 CFR § 2550.404c-1 and 57 F.R. 46924.
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her compensation by another amount (or no amount), then that
affirmative election will continue in effect until the employee makes
a subsequent affirmative election for a different amount.
At the beginning of the reasonable period ending on the January
1 effective date, each current employee receives a notice that
explains the new automatic compensation reduction election and the
employee’s right to elect to have no such compensation reduction
contributions made to the plan or to alter the amount of those
contributions, including the procedure for exercising that right and
the timing for implementation of any such election.
Each employee is notified annually of his or her compensation
reduction percentage, and of his or her right to change the
percentage, including the procedure for exercising that right and the
timing for implementation of any such election.
Plan A provides that both matching contributions and
compensation reduction contributions will be invested in accordance
with the participant’s election among a broad range of annuity
contracts. If no investment election is made by a participant,
contributions are invested in an annuity contract providing an
investment return based on the return on a balanced fund that
includes both diversified equity and fixed-income investments .
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LAW AND ANALYSIS
Section 403(b)(1) of the Code provides that amounts contributed
by certain employers, including an employer described in § 501(c)(3)
which is exempt from tax under § 501(a), for the purchase of an
annuity contract for an employee of such an employer are excluded
from the gross income of the employee if certain requirements are
satisfied.
Contributions to purchase annuity contracts under § 403(b) may
be made either pursuant to a salary reduction agreement or not
pursuant to a salary reduction agreement. Contributions made
pursuant to a salary reduction agreement are subject to different
requirements than are contributions not made pursuant to a salary
reduction agreement. (See, for example, §§ 403(b)(1)(E),
403(b)(7)(A)(ii), 403(b)(11) and 403(b)(12).) In general, a
contribution is not treated as made pursuant to a salary reduction

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agreement if under the agreement it is made pursuant to a one-time
irrevocable election made by the employee at the time of initial
eligibility to participate in the agreement. See §§ 402(g)(3)(C) and
403(b)(12).
Section 1.403(b)-1(b)(3)(i) of the regulations prescribes rules
applicable to contributions made pursuant to a salary reduction
agreement, including rules relating to the frequency and revocability
of such agreements and to the salary to which such agreements apply.
Section 1450(a) of the Small Business Job Protection Act of 1996
("SBJPA") provides that, for purposes of § 403(b) of the Code, the
frequency that an employee is permitted to make a salary reduction
agreement, the salary to which such an agreement may apply and the
ability to revoke such an agreement shall be determined under the
rules applicable to cash or deferred elections under § 401(k).
Section 1450(a) of SBJPA is effective for taxable years beginning
after December 31, 1995. Thus, § 1.403(b)-1(b)(3)(i) of the
regulations does not reflect current law, and the rules relating to
these aspects of salary reduction agreements are the same as those
for cash or deferred elections under § 401(k).
Section 401(k) provides that a profit-sharing or stock bonus
plan, a pre-ERISA money purchase plan, or a rural cooperative plan
can meet the requirements of § 401(a) even if it includes a qualified
cash or deferred arrangement. Section 401(k) also sets forth the
requirements that a cash or deferred arrangement must satisfy in
order to be a qualified cash or deferred arrangement.
Section 1.401(k)-1(a)(2)(i) defines a cash or deferred arrangement as an
arrangement under which an eligible employee may make a cash or
deferred election with respect to contributions to, or accruals or
other benefits under, a plan that is intended to satisfy the
requirements of § 401(a).
Section 1.401(k)-1(a)(3)(i) defines a cash or deferred election
as any election (or modification of an earlier election) by an
employee to have the employer either provide an amount to the
employee in the form of cash (or some other taxable benefit) that is
not currently available or contribute an amount to a trust (or
provide an accrual or other benefit) under a plan deferring the
receipt of compensation. Section 1.401(k)-1(a)(3)(iv) provides that
a cash or deferred election does not include a one-time irrevocable
election, made at the time an employee commences employment with the
employer or upon the employee’s first becoming eligible under any
plan of the employer, to have contributions made by the employer on
the employee’s behalf to the plan (or to any other plan of the
employer) equal to a specified amount or percentage of the employee’s
compensation. Section 1.401(k)-1(g)(3) defines elective
contributions as employer contributions made to a plan that were
subject to a cash or deferred election under a cash or deferred
arrangement.
Revenue Ruling 2000-8, 2000-7 I.R.B. 617 (February 14, 2000),

