Chapter 18: It’s Supposed To Go To Whom? Beneficiary Designation In Governmental Defined Contribution Plans

Here’s an interesting difference between public and private industry plans that we were reminded of recently and that we’d like to share with our governmental clients and their advisors because it can be so problematic.

In most private industry plans, federal law requires that the spouse be the automatic death benefit beneficiary of the participant’s interest under the plan or that the spouse consent to any beneficiary designation that doesn’t name them as the sole primary beneficiary. Not always so in governmental plans.

Take for example the designation of a death benefit beneficiary or beneficiaries under a governmental defined contribution plan or 457(b) plan in a community property state like California. We’ve found that in many cases, local governments are using generic plan documents that don’t even recognize the fact that the respective interests of the participant and the spouse may be governed by state community property laws.

California courts recognize that a defined contribution plan account balance that was accumulated during the course of a marriage is community property and may be subject to division upon marital dissolution.  As importantly, the courts also recognize that the participant may only be able to clearly designate the death benefit beneficiary as to the participant’s one-half community property interest and that the spouse has a one-half interest in the account, based on community property laws.

This can be a huge problem in the case of any governmental plan in a community property state where the plan’s document, forms and procedures do not adequately explain the rights of the participant and those of the spouse to decide how their respective community property interests under the plan will be distributed in the event of their deaths.

The best way to handle this is to make sure that the relevant plan document, plan summary, applicable procedures and beneficiary designation forms and instructions all clearly spell out the respective rights of the participant and the spouse in connection with any beneficiary designation. A commonsense, best practice would be to not allow any beneficiary designation to be made or changed by one spouse without the knowledge and express written consent of the other spouse.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or email us at

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Chapter 17: Bankruptcy Ruling Cuts CalPERS Down To Size

On February 4, 2015, the Judge overseeing the City of Stockton bankruptcy issued an opinion, overruling Franklin Templeton’s lone objections to the City’s plan of reorganization and, very pointedly, clarifying the true role of CalPERS – at least in a bankruptcy context.

For those new to the case, some quick background. When the City filed for chapter 9 protection in 2012, it successfully negotiated away over $2 billion in long-term debt with all of its creditors except one. Facing a potential loss over $32.5 million, Franklin Templeton rejected the City’s settlement offer and filed suit, arguing against CalPERS’ claim of public pension inviolability and basically asserting that the pension giant needed to get in line with its hand out for its money like everyone else.

According to the judge’s ruling, Franklin Templeton may have been right, but it didn’t win. And in the sense of a “win,” neither did CalPERS, which Judge Klein characterized as a bully with a glass jaw (really, read the opinion).

So what does it all mean? Here are my takeaways:

  1. A careful examination of the relationships between CalPERS, a participating employer and its employees reveals that CalPERS is not a major creditor of any participating employer because it does not guarantee the funding of employees’ pensions. “CalPERS is merely a servicing agent that does not guarantee payment.”
  2. In evaluating the respective rights and responsibilities of various chapter 9 creditors, it is the employees and retirees of a city who are one of the largest, if not the largest creditor. An insolvent city must negotiate with them to obtain appropriate wage and benefits concessions.
  3. Because CalPERS does not guarantee the pensions it “services,” CalPERS appears to lack standing to object to pension modifications in a chapter 9 proceeding.
  4. Provisions in the Public Employees Retirement Law that purportedly forbid the rejection in bankruptcy of a CalPERS contract and provide for a CalPERS lien for termination liabilities are both ineffectual in a federal bankruptcy context.
  5. The vaunted “vested rights” doctrine under both California case law and the state and federal Constitutions does not prevent Congress from enacting a law (the federal bankruptcy act) impairing a state or local government’s obligation of contract.

How will this all affect other pending and future municipal bankruptcies? Stay tuned.

