Carol V. Calhoun

For a long time, that was true. Unless a governmental plan committed such egregious violations that they turned up on the front page of the newspaper, they didn't get audited. But we're involved in one at the moment, in which the IRS is alleging violations of minimum distribution requirements.

Yes, we have seen governmental plans audited. The motivation to challenge IRS actions is limited by the fact that the IRS is generally willing to accept a settlement that is far less costly than disqualification (and any applicable excise taxes).

The IRS has authority to audit the compliance of governmental 401(a) or 403(b) plans with Internal Revenue Code requirements.

We have a grandfathered split dollar arrangement based on a modified endowment contract (MEC). The employer is entitled to the premiums paid (without interest) upon surrender of the contract or upon death. At this point, the employer (which is a tax-exempt organization) would like to get out of the contract, by either taking its share as a loan or by taking a cash withdrawal of its share. At that point, the employee would own the contract. The issue is what the tax consequences of this would be. Normally, distributions from an MEC are treated as coming first out of income (taxable) and only after that out of basis (nontaxable). However, in this case, the party taking the distribution would be a tax-exempt organization. Does anyone believe that either a) the employee would be taxed on the amount withdrawn, even though it is the employer getting the money, or b) the employer would be subject to UBIT on amount withdrawn?

Section 457(f)(2)(E) contains an exception to the normal rules under section 457 for "a qualified governmental excess benefit arrangement described in section 415(m)." Among the requirements of section 415(m) is that the plan "is maintained solely for the purpose of providing to participants in the plan that part of the participant’s annual benefit otherwise payable under the terms of the plan that exceeds the limitations on benefits imposed by this section." Given that "this section" is section 415, it appears that a qualified governmental excess plan can provide only benefits in excess of the 415 limits, not benefits that are cut back due to the limitations on compensation in section 401(a)(17). However, a governmental 401(a) plan is not bound by the rules against discriminating in favor of highly compensated employees. Would it therefore be possible to say that for everyone except one individual, the benefit is for example 2% of compensation times years of service, but that for a specified individual, the benefit is for example 4% of compensation times years of service? The 4% would likely be developed in order that the individual's benefit would be the same percentage of total compensation as everyone else's, but it would not directly reference compensation over the 401(a)(17) cap. At that point, all benefits not in excess of the 415 limit could be provided by the qualified plan, while those above that limit could be provided by the excess plan. Alternatively, has anyone seen any flexibility on the part of the IRS to allow an excess plan to deal with the compensation limits as well as the 415 limits?

This is correct. An annuity under a 403(b) plan must be purchased "for an employee." The employee is the owner. So the employer can set up a new investment for future contributions, and can advise employees to move the old money. However, it can typically not move the old money itself.

If their intent was simply to stop making contributions to the old plan and start a new one, they could consider simply merging the old one into the new one. As Tom Poje says, it is possible to terminate a PS plan without 401(k) features, without worrying about a successor plan. However, merging the plans would avoid the administrative issues of either terminating the old plan or maintaining two plans.

If no employee had compensation of at least $120,000 or was a five-percent owner, then no employee is a highly compensated employee, and the tests will automatically be passed.

A citation isn't really possible, because we're talking about the absence of a statute, not the presence of one. The statute says you can't get a tax deduction for a contribution of more than $X. It doesn't say that there is an excise tax on contributions of more than that amount, or that your plan is disqualified, or that it's a violation of ERISA. So even if you were talking about a taxable employer, it could make contributions of more than $X. It just wouldn't get a tax deduction for them. So what possible penalty could there be in the case of an organization that doesn't get tax deductions in the first place?

In either case, the deductibility limits do not apply.

There are two ways a 403(b) plan can be a non-ERISA plan. One is to be a governmental or nonelecting church plan. The other is to be a plan, other than either of the preceding, which has minimal employer involvement (as described in DOL regulations). The author's statement is true if the latter exemption is being used, but not if the former one is.

Section 411 doesn't apply to a governmental plan. See 411(e)(1)(A). However, in many states, federal or state constitutional provisions on the impairment of contracts have been interpreted to prevent adverse changes to present or future benefits for current employees. (This is actually a tougher standard than 411(d)(6), as it prevents even changes to future benefit accruals for such employees.) You would therefore want to research court decisions in the relevant state.

Yes, it would be a problem. In theory, contributions under a 403(b) plan must be nonforfeitable. 26 C.F.R. § 1.403(b)-3(a)(2). As a practical matter, though, there is a workaround built into the regulations whereby forfeitable contributions are treated as not having been made to the 403(b) plan, but rather to a separate I.R.C. § 403(c) annuity (or a tax-exempt employee trust where a custodial account is used), when they are made. (Forfeitable contributions are required to be kept in a separate bookkeeping account than nonforfeitable contributions.) Then, as amounts become vested, and assuming all of the 403(b) plan conditions (other than nonforfeitability) are met for those contributions, those amounts are retroactively treated as having been made to the 403(b) plan for purposes of the maximum limits on contributions when they become nonforfeitable. 26 C.F.R. § 1.403(b)-3(d)(2). But in this case, the contributions were nonforfeitable when made. Thus, making them forfeitable again would amount to out taking money already in the 403(b), which would be impermissible.

