Oden v. Board of Administration

• Decision Date: 14 March 1994
• Docket Number: No. A058988,A058988
• Court: California Court of Appeals Court of Appeals
• Parties: , 18 Employee Benefits Cas. 1061 Floyd C. ODEN et al., Plaintiffs and Respondents, v. BOARD OF ADMINISTRATION OF the PUBLIC EMPLOYEES' RETIREMENT SYSTEM et al., Defendants and Appellants.

Page 388

28 Cal.Rptr.2d 388

23 Cal.App.4th 194, 18 Employee Benefits Cas. 1061

Floyd C. ODEN et al., Plaintiffs and Respondents, v. BOARD OF ADMINISTRATION OF the PUBLIC EMPLOYEES' RETIREMENT SYSTEM et al., Defendants and Appellants.

No. A058988.

Court of Appeal, First District, Division 1, California.

March 14, 1994.

Review Denied June 16, 1994.

Daniel E. Lungren, Atty. Gen., Jose R. Guerrero and S. Michele Inan, Deputy Attys. Gen., Oakland, William C. Katzenstein, County Counsel, Robert M. Pepper, Principal Deputy Counsel, William D. Kenison, Deputy County Counsel, Riverside, for defendants and appellants.

Kronick, Moskovitz, Tiedemann & Girard, Mark L. Hefter, Sacramento, Wesley W. Peltzer, Smith & Peltzer, San Marcos, Best, Best & Krieger, Dallas Holmes, Jeffrey V. Dunn, Eric L. Garner, Riverside, for amici curiae on behalf of appellants.

Richard G. McCracken, W. David Holsberry, Philip Paul Bowe, Davis, Cowell & Bowe, San Francisco, for plaintiffs and respondents.

STRANKMAN, Presiding Justice.

A plaintiff class of pensioners under the Public Employees' Retirement System (PERS) and its class representatives obtained judgment directing issuance of a writ of mandate commanding the respondent class of more than 1,350 California public agencies and the Board of Administration of PERS to increase pensioners' retirement allowances.

The trial court judgment rests on an interpretation of Government Code section 20022's definition of "compensation," upon which pension contributions and allowances are calculated. "Compensation" is defined to include an employer "pick up" payment of employee pension contributions meeting federal taxation law standards, but exclude employers' payments credited as employee pension contributions. (Gov.Code, § 20022, subds. (a)(6), (b)(6).) ¹ At issue is the characterization We reject the trial court's statutory interpretation and conclude that employer-paid pension contributions made on an employee's behalf and paid in addition to an employee's salary are not "compensation" within the meaning of Government Code section 20022. We reverse the judgment.

of employer payments made in addition to an employee's salary and credited as an employee pension contribution--payments which meet the literal definitions of both an employer "pick up" and an employer payment credited as an employee contribution. The trial court characterized such payments as "compensation," thereby requiring higher retirement allowances and increased contributions.

PROCEDURAL BACKGROUND

Respondents Floyd C. Oden and William T. Shannon are retired public agency employees. They and respondent Retired Public Employees Association represent the respondent class of former California public agency employees and PERS pensioners for whom tax deferred, employer-paid pension contributions were made on their behalf, in addition to stated salary. Appellants are the Board of Administration of PERS and a class of public agency employers who paid the salary-addition pension contributions credited to their employees. Respondents sued appellants, disputing their exclusion of employer-paid salary-addition member contributions from reportable compensation and demanding increased retirement benefits based on compensation levels augmented by the amount of unreported contributions.

The trial court granted judgment issuing a writ of mandate commanding appellant class representative County of Riverside and the class of public agencies to report to PERS as compensation all salary-addition member contributions paid since October 3, 1985, and directing the Board of Administration of PERS to pay respondent pensioner class members increased retirement benefits which reflect the higher compensation level, retroactive to December 24, 1987.

DISCUSSION

I. The Public Employees' Retirement System

The Public Employees' Retirement Law (PERL, Gov.Code, § 20000 et seq.) establishes PERS, a retirement system for employees of the state and participating local public agencies. ² PERS is a prefunded, defined benefit plan which sets an employee's retirement benefit upon the factors of retirement age, length of service, and final compensation. (City of Sacramento v. Public Employees Retirement System (1991) 229 Cal.App.3d 1470, 1478, 280 Cal.Rptr. 847.) Retirement allowances are therefore partially based upon an employee's compensation. An employee's compensation is not simply the cash remuneration received, but is exactingly defined to include or exclude various employment benefits and items of pay. (§ 20022.) The scope of compensation is also critical to setting the amount of retirement contributions, because PERS is funded by employer and employee contributions calculated as a percentage of employee compensation. (City of Sacramento v. Public Employees Retirement System, supra, at p. 1479, 280 Cal.Rptr. 847.)