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Chapter 16: Same-Gender Spouse Ruling Requires Review Of Public Retirement Plans

On June 26, 2013, in United States v. Windsor (Windsor), the Supreme Court decided that section 3 of the Defense Of Marriage Act (DOMA) was unconstitutional.  DOMA had limited “marriage” to opposite-gender couples for purposes of federal law.  As result of this decision, the IRS has taken the general position that where a provision in the Internal Revenue Code (Code) refers to marriage, husband, wife, or husband and wife, the IRS will interpret the Code to include a valid same-gender marriage and the individuals of the same gender in that relationship.  A same-gender marriage is valid if it was validly entered into in a State whose laws authorize the marriage of two individuals of the same gender even if the married couple is now domiciled in a State that does not recognize the validity of same-gender marriage.  Therefore, employers and plans in States that do not currently recognize same-gender marriages may be required to recognize same-gender marriages performed in different States.  “Marriage” does not include individuals (whether of the opposite gender or the same gender) who have entered into a registered domestic partnership, civil union or other similar, formal relationship under State law that is not treated as a “marriage” under the laws of the State.

More recently, in Notice 2014-19 (Notice), the IRS issued guidance on what sponsors of qualified retirement plans may need to do in order to maintain the tax-qualified status of their plans in light of Windsor.  The Notice generally gives plan sponsors until the end of 2014 to make any necessary amendments to bring their plans into compliance.  The Notice also clarifies that a plan will not be treated as having a qualification failure if, prior to September 16, 2013, it only recognized same-gender spouses of participants domiciled in a State that recognized same-gender marriage.

An amendment is required if your plan’s current terms do not agree with the way in which the plan is to operate in light of Windsor.  Even if your plan does not currently define “spouse,” you may want to amend your plan in order to clarify exactly how you want to operate your plan with respect to same-gender spouses.

In the case of a governmental 401(a) plan, the deadline is the close of the first regular legislative session of the legislative body with the authority to amend the plan that ends after December 31, 2014.  For many public agencies whose governing boards meet on a monthly basis, compliance is required by January 2015. For 403(b) plans and 457(b) plans, the plan should be amended as soon as possible.  We recommend the following actions:

1.         Review the administration of your plan, starting on June 26, 2013, and confirm that your plan has complied with the Windsor case and the IRS guidance.  Once you have made this determination, document it.

2.         If your plan has not complied with the Windsor case and the IRS guidance in operation, take appropriate actions under the IRS’s Employee Plans Compliance Resolution System to correct the administration of the plan.

3.         Review your plan documents to determine if any of your plans contain a definition that is inconsistent with the Windsor case.  If so, amend the plan by the deadline stated above (e.g., January 2015).

4.         Even if your plan’s definition is consistent with IRS guidance (or the plan does not define “spouse” specifically), consider adopting a plan amendment to make clear the effective date of the change and the application of these requirements.  It is easier to administer new plan rules and requirements that are expressly spelled out.

5.         Review and update your plan summary and your employee communications as appropriate.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the web site. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at

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Chapter 15: Giving Employees Choices Can Sometimes Lead To Problems

Because many of our public agency clients have collectively-bargained employees, we continue to see a variety of efforts by employers and their bargaining partners to make the most of limited compensation and benefits dollars.  Sometimes, the parties believe that they can get more mileage from limited dollars by letting the employees choose between two employer-provided benefits.  In many cases, because the parties are working with monies earmarked for employee benefits (not salaries), these choices do not include the ability for the employees to receive cash instead of the employer-provided benefits.

For those of you who have guessed that such a situation does not create a constructive receipt problem – congratulations! You’ve been paying attention to our other writings about the perils of letting employees choose between cash and nontaxable benefits (see  So, if there is no constructive receipt tax problem, what is the concern?  Unfortunately, another lesser-known tax problem can arise when a choice is given to employees between additional deferred compensation (an employer contribution to a 457(b) plan or a 401(a) plan) and an additional health insurance subsidy (an employer contribution for health insurance).  This lesser-known problem stems from the “assignment of income” doctrine.

