Guest Article

(From the June 19, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

No ERISA Preemption of California Unrelated Business Income Tax

ERISA does not preempt the application of California's unrelated business taxable income (UBTI) tax to an ERISA pension trust, which is otherwise tax-exempt under both U.S. and California tax law. The California tax has neither the "connection with" the ERISA plan, nor a "reference to" ERISA plans specifically required by the Supreme Court's tests for ERISA preemption. Hattem v. Schwarzenegger, ___ F. 3d ___, No. 05-3926-cv (2d Cir., May 23, 2006). Many states have UBTI laws, and the application of those laws to ERISA plan trusts has been an issue for years.

Issues and Reasoning

The plaintiff, a trustee of a major communications company's $21 billion dollar ERISA plan trust, argued the trust had paid more than $6.1 million of UBTI to California since 1994 and had foregone "an unquantifiable amount of income by avoiding UBTI generating investments." (The plaintiff-appellants also claimed the UBTI is preempted by the Tax Injunction Act, which bars use of federal courts in determining state tax law disputes if state court remedies are available. But the appeals court rejected that argument out of hand.)

In affirming the lower court's decision, the appeals court began by noting the primary purpose of the UBTI laws is to even the competition between for-profit and not-for-profit organizations. (Given that pension trusts can -- and do -- own and operate considerable businesses, this is not an insignificant issue of fairness.)

The court based its conclusions against preemption of state law on the facts that the California UBTI law:

The opinion provides a valuable history of the evolution of ERISA preemption law, beginning with the very narrow preemption ruling in N. Y. State Conf. of BCBS Plans v. Travelers, 514 U.S. 645 (1995), and continuing through Cal. Div. of Labor Standards Enforcement v. Dillingham Const. Inc., 519 U.S. 316 (1997) and Egelhoff v. Egelhoff, 532 U.S. 141 (2001).

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2006, Deloitte.