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Credit Unions Under New Common Control Rules
(Posted December 29, 2008)
Question 299: This question relates to credit unions and the common control regulations for tax-exempt organizations (Sec. 1.414(c)-5). There are a number of credit unions that are "sponsored" by various types of employers (corporations, school districts, government agencies, etc.). The credit unions were essentially established to serve as financial institutions for the organizations' employees. And, in many cases, the credit union membership is limited to employees of those organizations. Every credit union has a board of directors. In situations where a credit union is sponsored by an employer organization, the board of directors is mainly comprised of employees of the organization. They are elected by the credit union membership, not appointed by the employer organization. But they are nonetheless employees of the organization. My question is: Are these credit unions under common control with the sponsoring employer under the new regulations?
Answer: This excellent question is important for several reasons besides the concerns of credit unions:
The relevant issue comes from Treas. Reg. §1.414(c)-5(b) and requires very careful analysis. I will put set forth the key language, and I will take the liberty of numbering the sentences so we can easily refer to it:
- It illustrates well that the new common control regulations apply to all types of tax exempt organizations. They are not limited to 501(c)(3) charities. Credit unions are exempt under Code §501(c)(1) or (c)(14).
- It also illustrates that the new regulations apply to qualified plans as well as 403(b) plans, even though they were issued as part of the 403(b) regulation package.
- It is timely because the new regulations go into effect for plan years beginning after 2008.
- It is also timely because I discuss those new regulations at length in my recently issued 5th edition of Who’s the Employer. (More on that later.)
- Finally, it illustrates an interesting peculiarity of the regulations.
Sentence 1 says that the common control rules apply to an exempt organization and “any other organization.” In general, the new rules are not limited to pairs of exempt organizations, but could apply to an exempt organization and a for-profit company, or an exempt organization and a government unit.
- In the case of an organization that is exempt from tax under section 501(a) (an exempt organization) whose employees participate in a plan, the employer with respect to that plan includes the exempt organization whose employees participate in the plan and any other organization that is under common control with that exempt organization.
- For this purpose, common control exists between an exempt organization and another organization if at least 80 percent of the directors or trustees of one organization are either representatives of, or directly or indirectly controlled by, the other organization.
- A trustee or director is treated as a representative of another exempt organization if he or she also is a trustee, director, agent, or employee of the other exempt organization.
- A trustee or director is controlled by another organization if the other organization has the general power to remove such trustee or director and designate a new trustee or director.
- Whether a person has the power to remove or designate a trustee or director is based on facts and circumstances.
- To illustrate the rules of this paragraph (b), if exempt organization A has the power to appoint at least 80 percent of the trustees of exempt organization B (which is the owner of the outstanding shares of corporation C, which is not an exempt organization) and to control at least 80 percent of the directors of exempt organization D, then, under this paragraph (b) and § 1.414(b)-1, entities A, B, C, and D are treated as the same employer with respect to any plan maintained by A, B, C, or D for purposes of the sections referenced in section 414(b), (c), (m), (o), and (t).
Sentence 2 sets forth the standard that we use to determine if common control exists under the regulations. If at least 80% of the board members (be it board of directors or board of trustees or any other governing body) of one organization are “representatives of” or “controlled by” the other organization, the two are under common control. Again, sentence 2 carefully indicates that it applies to an exempt organization and “another organization”
Sentences 3 and 4 define “representative of” and “controlled by,” respectively. Suppose I am on the board of exempt organization 1. Sentence 3 tells us that if I am a board member, agent, or employee of another exempt organization, I am a representative of that second organization. Sentence 4 tells us that if another organization has the general power to remove and replace me (under all facts and circumstances — see sentence 5), I am controlled by the second organization.
Now, compare the types of entities described in sentences 3 and 4. Sentence 4, defining “controlled by” follows the pattern of sentences 1 and 2. It is not limited to a pair of exempt organizations. In fact, if sentence 4 stood on its own, it could apply to any two organizations, regardless of exempt status. Of course, in context, at least one of the two organizations must be an exempt organization for the paragraph as a whole to apply.
But now look at sentence 3. In this very carefully crafted paragraph, sentence 3, the definition of “representative of” is limited to two exempt organizations. By its terms, sentence 3 does not apply to the combination of an exempt organization and a taxable business.
(Sentence 6 provides an example showing a chain of related organizations. The only taxable organization is C, which is part of the chain under the normal parent-subsidiary rules, without regard to the new regulations.)
This new rule does not apply to churches or church-controlled organizations. Treas. Reg. §1.414(c)-5(a). According to the regulatory preamble, it also does not apply to “a State or local government or a federal government entity.”
I submit there are two ways to interpret the limitation of sentence 3.
A. The Treasury didn’t mean it when they limited sentence 3 to two exempt organizations, and read in context they really intended it to apply to any pairing of an exempt organization and another organization. If that’s true, the employer-sponsored credit unions may be in deep trouble if they try to establish separate plans. But there is nothing in the regulatory language or the preamble to suggest that is true.
B. Alternatively, the Treasury meant what they said. An exempt organization can be under common control with any other organization if one of the two organizations controls at least 80% of the directors of the organization. If (and only if) you are dealing with two exempt organizations, you expand the common control situations to include directors of one organization who are “representatives of” or “controlled by” the other organization. If you can’t tell, I favor interpretation B. I am reading the words on the page and assuming that the Treasury meant what it said.
What does this mean for a credit union plan? Suppose a taxable organization sponsors a credit union for its employees. As the question describes, employees of the sponsor serve as the board of directors of the credit union. However, the sponsoring organization does not, itself, have the power to remove or appoint directors. Therefore, the sponsoring organization does not “control” the credit union directors. Since sentence 4 does not apply on the facts, we are left with sentence 3. This gives us the following picture
If you think this is convoluted, you are correct. But I think this is what they have given us. I should also note that the regulations also include an “anti-abuse rule” (which I call a “smell test”) which lets the IRS apply common control status when the IRS thinks it should. Treas. Reg. §1.414(c)-5(f). It is impossible to know how the IRS will apply that rule.
- If the sponsoring organization is a governmental unit, the new common control rules do not apply because of the preamble.
- If the sponsoring organization is an exempt organization, then sentence 3 applies. Since all directors of the credit union would be “representatives of” the sponsor (by virtue of their status as employees), the sponsor and the credit union would be under common control. I see no way around this.
- If the sponsoring organization is a taxable organization, then sentence 4 does not apply. The sponsor and the credit union would not be under common control.
This is only part of the discussion of the new common control rules from the 5th edition of Who’s the Employer. Although I have begun shipping the print edition of the book, I will continue to honor my
"pre-order" 10% discount on all orders received through January 7, 2009.
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