Without digressing too much into the case law, there are a number of U.S. Supreme Court cases that stand for the proposition that if a taxpayer who is entitled to receive income in the future gives up that right (generally by surrendering it to another taxpayer), the taxpayer will be treated for tax purposes as having first received the “future income” and then disposing of it.  How does the assignment of income doctrine cause a choice between an employer-made 457(b) plan contribution and an employer-made health premium subsidy to become taxable?  If you look more carefully at what is going on, you will see that the employee’s choice is between the receipt of future income (amounts that will be taxed when distributed from the 457(b) plan) and a nontaxable current benefit (tax-free employer subsidy of health coverage).  If the employee gives up the right to receive additional 457(b) distributions in the future in exchange for an additional current health insurance subsidy, the IRS views this as an assignment of income and has stated on several occasions that such a choice would result in current taxable income to the employees who elect the additional health insurance subsidy – even though they are not now receiving any cash and have elected to receive what appears to be a nontaxable benefit.  Having a cafeteria plan does not avoid the additional taxable income, even if the employee could otherwise reduce taxable compensation on a pre-tax basis for health insurance premiums under the cafeteria plan, because a cafeteria plan cannot allow a choice between nontaxable health benefits and deferred compensation.  Therefore, the employee’s choice to forego the deferred compensation contribution in favor of additional health insurance premiums is not being made under the cafeteria plan and, as a result, the choice does not result in a pre-tax health insurance premium deduction.

The takeaway from all of this is that employers and their collective bargaining partners need to be particularly careful when negotiating and designing benefit changes that involve employee choice.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the web site. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at

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Chapter 14: Not Everyone Wants To Share – How Many OPEB Trusts Do You Need?

Now that the general economic situation and public agency finances appear to be improving, a number of municipalities and special districts are once again looking at their unfunded OPEB (other post-employment benefits) liabilities with an eye to getting these liabilities under better control.  One obvious way to control the amount of such unfunded liabilities is to fund, or set aside money to pay for, emerging retiree health obligations. When evaluating and establishing appropriate OPEB funding vehicles, it is important to consider whether the employee groups who may be contributing to such funding (typically through negotiated wage reductions) will be willing to “share” a single trust or not.

To put a sharper point on this, picture me, a husky older teenage brother, sitting down for dinner with my three younger, much smaller siblings.  Our family frequently dined “family-style” – where one large (or sometimes not so large) plate of the main course was placed in the middle of the table for all to share.  I’m learning now, many years later, that my siblings often felt they were in a race with me to get their share of the main course.  If they waited too long, Jeff would eat it all up!

I mention this not-so-flattering story to illustrate the important question of whether a public agency should use only one, or more than one, OPEB trust to fund its retiree health obligations.  What got me thinking about this was a municipal client of ours that participates in the CalPERS-sponsored California Employers’ Retiree Benefit Trust (CERBT).  In discussing the situation with the client and representatives of CERBT, I realized that the current offerings of CERBT may not be a good fit for many public agencies – particularly those with more complicated retiree health benefit structures.

Here’s why.  Currently, CERBT provides and allows for only a single funding account, as part of its large multiple-employer trust, for each participating employer.  So, for example, a very large city (e.g., Los Angeles) would have one account and a small municipal water district would also have one account.  The problem is that a big city typically has many unions with which it negotiates, each with a different level of employee cost sharing and perhaps a differing level of retiree heath benefit.  If the firefighters are “contributing” more of their paychecks towards the funding of their retiree health benefits than the police officers are, but the police officers are retiring and drawing on benefits at a faster rate, one can see the beginnings of a “family-style” dilemma as described above.  That is, if you have only one trust, then everyone shares in the same funding – regardless of whether they are contributing the same amounts and whether they are withdrawing the same levels of benefits.  If asked about it, most unions would not be willing to share their retiree health trusts with a number of other unions.

