Introduction

Code � 401(a) qualified retirement plans that are "governmental plans" under Code � 414(d) are required to comply with only a subset of the rules applicable to qualified plans generally.  For example, governmental plans are exempt from the Code's minimum funding rules and are not required to test for nondiscrimination or file Form 5500's.  Thus, knowing whether a plan is a "governmental plan" is critical to determining which qualified plan rules apply to it.  Moreover, under Employee Retirement Income Security Act of 1974 ("ERISA") � 4(b)(1), "governmental plans" are not subject to ERISA, the comprehensive federal labor law that governs, and completely preempts state laws regarding, most nongovernmental retirement plans, and which places jurisdiction for most disputes regarding qualified plans in the Federal, not State, courts.  Finally, under ERISA � 4021(b)(2) the benefits of participants in a "governmental plan" are not insured by the Pension Benefit Guaranty Corporation (the "PBGC"), and PBGC premiums are not assessed with respect to "governmental plans." 

Thus, consistent, if not necessarily uniform, definitions of the term "governmental plan" across the three agencies that administer the Federal Pension law (the IRS, the United States Department of Labor, or "DOL," which administers ERISA, and the PBGC) would seem appropriate.[1]  Moreover, the IRS has, in the last several years, significantly increased its regulatory presence in the governmental plan area, and therefore establishing a sound basis for classifying plans as governmental, or not, at least for purposes of the Code, would seem on its face to be an important step forward for both the IRS and the regulated community. Remarkably, even though ERISA was enacted nearly 40 years ago, neither the IRS, the DOL, or the PBGC has yet issued regulations defining the term "governmental plan."

Draft Rules for Determining Governmental Plan Status Would Create an Objective Federal Income Tax Law Definition of "Governmental Plan" Based on Lists of Factors

The ANPRM includes draft proposed regulations defining the term "governmental plan" for purposes of IRC � 414(d).  As a threshold matter, it is worth notingthat the draft proposed regulations would establish objective federal income tax law tests for determining whether a plan sponsor is a government or an agency or instrumentality of a government for purposes of Code � 414(d).  Thus, while under the draft proposed regulations a state or local government administrative or judicial determination that a plan's sponsor was a governmental entity would be evidence that any qualified retirement plan that it sponsored was a governmental plan, it would not be dispositive.    

The fact that under the draft proposed regulations a State agency's or court's determination of the governmental status of a plan sponsor would not be dispositive of the issue of whether the sponsor's qualified retirement plan was a governmental plan may seem an affront to federalism.  However, the IRS and Treasury likely view Code � 414(d) as simply part of the Code and therefore within their and the Federal courts' exclusive jurisdiction to interpret.  The alternative approach, which would have been to view Code � 414(d)'s reference to plan sponsors that are governments and agencies and instrumentalities of governments as references to things having legal significance independent of the Code, like marriage or property rights, was apparently rejected by Treasury and the IRS, perhaps out of concern that such an approach would be difficult to administer and produce inconsistent and uncertain results.  Nevertheless, it is to be hoped that in any eventual proposed regulations the IRS and Treasury will promote State administrative and judicial determinations of a plan sponsor's governmental status from an "other" to a "main" factor, or perhaps potentially even a preeminent factor, perhaps while making clear that the actual weight of this factor in an individual case would be dependent on things such as the authority of the agency or court that made the determination, the precise issue before the administrative agency or court, the extensiveness of the agency's or court's fact-finding, the depth of its analysis of the factual and legal issues, and the extent to which the agency or court provided a detailed written rationale for its determination, such as a published opinion.    

In any event, the draft proposed regulations' suggested new objective federal income tax test for determining Code � 414(d) "governmental plan" status would provide:

• That a governmental plan must be established and maintained by a "governmental  entity" for its employees;
• That a "governmental entity" is the United States or any one of the 50 States, a State political subdivision (such as a county, city, or township), or an agency or instrumentality of the United States or of a State or political subdivision of a State; 
• Two lists of factors ("main" and "other" factors) to be used to determine whether a purported agency or instrumentality of a State or political subdivision is in fact a "governmental entity;[2]" 
• That a governmental plan may not permit any participation by nongovernmental employees; and
• Rules for transition situations, for example when a governmental entity maintaining a plan becomes privatized.

