Employee benefits & pensions: IRS clarifies rule for contributing unused paid time off to sec. 401(k) plans.

• Author: Sirkin, Stu

The IRS has issued Rev. Ruls. 2009-31 and 2009-32 to clarify issues involving the contribution of the dollar value of unused paid time off (PTO) to the employer's Sec. 401(k) plan. Rev. Rul. 2009-31 addresses two situations for continuing employees in which the employee either has no election or has an election. In both cases the unused PTO may be contributed to the qualified plan, but the tax treatment differs. Rev. Rul. 2009-32 addresses the same two situations for terminating employees. The affected year differs depending on whether the employee terminates on October 1 or December 28 because contribution to the Sec. 401 (k) plan occurs roughly two weeks after the termination of employment.

Rev. Rul. 2009-31: Active Employees

Situation 1--No employee election: Company Z provides 240 hours of PTO each calendar year. Employees may not carry over unused PTO to the next year. Z amends its PTO and Sec. 401 (k) plans to provide that on December 31, any unused PTO is forfeited and the dollar equivalent of that unused PTO is contributed to the Sec. 401(k) plan (and allocated to the participant's account as of that same December 31). The contribution is capped by the maximum contribution under Sec. 415 for the year (e.g., $49,000 for 2009). Z pays any amount above the permissible Sec. 415 contribution for that employee to the employee by the following February 28.

Because the employee had no election, the contribution is treated as Z's nonelective contribution to the plan for the year in which the December 31 forfeiture and contribution take place. Because the dollar equivalent is not paid, set apart, or otherwise made available so the participant can draw on it, the IRS provides that under the doctrine of constructive receipt and Sec. 451, the amount is not includible in the participant's gross income in the year of conversion. An amendment allowing this treatment does not violate the plan qualification rules as long as this contribution (along with other employer contributions) is nondiscriminatory. In addition, the amendment docs not make the PTO plan fail to be a bona fide sick and vacation leave plan for purposes of Sec. 409A.

Situation 2--Employee election: In the second situation, the IRS changes the facts so that Company Y has a PTO plan that allows the employee to carry over to the next year (the carryover limit) some of the unused PTO. Y pays any unused PTO above the carryover limit to the employee by February 28 of the following year. Y...