What can be done? By far, the easiest thing to do is to establish multiple OPEB trusts (or, OPEB sub-trusts).  That way the contributions, funding level, and participant utilization will be separate and distinct for each bargaining group.  Although the CalPERS CERBT currently does not offer the option of allowing each participating employer to establish multiple sub-trusts for this purpose, there are a number of reputable providers that do provide for such an option, such as the multiple-employer OPEB trust offered by PARS.  Our understanding is that there are relatively little if any start-up costs for an agency or city to set up multiple trusts of this sort and that the ongoing costs are very competitive with those charged by CalPERS.  Of course, it is up to each employer to determine what is best for it employees, but it may be ill-advised to assume that all of your bargaining groups will be happy with “family-style” retiree health funding.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the web site. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at

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Chapter 13: Some Things Are Worth Repeating – Beware of PTO Cash-Outs!

Recently, I spoke to a roomful of public agency human resources managers. As I sometimes do, I took a few informal surveys of my audience.  One of the questions I posed was: “How many of your agencies allow employees to cash out some or all of their accumulated vacation, paid time off, or sick leave?”  Not surprisingly, roughly 75% to 80% of the represented agencies said that their HR policies and MOUs provide for the cash-out of significant amounts of PTO – with little or no restriction. When I asked why they did this, most responded: “Because practically all other agencies do this as well.” So, if everyone is doing this, what’s the problem?

The problem is that this practice creates a “gotcha” income tax problem for most of the agency’s employees – particularly, those who do not elect to take or cash out their PTO.  Most people I speak with have a hard time appreciating why an employee with hundreds of hours of unused PTO would be taxable on the value of PTO that they do not either take or cash out. But, an important concept in our tax laws, known as “constructive receipt,” can make a person taxable on income (cash) that the person could take, but chooses not to.  It’s kind of like gaining a few extra pounds just because you bought a container of ice cream.  As explained in detail in our article, “When Having Your Cake And Eating It May Be a Bad Thing: Cautions About Cash-Outs Of Unused Leave Or PTO,”, this is more than a tax problem for employees. Employers with such policies have almost certainly under-reported income taxes and payroll taxes!

We are repeating our cautions and advice on this topic because we strongly believe that this is still a widespread practice and problem. If your agency has a policy of allowing PTO or vacation buy-backs or cash-outs, you should have the policy reviewed immediately. There are a number of things that employers can do to stop the problem and prevent future cash-outs from having unsettling and unanticipated tax effects.

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Chapter 12: When Treating Everyone The Same May Not Work – Working With PEMHCA’s Equal Contribution Rule

By Jeff Chang

Sometimes the realities of family budgets – budgets in general – collide with notions of fairness and equal treatment. I can still remember the deep disappointment in the eyes of our youngest child many years ago when we explained that the family would not be purchasing another car when she got her driver’s license, even though we had purchased one when her oldest brother had received his.  Today, many of California’s cities and public agencies are faced with a similar dilemma due to the expectations of their employees and their past practices.  If, however, a municipality or public agency decides that its budgetary constraints must override its equal treatment of employees, there are a number of ways to make adjustments to benefit levels – even when it comes to health insurance benefits offered through CalPERS.

Hundreds of California’s public employers and approximately 1.3 million public employees, retirees and their families participate in the health insurance program offered by CalPERS. This makes CalPERS the third largest purchaser of health care in the nation. Participation in the CalPERS health insurance program is separate from participation in the CalPERS retirement program.

To take advantage of the purchasing power and administrative structure of the CalPERS health insurance program, California public employers must apply to CalPERS and agree by resolution to become subject to the Public Employees’ Medical and Hospital Care Act (PEMHCA).  One of the requirements of the PEMHCA – one which can potentially cost a public agency a considerable amount of money – is the so-called “equal contribution rule.”  The equal contribution rule generally requires a PEMHCA employer to pay the same amount toward health insurance premiums for its retirees as it does for its active employees. In other words, by agreeing to participate in the CalPERS health insurance program, an employer is creating a built-in retiree health insurance benefit!

The PEMHCA provides that the employer’s equal contribution rate be at least as much as the so-called “PEMHCA minimum.” This is $119 per month for 2014 and is subject to annual adjustment.