The W-2 is the only option. The amount is wages, and is subject to income (though not FICA) withholding as such, even though payment is delayed until after termination of employment. It's the same way as you would deal with deferred compensation from a taxable entity.

How does a government "acquire" a not-for-profit entity? Such entities have no owners, so you can't purchase one. Did the government buy the assets, or what happened? The other issue to consider is whether the nonprofit is now itself a governmental instrumentality. If the only member of the nonprofit is a governmental entity, there is a good chance that it is. In any event, if the nonprofit has somehow failed to become a governmental instrumentality, and is still an ERISA plan and subject to coverage rules, I'm not sure how you could possibly apply them on a controlled group basis, given that such rules do not apply to governmental plans. You would, of course, still have to apply the universal availability rules.

Rather than having a separate rate group for each person, it would be simpler just to provide in the 401(a) plan that it will match contributions to the 457(b) plan. So long as you identify the 457(b) plan involved (so as to preclude employer discretion) , this would not be a legal issue.

No, the relevant language is that , What the DOL is saying is that a plan established and maintained for nonemployees does not fit within this definition, regardless of whether those nonemployees are fulfilling a governmental function.

Well, they wouldn't necessarily violate the exclusive benefit rule, but the plan would become subject to the ERISA rules that apply to nongovernmental plans--which would mean it would have to comply with things like the J&S rules. I didn't claim it made sense, but that was the position the DOL was taking, based on the literal language of the statute. As you can see in Advisory Opinion 94-02A, the DOL made us represent that there had never been any independent contractors in the plan before it would issue the opinion.

We definitely encountered this years ago, when we asked the DOL for an opinion letter stating that a particular 457(b) plan was a governmental plan. They made us exclude independent contractors from the plan before issuing the letter. See https://benefitsattorney.com/authorities/advisory-opinion-94-02a/ Of course, these days, neither the DOL nor the IRS will issue guidance on whether a plan is a governmental plan. But I would still keep plans for employees and independent contractors separate.

That would be a question of state law. Governmental plans are not subject to Internal Revenue Code prohibitions on cutbacks of benefits. However, many state courts have held that state constitutional prohibions on the impairment of contracts preclude cutbacks. The existence of such prohibitions, the extent to which they apply (e.g., only to existing accruals or to all future accruals for existing employees), and the extent to which they protect the form of benefits as opposed to just their actuarial value varies from state to state.

No. The requirement that a qualified joint and survivor annuity be provided, unless the spouse consents to a different form, comes from section 401(a)(11), which incorporates by reference section 417. However, section 401(a)(11) is made inapplicable to governmental plans by the last sentence of section 401(a) (following 401(a)(37)). I've got a checklist of which requirements do and do not apply to governmental plans at this link, if that's helpful.

Assuming that the sponsoring employer was not governmental, I can see no reason that Forms 5500 would not be required. Normally, these could be filed under the Delinquent Filer Voluntary Compliance Program (DFVCP).

Are we talking about a governmental 457(b) or a 457(b) of a nongovernmental entity? In the case of a nongovernmental entity, a 457(b) is purely a contractual obligation. Thus, I would assume that the contract could be set up in the first place so as to provide for forfeiture in the event of a crime against the employer. Doing so would likely not result in the amounts contributed being treated as subject to a substantial risk of forfeiture. 26 C.F.R. § 1.83-3(c)(2) says that it would not for purposes of section 83, and an old EO Text indicates that the same rule applies for purposes of section 457(b). In the case of a governmental entity, the same rules should apply. However, there are two issues. First, because a governmental 457(b) plan is funded, some provision would need to be made for what would happen in the event that an amount was forfeited. Presumably, this would involve decreasing future employer contributions, inasmuch as adding it to other participants' account could result in going over the annual 457(b) maximum. The second issue is that governmental entities are often subject to Constitutional rules prohibiting modification of even future accruals under a retirement plan with respect to individuals who have already begun participation. Thus, if a plan does not initially provide for forfeiture, it may be impossible to modify the plan to do so with respect to existing participants. Obviously, the judicial decisions in the particular state should be consulted to determine whether this is an issue.

For those following along at home, I was able to talk to a senior IRS official about this. He says that although EPCRS is not explicit about VCP fixing the participant taxation issue (as opposed to the qualification issue), the IRS will not challenge the tax-deferred status of elective deferrals to an ineligible 401(k) plan if VCP procedures are followed. Thus, we can do what we hoped: shut down the 401(k) plan to future deferrals (and eventually terminate it), and allow participants to make new deferrals and roll over the old money to a new 457(b) plan. Of course, this means that participants won't have to roll over, but can choose to just take the money, but the client does not consider this a problem.

Thanks--good to know!