In Private Letter Ruling 201833012, issued on August 17, 2018, the IRS ruled that an employer's nonelective contribution to a Section 401(k) plan, which was conditioned on an eligible employee's repayment of outstanding student loan balance, would not violate Section 401(k)'s "contingent benefit" prohibition.

Recognizing their employees are burdened by student loan debt that prevents them from saving funds for retirement and other purposes, employers have considered a number of innovative alternatives to help employees repay their debts. Among the alternatives considered was to informally seek relief from the IRS to permit employers to make pre-tax contributions to their Section 401(k) plans conditioned on their employees' repayment of student loans. PLR 201833012 is the first ruling in which the IRS has formally approved pre-tax contributions to a Section 401(k) plan tied to employee student loan repayment (SLR). Although this is a private letter ruling, which can be relied upon only by the particular taxpayer, the ruling provides welcome guidance to employers seeking a cost-effective way to compensate employees burdened by student loans. We are aware that, following the release of this private letter ruling, a coalition of employers sent a letter to the Department of the Treasury and IRS requesting the issuance of a revenue ruling providing published guidance on the issue on which all employers could broadly rely.

Background

Under Section 401(k)(4)(A) and Treas. Reg. 1.401(k)-1(e)(6), a Section 401(k) plan may not make any other benefit provided by an employer contingent on the employee's making elective deferrals to his or her Section 401(k) account in lieu of receiving cash compensation from the employer. However, this rule does not apply to matching contributions under Section 401(m).

PLR 201833012

In PLR 201833012, the taxpayer sponsored a Section 401(k) plan to which its employees could contribute a portion of their salaries as pre-tax or Roth 401(k) elective deferrals or as after-tax employee contributions during each pay period. If an employee made elective contributions equal to at least 2% of his or her eligible compensation during the pay period, the employer would make a matching contribution on behalf of the employee equal to 5% of the employee's eligible compensation.

The taxpayer proposed to amend its Section 401(k) plan to offer a student loan benefit program (Program), and, in requesting the private letter ruling, sought confirmation that the Program would not violate Section 401(k)(4)(A)'s prohibition against "contingent benefits." Under the terms of the Program, the taxpayer would make an employer nonelective contribution (SLR nonelective contribution) equal to 5% of the employee's eligible compensation, conditioned on the employee's making a student loan repayment equal to at least 2% of his or her eligible compensation for the pay period. The taxpayer would not extend student loans to employees; hence, the SLRs would be made to an unrelated third party.

Participation in the Program would be entirely voluntary and all employees participating in the taxpayer's Section 401(k) plan would be eligible to participate in the Program. Program participants could still make elective deferrals to their Section 401(k) accounts, but would receive SLR nonelective contributions from the taxpayer instead of regular matching contributions. Participants that did not make SLRs of at least 2% of compensation would remain eligible to receive matching contributions equal to 5% of their eligible compensation, as long as they made elective deferrals equal to at least 2% of eligible compensation for the pay period.

An SLR nonelective contribution would be subject to all of the applicable tax-qualified plan requirements, including eligibility, vesting, distribution rules, contribution limits, and coverage and nondiscrimination testing. The SLR nonelective contribution would not be treated as matching contributions for purposes of any testing under, or requirement of, Section 401(m). All other matching contributions would be included for Section 401(m) testing purposes.

The IRS ruled that the SLR nonelective contributions would not violate the contingent benefit prohibition under Section 401(k)(4)(A) and Treas. Reg. 1.401(k)-1(e)(6). In support of this ruling, the IRS noted that: (1) the SLR nonelective contributions are conditioned on the eligible employee's making an SLR, and not on the employee's making a Section 401(k) elective contribution, and (2) the eligible employees who make SLRs and receive the SLR nonelective contribution could still make Section 401(k) elective contributions.

Implications

This private letter ruling is welcome news for employers concerned about their employees' student loan debt burden. Many employers recognize that the employer's repayment of the employees' student loans is a benefit to can be used to attract and retain valuable workers. Repayment of an employees' student loans, however, generally results in taxable income to the employees. This ruling offers employers a way to compensate employees on a pre-tax basis, conditioned on the employees' repayment of their student debt.

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