II. Taxation of Pension Contributions

As indicated above, PERS is funded by both employer and employee contributions. These two sources of contribution, distinguished more by form than in substance, are nevertheless subject to disparate tax treatment. "The distinction between 'employers' contributions and 'employees' contributions to qualified pension plans is almost wholly nominal. It is a matter of indifference to an employer whether it pays $30,000 salary to the employee plus $3,000 to a pension plan on the employee's behalf, or instead $33,000 to the employee, of which it sends $3,000 to a pension plan.... But the However, where designated employee contributions are required by the system, as with today's PERS, tax deferral cannot be accomplished by reallocating all contributions to the employer. Employee contributions are mandatory and, once designated as employee contributions, are generally forbidden from being favorably treated as employer contributions under federal tax law. (26 U.S.C. § 414(h)(1).) But an exception has been recognized for state and local governmental employers, in recognition of various restraints preventing public employers from reallocating contributions to themselves and eliminating employee contributions. (Foil v. C.I.R. (5th Cir.1990) 920 F.2d 1196, 1202.)

                tax consequences of the distinction are substantial."  (Howell v. United States (7th Cir.1985) 775 F.2d 887.)   Employers' contributions are [23 Cal.App.4th 199] not taxable income to the employee until benefits are paid upon separation or retirement, whereas employees' contributions are ordinarily taxable income when made, but not taxed at disbursement of benefits.  (Ibid.)  Accordingly, tax deferral is achieved where retirement contributions are made by the employer, rather than the employee
                

Designated employee contributions to a qualified governmental pension plan are treated as tax deferred employer contributions where the employer "picks up" the employee contributions. (26 U.S.C. § 414(h)(2).) ³ A "pick up" allows governmental employers "to control the tax consequences of pension contributions" and has two features: (1) the government employer formally designates employee contributions as employer contributions, for federal tax purposes; and (2) the employee does not have the option of directly receiving the contribution payments. (Howell v. United States, supra, 775 F.2d at pp. 888, 890.) The federal pick up law satisfies PERS's need for dual characterization of retirement contributions: a contribution is designated an employee contribution under state retirement law but treated as an employer contribution under federal tax law. (See id., at p. 888.)

III. Types of Employee Contributions

Employees' contributions to PERS are currently made in two primary ways: (1) employee-paid salary deduction; and (2) employer-paid salary addition. In the first method, a pension contribution is withheld from the employee's stated salary. Effectively, "[t]he government establishes two 'salaries.' One, for state purposes, is the base from which contributions are withheld; the other, for federal purposes, is a lower salary from which nothing is withheld; the difference between the salary for state purposes and the salary for federal purposes is the 'picked up' contribution." (Howell v. United States, supra, 775 F.2d at p. 888.) The employee pays income tax on his reduced wages, less the amount of the pension contribution. (Ibid.) In the second method, the employer directly picks up and assumes the pension contribution, "topping up the total compensation so that the employee then receives his full stated salary without a deduction for pensions." (Ibid.) The employee pays income tax on his stated salary; he does not pay tax on the pension contribution.

Both salary deduction and salary addition methods of paying employees' contributions are tax advantaged pick ups under federal law. (Howell v. United States, supra, 775 F.2d at p. 888.) However, the two methods take advantage of distinct aspects of the dual characterization permitted under the pick up law. An employee-funded salary deduction is an employee payment from salary, which would not be tax deferred absent the pick up law which permits it to be treated as an employer contribution under federal law. An

employer-funded salary addition is an employer payment exceeding salary which would be tax deferred but could not be designated as an employee contribution under state law without the pick up statute.

IV. PERS Characterization of Employee Contributions

While both methods of paying employees' contributions are "pick ups" under federal law, not all employees' contributions have been considered "compensation" under California law. PERS regards employee-paid salary deductions as compensation while excluding employer-paid salary additions from compensation. The employee's stated salary is treated as compensation by PERS, regardless of deducted or added pension contributions.

Class representative County of Riverside began paying pension contributions on its employees' behalf and in addition to salary in 1981...