Fortunately, the equal contribution rule does not require an employer to pay for the most expensive health insurance coverage for its employees and retirees.  The level of employer-paid premium is usually determined by labor negotiation or is a matter of historical practice and budget.  So, for example, if an employer has agreed with its active employees to pay the cost of health insurance premiums up to the cost of the most expensive HMO option, it likely will find itself paying the same amount towards its retiree health insurance premiums.

One way for a PEMHCA employer to potentially save money is to lower its equal contribution commitment for both actives and retirees to the PEMHCA minimum and then separately subsidize actives’ and retirees’ health care premiums through the use of cafeteria plans or health reimbursement arrangements (HRAs). In this way, an employer can differentiate between the treatment of active employees and retirees. It also can differentiate within its active employee and retiree groups by providing differing levels of subsidies through cafeteria plans or HRAs.  This practice of moving to the PEMHCA minimum and providing “outside-of-CalPERS” subsidies is becoming increasingly widespread.

There is, of course, another technique that when used independently of or in conjunction with the one just described can give employers even more control over the health benefits provided and their benefits budgets. We call this technique the “rate group” method.  To take advantage of this, a PEMHCA employer simply files with CalPERS a new PEMHCA equal contribution resolution that specifies that it is dividing its employees into various coverage groups – each with its own equal contribution rate.  For example, the new resolution could specify that all collectively-bargained employees will receive one level of employer-paid premium while all unrepresented employees will receive a different level.  Again, under the equal contribution rule, retirees within a designated group must receive that same level of employer-paid premium as their active counterparts; but now we have two rate groups rather than one.

Currently, CalPERS’ rules governing the designation of such groups are quite flexible. For example, it is our understanding that CalPERS will permit:

  • groups that are not limited to designated bargaining units;
  • multiple groups within the larger unrepresented population of an employer’s employees; and
  • groups defined by reference to a date of hire or a date in an MOU.

The ability to break employer health premium subsidies into various groups of actives and retirees seems to make working within the constraints of the equal contribution rule much more palatable. It also can pave the way for considerable cost savings, both with respect to employer obligations for active employees and for retirees. Finally, it would make the design and operation of the “outside-of-CalPERS” subsidies under cafeteria plans and HRAs somewhat simpler.

Because the rules relating to the use of the rate group method are not all that obvious or explicit, employers should utilize this approach only with full disclosure to CalPERS and its acknowledgment of the practice.

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Chapter 11: Exercise Caution When Using a Pre-approved “Governmental” Retirement Plan

In the governmental non-ERISA marketplace, there are a number of investment providers and plan recordkeepers that offer and provide retirement plan documents for use by governmental employers that have been “pre-approved” by the IRS. Typically, these plans consist of a basic plan document, about 30 to 50 pages in length, that sets forth “boilerplate” plan language that cannot be modified, along with an adoption agreement containing a number of fill in the blanks and check the box options that are used by the adopting employer to select its plan’s features. When a plan is pre-approved by the IRS, it issues an opinion letter or advisory letter. The IRS letter indicates that the form of the plan has been vetted by the IRS and the IRS has determined that it meets the basic requirements for a tax-qualified plan under Internal Revenue Code section 401(a).

Generally speaking, a governmental employer can complete, execute, adopt and utilize a pre-approved plan without the necessity of obtaining its own favorable determination letter regarding the plan’s tax-qualification from the IRS. However, as with so many things, life is not always that simple. Here are a few cautions and concerns that public agencies that utilize such plans, particularly in California, should be aware of:

