You have requested a letter ruling on behalf of the (Authority), a political subdivision of the Commonwealth, on the Massachusetts tax consequences to Authority employees of a recent change to the Authority's retirement plan. The facts as you have explained them to us are as follows.
The Authority's retirement plan requires Authority employees to contribute 4% of their salaries annually to the retirement fund. Contributions are deducted from employees, salaries and paid directly into the fund. Generally, the Internal Revenue Code treats such contributions as having been made by the employee, which meant that they were part of each Authority employee's federal gross income for the year.
In February 1986, however, the Authority amended its plan by adopting the "pick-up" provision of Code § 414(h)(2). In doing so, the Authority stated that the picked-up contributions "shall, as permitted by IRC Section 414(h)(2), be considered employee contributions for all purposes of the Fund and included as employee compensation as defined by the Plan" (Pension Agreement, Art. V, § 3(c)). code § 414(h)(2) provides that:
in the case of any plan established by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing, where the contributions of employing units are designated as employee contributions but where any employing unit picks up the contributions, the contributions so picked up shall be treated as employer contributions.
The effect of Code § 414(h)(2) is to exclude the employee pension contributions that the Authority has "picked up" from the employees, federal gross income and from withholding requirements. See Rev. Rul. 77-462. When an employee receives amounts from the fund upon retirement, however, those amounts are taxable for federal income tax purposes. See Id.
The change to the Authority's retirement fund raises two Massachusetts tax questions: (1) how the picked-up contributions will be treated under G.L. c. 62; and (2) how payments to a retiree will be treated under G.L. c. 62. we conclude that: (1) an Authority employee is not required to include the retirement fund contributions picked up by the Authority as part of Massachusetts gross income; and (2) a retired Authority employee may exclude from Massachusetts gross income amounts received from the retirement fund. 1
A. Contributions to the Fund
The Massachusetts personal income tax statute, G.L. c. 62, imposes a tax on a taxpayer's Massachusetts gross income, which, the statute specifies, is the taxpayer's federal gross income, with certain items added thereto and other items excluded therefrom not here relevant. G.L. c. 62, § 2(a). Under Code § 414(h)(2), an Authority employee excludes retirement fund contributions picked up by the Authority from federal gross income. As a result, the employee will also exclude those contributions for Massachusetts tax purposes, unless one of the provisions of G.L. c. 62, § 2(a), requires the employee to add such contributions to federal gross income. There is no such requirement in G.L. c. 62. The picked-up retirement fund contributions are therefore not included in an employee's Massachusetts gross income. (Since the contributions are not included in gross income, employees may not deduct them from income under G.L. c. 62, § 3(B)(a)(4).)
B. Benefits Received from the Fund
On the other hand, amounts received by a retired Authority employee from the retirement fund are included in federal gross income. Code 5 61(a)(11). They will therefore also be taxable for Massachusetts purposes unless a specific provision of G.L. c. 62 excludes them. Section 2(a)(2)(E) of G.L. c. 62 provides that a taxpayer may exclude from Massachusetts gross income "([i]ncome from any contributory annuity, pension, endowment or retirement fund of the United States government or the commonwealth or any political subdivision thereof, to which the employee has contributed." See also G.L. c. 62, 5 3(B)(a)(4). We conclude that the Authority's retirement fund is one "to which the employee has contributed" and, as a result, that the benefits Authority employees will receive from the fund when they retire are exempt from Massachusetts taxation.
Analyses of both the practical aspects of the plan as amended and the statutory language of the applicable provisions of G.L. c. 62 support this conclusion. First, the change to the Authority's retirement plan alters the substance of the pension arrangement with the Authority's employee in only one way: now, the contribution each employee must make to the fund is hot taxable to the employee. The amount of the contribution, representing a percentage of the employee's total salary, remains the same as before the Authority amended its plan. The pension benefits the employee will be entitled to receive, based on the employee's salary history over the course of his or her employment, remain the same. Moreover, the amount an employee must contribute under the Federal Insurance Contributions Act (Code § 3101 et seq.), also based on the employee's total salary, remains the same. The retirement fund contributions thus may be said to come from the employees despite the fact that the contributions are not taxed to the employees as a result of Code § 414(h)(2). Second, there is no requirement in G.L. c. 62 that the exclusion of retirement benefits from taxable income under G.L. c. 62, § 2(a)(2)(E) and § 3(B)(a)(4) apply only to retirement plans that were subject to the $2,000 limit on nontaxable contributions under G.L. c. 62, 5 3(B)(a)(4).
Very truly yours,
Stephen W. Kidder
Commissioner of Revenue
December 1, 1987
1 You have represented that the Authority has the power to adopt the pick-up arrangement of Code 5 414(h)(2) and that it has done so in conformance with IRS requirements. We condition this ruling on these representations.