ABATax Employee Benefits Committee Comments

Section of Taxation
Comments from the Employee Benefits Committee

Comments Concerning Nondiscrimination Standards for Governmental Plans

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Definition of Controlled Group

Issue
Section 414 contains several provisions for determining the "controlled group of employers," the related businesses that are considered the employer for most employee benefit plan purposes. While the statutory rules are effective for determining the controlled group for private employers, they are not effective for determining the controlled group among governmental employers.

Analysis
The controlled group rules generally determine the scope of the employer based on some determination of ownership, such as stock ownership of a corporate employer, a standard that is ineffective for determining relationships between governmental entities. In fact, the controlled group rules generally take separate employers and treat them as a combined employer. In the employee benefit plan context, there is no guidance concerning which governmental employers are considered separate, much less those that would then be combined. 29

The nondiscrimination moratorium for governmental plans significantly reduces the importance of the controlled group rules for governmental employers. However, the controlled group rules are still important for governmental plans for purposes of applying the §415 limits on contributions and benefits and the §401(a)(17) limit on compensation. Benefits and contributions from different plans sponsored by different employers that are part of the same controlled group are aggregated in applying the limits of §415. Likewise, compensation paid by different employers that are part of the same controlled group is combined in applying the limits of §401(a)(17).

In the only known guidance on the application of the controlled group rules to governmental employers for these purposes, a general information letter 30 states the following:

Where separate governmental plans are maintained by different governmental units, the governmental units are treated as a single employer for purposes of the aggregation requirement under section 415(f) pursuant to a reasonable and good faith interpretation of the rules and definitions under sections 414(b), (c), (m), and (o) of the Code. The controlled group definition under Notice 89-23, 1989-1 C.B. 654 (the 80 percent control or funding test), is considered a reasonable (but not exclusive) interpretation of these definitions consistent with the unique nature of governmental entities.

Recommendation
Given the limited use of the controlled group rules for governmental employers and the complex issues to be resolved in establishing definitive controlled group rules for governmental employers, expending critical IRS resources in establishing more complete guidance does not appear to be warranted. The reasonable, good faith standard established in the general information letter should be sufficient for governmental employers and their advisors to determine the appropriate application of the §415 limits on contributions and benefits and the §401(a)(17) compensation limit. However, providing the only statement of the controlled group rules for governmental employers in a general information letter is generally insufficient to apprise such employers of this standard.

The reasonable, good faith standard for the application of the controlled group rules for governmental employers should be announced in IRS guidance of general application. The guidance concerning the definition of governmental plans discussed above could serve as a suitable vehicle. If the IRS has internally developed other reasonable interpretations concerning the application of the controlled group rules to governmental employers, those should be included as well.

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Clarification of §401(k) and §401(m) Treatment

Issue
One change made to the moratorium during the conference deserves a minor clarification. Sec. 912(b) of the House bill (H.R. 2014) and sec. 1308(b)(2) of the Senate bill (S. 949) contained provisions treating governmental plans as satisfying the requirements of §401(m)(2) of the Code. This provision was omitted in conference and is not contained in the legislation enacted on August 6, 1997. Additionally, the text of the legislative provisions does not discuss the application of the requirements of §401(k)(3) of the Code to "grandfathered" §401(k) plans sponsored by governmental employers.

Analysis
Section 401(m)(2) provides a nondiscrimination test for matching and employee contributions to a qualified plan, referred to as the Average Contribution Percentage test (ACP test). The ACP test is a subset of the general nondiscrimination test set forth in §401(a)(4). For example, plans that are the subject of collective bargaining are generally exempt from the nondiscrimination standards of §401(a)(4) 31 and specifically exempt from the ACP test. 32 More broadly, §401(m) is by its terms merely a prerequisite for satisfying §401(a)(4) with regard to matching and employee contributions. 33 Accordingly, the permanent moratorium for government plans from the nondiscrimination standard under §401(a)(4) presumably covers the ACP test as well. The legislative history of the moratorium in its early stages confirms this, indicating that "the exemption from the nondiscrimination and participation rules includes exemption from the ACP and ADP tests." 34

Though governmental employers are generally precluded from sponsoring §401(k) plans, 35 certain "grandfathered" governmental §401(k) plans are allowed. 36 Section §401(k)(3) provides a nondiscrimination standard for elective deferrals into a qualified cash or deferred arrangement, referred to as the Average Deferral Percentage test (ADP test). It is our understanding that the IRS views the ADP test as both a nondiscrimination standard and a qualification requirement for a qualified cash or deferred arrangement, thereby making the ADP test a prerequisite for the pre-tax treatment of elective deferrals and potentially outside the scope of the nondiscrimination moratorium. 37 The legislative history of the moratorium (referenced above), however, indicates congressional intent that governmental §401(k) plans be exempt from the ADP test.

Recommendation
The IRS should clarify that the reason for the removal from the legislation of the specific exemption from the ACP test was that a specific exemption was unnecessary, not that the ACP test continues to apply to government plans. Otherwise, some plans might not be aware of the exemption and continue to perform compliance testing. Additionally, the IRS should clarify the application of the ADP test to §401(k) plans maintained by governmental employers. The IRS should issue guidance indicating that the moratorium on the nondiscrimination standards includes both the ADP test for elective deferrals and the ACP test for matching and employee contributions.

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