  • Many pre-approved plans for governmental employers are sent out to public agencies for their completion and use with almost no guidance or instruction as to how they should be completed. Adopting employers need to get appropriate advice and help in filling out the various optional provisions of their plans – the failure to properly complete the proffered forms could lead to serious adverse tax consequences.
  • Most public agency retirement plans adopted in California are now subject to the requirements of the Public Employees Pension Reform Act of 2013 (PEPRA). PEPRA requires affected plans to be amended to comply with its provisions. In many cases, PEPRA applies to defined contribution plans, as well as defined benefit plans, maintained by California public agencies. If an agency amends its pre-approved plan to comply with PEPRA it will, most likely, take its plan out of pre-approved status. An agency using pre-approved plans should get advice on the application of PEPRA to its plans and the advisability of getting its own IRS determination letters.
  • Some pre-approved plans do not have sufficient flexibility to be used in some cases. For example, most of the pre-approved plans we have reviewed cannot accommodate an employer “matching” contribution made to one plan, which is based on the elective deferrals made under another plan. Also, many pre-approved governmental plans cannot accommodate the sponsor’s desire to provide designated allocations to various employee groups on a basis other than relative compensation. If an agency changes the pre-approved plan to accommodate this desire, it will, most likely, take its plan out of pre-approved status. At that point, it would be advisable for the agency to obtain its own determination letter.
  • Some pre-approved plan documents automatically appoint the sponsoring entity as the “trustee” for the plan. In many instances, this will violate the California Financial Code.
  • In some cases, the governmental pre-approved plan may be written in a way that confuses the adopting employer about its administrative and fiduciary duties under applicable state law.
  • Many pre-approved plans are provided as part of a “bundled” retirement package that includes plan recordkeeping and plan investment services. While there is nothing inherently wrong with such bundled arrangements, it is important for public agencies to understand that they do not necessarily have to use a provider’s plan document in order to gain access to its recordkeeping services or investment options. Most providers will unbundle these services from the plan document at the agency’s request.

In future chapters, we will talk about the process of selecting providers in connection with an agency’s retirement plans and how to evaluate their offerings.

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Chapter 10: Are You “Bitaxual”? If So, Watch Out!

This entry comes to you with the help of my colleague Wendy Tauriainen.

In our office, we enjoy the inside jokes of the pension and benefits world (yes there actually are jokes). One of them is the label “bitaxual” for those entities that are lucky enough to be both exempt from tax based on the fact that they are an “instrumentality” of government and because they have received a tax-exemption from the IRS as a Code section 501(c)(3) organization. One example of a governmental entity that might hold this special status is a public hospital district. So-called bitaxual entities are special because they can simultaneously maintain an eligible deferred compensation plan under Code section 457(b) and a Code section 403(b) plan.

We want to alert our readers to a development that is taking some governmental entities by surprise.  Recently, a number of our governmental clients, which are also 501(c)(3) tax-exempt organizations, have come to us after the IRS revoked their 501(c)(3) tax-exempt status for failing to file a Form 990 – Return of Organization Exempt from Income Tax.  This can be especially alarming for governmental 501(c)(3) entities that sponsor a 403(b) plan – a type of plan that can be sponsored only by a
501(c)(3) entity or a public education employer.  Without that 501(c)(3) status, a 403(b) plan that is sponsored by a governmental employer that is not a public education employer has suddenly lost its tax-favored status with potentially disastrous results for plan participants.

Here’s how it happens.  The IRS maintains a list of 501(c)(3) entities.  These entities, with certain exceptions, are required to file an annual Form 990.  Generally, governmental entities meet one of those exceptions and are not required to file a Form 990.  However, the IRS checks its database of 501(c)(3) entities looking for charities that haven’t filed their Form 990.  If the IRS finds one, and doesn’t know that the 501(c)(3) is also a governmental entity, it will automatically revoke the entity’s 501(c)(3) status if no Form 990 was filed for three consecutive years. 

How does the IRS know if your 501(c)(3) is also a governmental entity exempt from filing a Form 990?  It doesn’t, unless you apply to the IRS for a ruling on that question.  While such a ruling is not required for the Form 990 governmental entity exemption to apply, it may be worth considering.  Also pay careful attention to any letter you receive from the IRS demanding that your 501(c)(3) file a Form 990.  Ignoring these letters could result in an automatic revocation of 501(c)(3) status and the attendant consequences to your ability to raise funds or sponsor a benefit plan available to 501(c)(3) entities only.  Further, once 501(c)(3) status is automatically revoked, reinstatement can be an arduous process with no assurance that the reinstatement application will be successful. 