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holds that where a newly hired or a current employee has an effective
opportunity to elect to receive an amount in cash or have that amount
contributed by the employer to a profit-sharing plan, those employer
contributions made on the employees’ behalf to the plan in lieu of
receipt of cash compensation will not fail to be considered elective
contributions within the meaning of § 1.401(k)-1(g)(3) made under a
qualified cash or deferred arrangement within the meaning of § 401(k)
merely because they are made pursuant to an arrangement under which,
in any case in which an employee does not affirmatively elect to
receive cash, the employee’s compensation is reduced by a fixed
percentage and that amount is contributed on the employee’s behalf to
the plan.
The definition of a cash or deferred election in § 1.401(k)-
1(a)(3)(i) requires that the employee have an election between the
employer paying cash (or some other taxable benefit) to the employee
or making a contribution to a trust on behalf of the employee. The
regulation does not require that the employee receive an amount in
cash in any case in which the employee does not make an affirmative
election to have that amount contributed to the trust. Similarly,
under § 403(b), there is no requirement that an employee receive an
amount in cash in any case in which the employee does not make an
affirmative election to have that amount contributed to an annuity
contract. Thus, a contribution to purchase an annuity contract under
§ 403(b) will not fail to be made under a salary reduction agreement
merely because, when an employee fails to make an affirmative
election with respect to an amount of compensation, that amount is
contributed on the employee's behalf to an annuity contract, provided
that the employee had an effective opportunity to elect to receive
that amount in cash. The employee has an effective opportunity to
elect to receive an amount in cash as required under § 1.401(k)-
1(a)(3)(i) if the employee receives notice of the availability of the
election and the employee has a reasonable period before the cash is
currently available to make the election.
In this case, compensation reduction contributions made by Employer X
to Plan A, including those made on behalf of a newly hired employee
who has not filed an election to the contrary and those made on
behalf of a current employee who has elected less than 4-percent
compensation reduction contributions, are amounts contributed
pursuant to a procedure under which the employee receives a notice
explaining his or her rights to have no compensation reduction
contributions made and, after receiving the notice, the employee has
a reasonable period before the cash is currently available to elect
to receive the cash in lieu of having it contributed towards the
purchase of an annuity contract. Thus, an employee has an effective
opportunity to elect to receive cash or have a contribution made
towards the purchase of an annuity contract. In addition, the
employee is not able to receive, prior to a distributable event
described in § 403(b)(11), amounts contributed towards the purchase
of an annuity contract. Finally, compensation reduction
contributions made under the plan are not contributions made pursuant

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to a one-time irrevocable election because the employee can change
the election in the future. Consequently, the compensation reduction
contributions under Plan A as amended are contributions made pursuant
to a salary reduction agreement described in § 403(b).
HOLDING
Where, as in this case, a newly hired or current employee has an
effective opportunity to elect to receive an amount in cash or have
that amount contributed by the employer to an annuity contract
described in § 403(b), those contributions made on the employee’s
behalf to the annuity contract in lieu of receipt of cash
compensation will not fail to be considered to be made under a salary
reduction agreement merely because they are made pursuant to an
arrangement under which, in any case in which an employee does not
affirmatively elect to receive cash, the employee’s compensation is
reduced by a fixed percentage and that amount is contributed on the
employee’s behalf to the annuity contract. This holding would be the
same if (1) Plan A were described in § 403(b)(1)(A)(ii) (relating to
arrangements maintained by State and local school systems), or (2)
the funding vehicles under Plan A were custodial accounts described
in § 403(b)(7) or retirement income accounts described in
§ 403(b)(9), provided the requirements of such respective Code
sections are otherwise satisfied.
PAPERWORK REDUCTION ACT
The collection of information contained in this revenue ruling has
been reviewed and approved by the Office of Management and Budget
(OMB) in accordance with the Paperwork Reduction Act (44 U.S.C. 3507)
under control number 1545-1694.
An agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless the collection of
information displays a valid OMB control number.
The collections of information in this revenue ruling are in the
third, fifth, seventh and eighth paragraphs in the section headed
"FACTS" and in the tenth paragraph in the section headed "LAW AND
ANALYSIS." The collections of information are required to enable
personnel in the Tax Exempt and Government Entities Division of the
Internal Revenue Service to determine if an employer's retirement
plan satisfies the requirements to obtain favorable tax treatment and
to enable certain employee elections to meet the requirements of
§ 403(b). The collections of information are required to obtain a
benefit. The likely respondents are State and local government
entities and not-for-profit institutions.
The estimated total annual reporting burden is 175 hours. The
estimated annual burden per respondent is 1 hour and 45 minutes. The

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estimated number of respondents is 100. The estimated annual
frequency of responses is on occasion.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any Internal Revenue law. Generally, tax returns
and tax return information are confidential, as required by 26 U.S.C.
6103.
DRAFTING INFORMATION
The principal author of this revenue ruling is Roger Kuehnle of the Tax
Exempt and Government Entities Division. For further information
regarding this revenue ruling, call the Employee Plans’ taxpayer
assistance telephone service at (202) 622-6074/6075 (not toll-free
numbers) between 1:30 and 3:30 p.m. Eastern Time, Monday through
Thursday.