Question 304: A county government says it owns and controls a county hospital. An IRS letter to the hospital does not say it is qualified under Internal Revenue Code section 501(c)(3), although it says the hospital is an organization described in sections 509(a)(1) and 170(b)(1)(A)(iii). The hospital wants to establish a retirement plan to cover its employees. Can the hospital sponsor a 401(k) plan, or is it considered a "governmental" entity and hence ineligible to sponsor a 401(k) plan?
Answer: You haven't provided enough facts to answer your question. Code section 509(a)(1) says the organization is not a private foundation. The reason it is not a private foundation is that it falls under Code section 170(b)(1)(A)(iii), which describes certain organizations providing hospital care or medical care, education, or research. It doesn't answer the question of whether it a "local government or political subdivision thereof."
(As your question indicates, you already know that section 401(k)(4)(B)(ii) states that 401(k) does not apply "if it is part of a plan maintained by a State or local government or political subdivision thereof, or any agency or instrumentality thereof.")
Recently the IRS released a draft proposed regulation that would define a "governmental" plan. It's only a draft (not even a proposal, yet) and taxpayers cannot rely on it. But it does a good job of outlining the current law on the subject.
With or without the regulation, determining whether the plan would be a governmental plan is not a casual undertaking. It will require information and analysis.

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