To sum up, if you are a governmental 501(c)(3), consider applying to the IRS for a ruling that you are a governmental entity exempt from filing Forms 990.  Also, keep a close eye on the mail and make sure to let the IRS know of your governmental status if the IRS starts asking for Forms 990.   It is much easier to deal with the IRS before it revokes your 501(c)(3) status than after it has taken that step.

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Chapter 9: Suffering A California Pension Reform Confusion Headache? This Might Help

A recent matter that came to our firm involving interpretation of the California Public Employees’ Pension Reform Act of 2013 (PEPRA) brought to light yet another painfully confusing question. What exactly is a “new member?”

During a recent phone call with counsel for a local agency, we discussed whether a new manager that the agency was planning to hire should be treated as a “new member” for PEPRA purposes. The determination would have significant financial implications for both the agency and the new manager. If, for example, the new manager could be viewed as a “classic member” rather than a “new member,” he would (among other things):

  • Be able to participate in the higher pre-existing pension formula used by the agency;
  • Not be required to contribute at least one-half of the employer’s normal cost for his pension; and
  • Be able to take advantage of the final pay provision of the pre-existing plan rather than be subject to the 36-months, highest average pay rule.

Conversely, if the new manager was a “new member” under PEPRA, the agency’s costs for providing regular retirement benefits presumably would decrease because of the various PEPRA limitations, but both the agency and the new manager could have a more difficult time negotiating an overall package of compensation and benefits that the parties felt were comparable to those for other similar managers.

In our case, the agency’s counsel informed us that the new manager:

  1. Had been employed by another California public agency over ten years ago;
  2. Had participated in a public retirement system during that time; and
  3. Had been employed by a private sector employer for the last ten years.

The agency’s counsel also informed us that his client had already determined that the proposed manager was a new member for PEPRA purposes. To this, we asked, “Has the agency looked into whether there is reciprocity between the manager’s original public retirement system and the one in which the agency participates?”  His response was that the agency had concluded that the new manager must be a new member because he had not been employed by a public agency for over six months and, therefore, must have suffered a six-month break in service.  We explained that the new law was not that simple and that the “six-month break in service rule” applied only to an individual who had participated in a public retirement system, such as CalPERS, had a six-month break in service, and then returned to the same retirement system, but with a new participating employer. This was not the case in our situation. So what was missed?

First, the agency had “relied” on information it had read in a summary of PEPRA. One that stated: In addition, if an individual has a break in service of more than six months, and then returns to a retirement system with a new employer, that individual will be considered a new member and must be provided the lower benefit formulas specified by PEPRA.

While this statement is on its face accurate, agencies must bear in mind that this description deals with only one of three ways an individual can be a new member and pertains only to participation and re-participation in the same retirement system. In our case, the new manager had participated previously in a pubic retirement system that was different than the one in which the hiring agency participated.

Second, there were two other ways that an individual could be a new member under PEPRA.  Government Code section 7522.04(f) states (as relevant here):

New member” means any of the following:

  1.  An individual who becomes a member of any public retirement system for the first time on or after January 1, 2013, and who was not a member of any other public retirement system prior to that date.
  2. An individual who becomes a member of a public retirement system for the first time on or after January 1, 2013, and who was a member of another public retirement system prior to that date, but who was not subject to reciprocity under subdivision (c) of Section 7522.02.
  3. An individual who was an active member in a retirement system and who, after a break in service of more than six months, returned to active membership in that system with a new employer.

Even though the third basis for being a new member was inapplicable in this case, we still needed to look at clauses (1) and (2).  Clause (1) clearly didn’t apply because the new manager had previously participated in a public retirement system prior to 2013. However, clause (2) could apply if there was no reciprocity between the retirement system in which he previously participated and the agency’s retirement system.  The agency needed to determine whether such reciprocity existed.  If it did, the new manager would not be a “new member.” 

Painful PEPRA headache gone for now? Just wait.

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