Principal Problem Areas in Draft Proposed Regulations Are (1) Factor Test for Determining Governmental Status of Agency or Instrumentality and (2) Requirement Not to Include Any Nongovernmental Employees

The two sets of rules contained in the draft proposed regulations that have so far proved the most troublesome for the regulated community, and that are likely to continue to do so, are (a) the factor test for determining whether a purported state or local government agency or instrumentality is in fact a "governmental entity" and (b) the requirement that a governmental plan not permit any participation by nongovernmental employees.  These two sets of rules have provoked controversy for two reasons.  First, plans of purported governmental agencies or instrumentalities that have long complied with the governmental plan rules previously articulated and administered by the IRS could if their sponsors fail the new factor test for determining governmental entity status, have thrust onto them the costly burdens of ERISA and PBGC compliance at a time when they can ill afford them.  Second, individual participants in qualified retirement plans sponsored by governmental entities of all types whose personal status as governmental employees may be in question, for example some charter school teachers could, absent adjustments to the draft proposed regulations, find themselves excluded from future participation in such plans because of the requirement of the draft proposed regulations not to include any nongovernmental employees. 

Indeed, a search of the Federal e-Rulemaking Portal at www.regulations.gov on March 5, 2012 indicated that by that date a total of 637 public comment letters had already been filed regarding the ANPRM, and it seems that the majority of those comment letters concerned the determination of whether entities that might not be treated as governmental agencies or instrumentalities under the standards of the draft proposed regulations (for example, charter schools, whose employees often participate in State teachers' retirement systems), should be permitted to participate in "governmental plans," either by liberalizing the factor test for governmental agency or instrumentality status so that the entities in question would be treated as governmental agencies or instrumentalities, or, alternatively, by permitting nongovernmental employees to participate in governmental plans in some circumstances (for example, where a teacher was formerly employed by a public school and continued to be covered by a state teachers' retirement system after becoming employed by a charter school).

Elaboration of "Established and Maintained" Test in Draft Proposed Regulations Also Problematic

Other problems also exist with the ANPRM.  For example, there seems to be a potentially significant problem with the way the ANPRM elaborates on the basic and seemingly straightforward requirement that a "governmental plan" must be "established and maintained" for governmental employees by a governmental employer.  By seeming to provide that each "governmental entity" (whether a State, a political subdivision of a State, or an agency or instrumentality of either) is, for purposes of Code � 414(d), separate from each other governmental entity, and then providing in draft Proposed Regulations � 1.414(d)-(1)(k) that a governmental plan must be established and maintained by "a governmental entity"(emphasis supplied) for "that governmental entity's" (emphasis supplied) employees, the draft proposed regulations could, at least arguably, leave plans such as those covering the municipal and public safety employees of many municipalities in Texas and other States, which were created by the state legislature for the employees of those municipalities, in an uncertain regulatory position. 

It seems very likely that the IRS and Treasury did not intend to create the problem explained in the preceding paragraph regarding Code � 414(d)'s "established and maintained" requirement.  Quite possibly there was simply a lack of a complete understanding on their part of the complexity of the relationships that often exist between governmental plans, state legislatures, employees, and political subdivisions.  For a more detailed analysis of this issue and proposed changes to the wording of the draft proposed regulations addressing this issue, you may click here for a copy of Strasburger & Price's recent comment letter to the IRS and Treasury on this issue.[3] 

Comment Deadline Ends June 18, 2012

At recent professional meetings, representatives of Treasury and the IRS have shown what appears to be a genuine willingness to listen to governmental plan sponsors and participants, and to attorneys practicing in the area, with respect to issues perceived to arise under the ANPRM.  Treasury and the IRS have stressed that the ANPRM is a preliminary document designed to generate feedback early in a process that will eventually culminate in final regulations.  This approach is quite welcome and in our view well-considered.   

In view of the outpouring of concern regarding the ANPRM from governmental plan sponsors and participants, the IRS extended the deadline for submitting comments on the ANPRM, which originally was February 6, 2012, to June 18, 2012.  See 77 Fed. Reg. No. 23, February 3, 2012, page 5442.  Governmental plan sponsors should carefully study the impact of the rules suggested by the ANPRM's draft proposed regulations and, if they determine that there is any significant risk that these rules would impact them adversely, should consider filing their own comments by the June 18, 2012 deadline. 

For further information about this article, please contact [email protected], [email protected], or [email protected].  To learn more about Strasburger's Employee Benefits and Executive Compensation team, click here.