Request By:
Hon. Scotty Baesler, Mayor
Lexington-Fayette
Urban County Government
200 East Main Street
Lexington, Kentucky 40507
Opinion
Opinion By: David L. Armstrong, Attorney General; By: Alex W. Rose, Assistant Attorney General
In your letter of August 8, 1983, you asked whether employee contributions to the Policemen's and Firefighter's Retirement Fund which were picked up by the employer were required to be tax deferred for Kentucky income tax purposes. You state that some members of the fund have expressed a wish to have a non-taxable income when they retire and thus desire to have available to them the option of having their contributions taxed now. You also indicated in your letter that the Internal Revenue Service has issued a private ruling holding that the Policemen's and Firefighter's Retirement Fund of the Lexington-Fayette Urban County Government was a plan within the provisions of 26 U.S.C. § 414(h)(2).
Your attention is directed to the specific provisions of KRS 67A.510(2), which state, in part, as follows:
"The urban-county government shall, solely for the purpose of compliance with Section 414(h) of the United States Internal Revenue Code, pick up the employe contributions required by this section for all compensation earned after August 1, 1982, and the contributions so picked up shall be treated as employer contributions in determining tax treatment under the United States Internal Revenue Code and KRS 141.010(9)."
Generally, the word "shall" is construed to be mandatory or compulsory and such ordinary meaning has been codified in KRS 446.010(29). However, whether the word "shall" is mandatory or merely directory in any given context depends ultimately upon the legislative intent as determined by an examination of the statute involved.
Stanfield v. Willoughby, Ky., 286 S.W.2d 908 (1956).
Generally, a statute is directory if it relates to some immaterial matter or if it does not reach the substance of the thing to be done and, if by omission to observe it, the rights of those interested will not be prejudiced.
Fannin v. Davis, Ky., 385 S.W.2d 321 (1964). An examination of the relevant statutes, viz. KRS 67A.360 et seq., indicates that the Policemen's and Firefighter's Retirement Fund of the Lexington-Fayette Urban County Government is a pension plan qualified under Section 401(a) of the Internal Revenue Code. The trustee of such plan is exempt from federal income taxes pursuant to Section 501(a) of the Code. When KRS 67A.510 was amended in 1982 to provide for employee contributions to be picked up by the employer, the stated purpose of that amendment was to comply with 26 U.S.C. § 414(h). Section 414(h), in conjunction with Section 3401(a)(12)(A) of the Internal Revenue Code, postpones the employees' federal income tax liability until such time as the contributions are distributed or made available to the employees. See Rev. Rul. 77-462, 1977-2 C.B. 358.
The rationale for this treatment of the contributions is that covered employees can defer the tax until they actually receive the benefits, which would generally occur after retirement when their incomes and hence applicable tax rates would be lower. See 1974 U.S. C.C.A.N., at 4639. Because the tax deferment is contingent upon the statutory enactment of the pick-up provisions, the word "shall" in subsection (2) of KRS 67A.510 must be deemed mandatory. Failure to observe this statutory provision would defeat the very purpose of the 1982 amendment.
In addition, subsection (2) specifically prohibits the employee from receiving the contributed amounts directly. Consequently, these picked-up contributions cannot constitute to the employee gross income on which income tax liability accrues. See 26 U.S.C. § 61 and KRS 141.010(9)(d). Any exception to the treatment of the picked-up contributions on behalf of an employee finds no support in the law and could very well jeopardize the fund's status under the private ruling of the Internal Revenue Service.