Chapter 3: The Trouble With Being “Governmental” – Falling On The Wrong Side Of This Definition Could Hurt

Last fall, the IRS announced that it would begin the process of issuing regulations to clarify what is a “governmental plan” under Internal Revenue Code section 414(d) and asked interested parties to comment on the general approach it was taking with respect to the regulation. February 6, 2012 was established as the deadline for submitting comments on the Service’s Advanced Notice of Proposed Rulemaking (also known as Announcement 2011-78).

Because we deal with so many different types of public agencies in our practice, and have sought IRS guidance on this issue on numerous occasions, we know that the process of developing a helpful and administrable definition of a governmental plan will be challenging and difficult. More importantly, based on what we have seen so far, we think that many, many organizations and entities that currently view themselves as governmental for retirement plan purposes could be in for rude awakenings when the final rule comes out. For example, we know that the IRS has had difficulty in the past in deciding whether some of the following types of entities would qualify as governmental plan sponsors:

  • A joint powers authority consisting of both governmental subdivisions and public nonprofit organizations;
  • Certain charter schools; and
  • Certain auxiliary organizations connected with State and community colleges and universities.

Along with many other organizations, we filed comments with the IRS. If you care to view them, click here.

If you are involved with a public agency that is not 100% sure of its governmental status, you most likely are aware of the potential problems that could arise if the agency were determined to be not a governmental plan sponsor. Lurking among the possible parade of horribles are:

  • What happens to your past and future participation in a State retirement system like CalPERS or CalSTRS?
  • Will your agency’s tax qualified retirement plans be retroactively disqualified because you adhered to the wrong set of qualification rules?]
  • What will become of your Social Security replacement plan, and the fact that you and your employees have not been paying into Social Security for years?
  • Could your participation, along with many other “nongovernmental” employers, ruin the tax-exempt status of CalPERS or CalSTRS?
  • What about that section 457(b) plan of yours? Remember, you’ve been operating under the governmental rather than the
    tax-exempt set of rules.
  • If the IRS’s final rules would treat your entity as nongovernmental, is there any chance you would be grandfathered under the
    pre-existing rules, or be eligible for some type of transition relief?

Obviously, there is a lot to think about, particularly if you know you exist in that gray area of the law. If you believe you could be adversely affected by the final rules, you should look into joining forces with other similarly-situated entities and letting the IRS know about your concerns. The IRS rulemaking process is just beginning and there is still much that can be done to address some of the difficult issues raised here.

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