Speakers Ask IRS for Clear Rules, Respect For States in Governmental Plan Rulemaking

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IRS Hearing on Definition of Governmental Plan  

Key Topic: IRS hears testimony from attorneys on federalism principle and need to respect state and local authority in crafting a regulation.

Key Takeaway: Practitioners say clear rules are necessary to avoid an avalanche of requests for private letter rulings.

By Florence Olsen  

The Internal Revenue Service should avoid asking public retirement system administrators to enforce IRS rules that are unclear, uncertain, and impractical, public pension attorneys told IRS and Treasury Department officials at a regulatory hearing July 9.

“As a practical matter, public retirement system administrators cannot be the police for IRS in enforcing uncertain rules,” Judith W. Boyette, a partner at Hanson Bridgett in San Francisco, testified at the hearing.

Boyette was among more than a dozen speakers at a rulemaking hearing aimed at clarifying the definition of “governmental plan” under Section 414(d) of the tax code, as well as related terms in that section, such as “state,” “political subdivision” of a state, and “agency or instrumentality” of a state or political subdivision of a state. In November 2011, IRS released a draft proposal (REG-157714-06) as a preliminary step in the rulemaking process (216 PBD, 11/8/11; 38 BPR 2082, 11/15/11).

Public retirement system administrators are most concerned that any IRS rules that would draw a brighter line between governmental and nongovernmental plans be “clear, certain, and practical,” Boyette said. She and other attorneys said that IRS has taken on a challenging project in trying to draw a clear line between the two.

Federalism Principle.

Boyette also recommended that IRS change its draft rules “to better recognize the fundamental principle of federalism,” a comment echoed by others who testified.

“While we certainly understand that the service cannot blindly accept any statement that an entity is a governmental entity, if that statement is supported by sound state or local government authority, that authority must be respected and accepted,” she said.

Another attorney, speaking on behalf of the State Bar of Texas Section of Taxation, said the draft document that IRS released was a useful first step in the rulemaking process. “It's helpful to have something so detailed,” said Stephanie Schroepfer, a partner at Fulbright & Jaworski in Houston.

Schroepfer said her suggestions on behalf of the state bar mostly involve “possible tweaks” that would expand or clarify the list of possible factors to be used in a facts-and-circumstances determination of an entity's governmental status.

“For example, it would be very helpful if the factors could be modified to specify that an entity may be a governmental entity if it possesses 'some' sovereign powers,” rather than “sovereign powers,” Schroepfer said.

Schroepfer suggested that IRS treat its list of factors in the draft proposal as a nonexclusive list and, in the next step in the rulemaking process, add language to the effect that “no inference should be drawn necessarily from the failure to satisfy one or more of the factors.”

Private Letter Rulings.

If IRS were to make those changes, many government entities would “get comfortable” and would not feel a need to apply for private letter rulings on their plans' governmental status, Schroepfer said. “We see a real potential for you to be swamped with ruling requests if there is not some expansion and some implementation of safe harbors,” she added.

Another attorney, also speaking on behalf of the state bar section, said that some universities are concerned about what might happen under the draft proposed regulation to many governmental entities that are “creatures of state law.”

Attorney Henry Talavera, a shareholder at Polsinelli Shughart in Dallas, asked IRS to consider broadening its draft definition of instrumentality. If a university or other entity identifies certain individuals as “part of us and our instrumentality,” that should govern, he said. “I understand that that's a broad expansion of the rules, but that's what we would like,” he added.

Potential Cycle C Logjam.

The rulemaking that IRS has undertaken is especially difficult because of changes in the delivery of essential governmental services, notably the outsourcing of some of those services to the private sector, Mary Beth Braitman, a partner at Ice Miller in Indianapolis, testified at the hearing. “We think those present some of the most difficult and challenging areas for this project,” Braitman said.

Meanwhile, she added, IRS should keep on track with its determination letter program submission cycle for governmental plans, which opens in fewer than seven months. Governmental plans should be permitted to “self identify” themselves for the next Cycle C submissions, she said, “so we don't create some logjam waiting for final regulations that are still in the offing and get really far behind.”

By Florence Olsen