“We are a national 501(c)(3) tax-exempt organization who recently started employing individuals who live and work in Puerto Rico. Since citizens of Puerto Rico are also U.S. citizens, can they participate in our 403(b) plan?”
Charles Filips, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:
This is a very good question. Unfortunately, there is no straightforward answer. An employee benefit plan covering Puerto Rico bona fide resident employees or individuals who primarily render their services in Puerto Rico must be qualified under Puerto Rico Code Section 1081.01. However, there is no direct Puerto Rico counterpart to Code Section 403(b). As a result, allowing the participation of Puerto Rico resident employees in a 403(b) plan that is not qualified in Puerto Rico would cause negative tax consequences under Puerto Rico tax law for both the plan sponsor and the Puerto Rico participants as plan contributions would be treated as Puerto Rico taxable wages.
In theory, a 403(b) plan could cover Puerto Rico resident employees only if such plan’s framework meets the Puerto Rico qualification requirements under Puerto Rico Code Section 1081.01 as a defined contribution profit sharing plan or a stock bonus plan and secures a favorable determination letter from the Puerto Rico Treasury Department. The 403(b) plan, in form and operation, must meet the Puerto Rico Code Section 1081.01 requirements regarding Puerto Rico resident employees. To be qualified under the Puerto Rico Code, the plan must comply with these requirements, among others:
- The plan must be funded through annuities or a trust (custodial accounts are not funding vehicles allowed under the PR Code).
- For the plan to offer elective deferrals under a cash or deferred arrangement, the plan must be part of a defined contribution profit sharing plan or a stock bonus plan.
- Plans qualified under the Puerto Rico Code are subject to all the provisions of Title I of the Employee Retirement Income Security Act (ERISA).
- Plans qualified under the Puerto Rico Code must comply annually with the nondiscrimination tests of the Puerto Rico Code.
- Puerto Rico income tax must be withheld on distributions from the plan to Puerto Rico resident participants and reporting to the Puerto Rico Treasury Department and the Puerto Rico resident participants must be made upon distributions.
- The plan must contain the Puerto Rico Section 1081.01 requirements for Puerto Rico resident employees.
Compliance by a U.S. 403(b) plan with Puerto Rico tax qualification requirements is not practical (though some U.S. 401(a) plans are dual-qualified). Consequently, as an alternative, 501(c)(3) tax-exempt organizations normally set up a separate plan qualified for tax purposes only in Puerto Rico for its employees who are bona fide residents of Puerto Rico.
Plan sponsors are encouraged to consult with Puerto Rico counsel before making a decision to grant retirement benefits to their Puerto Rico resident employee. Factors such as tax, administrative and compliance matters shall be considered.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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