IRS Issues Draft Governmental Plan Regulations

Generally, under the law, a governmental plan is exempt from most of the provisions of the Employee Retirement Income Security Act of 1974 (ERISA) that apply to a plan maintained by a non-governmental entity such as a corporation. The current list of exemptions for a governmental pension plan includes the minimum funding rules, the non-discrimination rules, and coverage by the Pension Benefit Guaranty Corporation (PBGC).

On November 8, 2011, the Internal Revenue Service published two advanced notices of proposed rulemaking (ANPRMs) concerning the definition of a governmental plan under Internal Revenue Code section 414(d). Section 414(d) was added to the Internal Revenue Code by ERISA. One ANPRM sets forth general rules that would apply to any plan that wanted to be considered as a governmental plan and the other ANPRM sets forth special rules for plans maintained by Indian Tribal governments. Each ANPRM includes a draft regulation and invites comments. This alert will focus on the most important features of the general requirements that would apply to all plans under section 414(d).

Action Needed: Entities should carefully review the ANPRM and the draft rules for the possible impact on their plans, and then consider if they want to submit comments, which are due by February 6, 2012.

Cheiron Observation: No regulations have been issued under section 414(d), so this represents a significant step for the IRS.1 For those not familiar with regulatory terminology, the ANPRM is comparable to the Governmental Accounting Standards Board's Preliminary Views in the overall process of issuing a final rule.

Overview of Draft Rules

Section 414(d) of the Code generally defines a governmental plan as "a plan established and maintained for its employees by the Government of the United States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing." The draft rules begin by defining whether an entity is an agency or instrumentality of the United States, of any State, or of any political subdivision of a State, and would also define the term "political subdivision of a State."

Next, the draft rules would define what it means for a plan to be "established and maintained" by a governmental entity. The draft rules include provisions for changes in status of an entity maintaining a plan. The change in status can be from a governmental entity to a private entity or from a private entity to a governmental entity.

Cheiron Observation: The definition of an agency or instrumentality of a State or of a political subdivision of a State is arguably the most important part of the draft rules. The determination of whether an entity is an "agency or instrumentality" is the focus of most of the examples and is the reason that the IRS decided to move forward with the guidance project. The "agency or instrumentality" definition will potentially affect many plans that cover workers not directly employed by a state, city, or town.

Agency, Instrumentality, or Political Subdivision

The draft regulations use a facts and circumstances test to determine whether an entity is an agency or instrumentality of a state or of a political subdivision of a State. The facts and circumstances would include major factors and other factors to be considered in making the determination. The way the entity refers to itself is not a factor to be weighed. The major factors are whether:

- the entity's governing board or body is controlled by a State or political subdivision of a State;

- the members of the governing board or body are publicly nominated and elected;

- the entity's employees are treated in the same manner as employees of the State (or political subdivision) for purposes other than providing employee benefits (for example, the entity's employees are granted civil service protection);

- a State (or political subdivision) has fiscal responsibility for the general debts and other liabilities of the entity (including responsibility for the employee benefits under the entity's plans); and

- in the case of an entity that is not a political subdivision, the entity is delegated the authority to exercise sovereign powers (which generally means the power of taxation, the power of eminent domain, and police powers) of the State (or political subdivision), and the delegation is pursuant to a statute of a State (or political subdivision).

The draft regulation makes it clear that control of an entity's governing board is not satisfied if the power of control is materially restricted. For example, if public officials of a State have the power to appoint, and to remove and replace a majority of the entity's governing board, the factor of control would appear to be met. However, if a board member can be replaced only with an individual chosen from a list of designees selected by the other board members, then the control is materially restricted.

The preamble to the draft regulation also states that control cannot be a mere legal possibility. Examples of situations where control might be a mere legal possibility are where there are a number of tiers of intervening corporations between the entity and the State, and where the legal power of control is shared among so many governing entities that none of them can be said to be responsible in the event of a failure to exercise control.

Other factors to be considered in whether an entity is an agency or instrumentality of a State or of a political subdivision of a State include whether:

- the entity's operations are controlled by a State (or political subdivision);

- the entity is directly funded through tax revenues or other public sources (but not from public funds under a contract to provide a governmental service or through grants);

- the entity is created by a State (or political subdivision) pursuant to a specific enabling statute that prescribes the purposes, powers, and manners in which the entity is to be established and operated;

- the entity is treated as a governmental entity for Federal employment tax or income tax purposes (such as the authority to issue tax-exempt bonds) or under other Federal laws;

- the entity is determined to be an agency or instrumentality of a State or of a political subdivision of a State for purposes of State laws (e.g., the entity is subject to open meeting laws or to the requirement to maintain public records that apply only to governmental entities);

- the entity is determined to be an agency or instrumentality of a State or (political subdivision) by a State or Federal court;

- a State (or political subdivision) has the ownership interest in the entity and no private interests are involved; and

- the entity serves a governmental purpose.

The draft regulation contains a variety of examples that apply the factors described above. The examples include entities that are a utility company, a non-profit corporation, a clinical practice run by a medical school faculty, and a non-profit corporation running a hospital. The conclusion in most of the examples is that the entity is not an agency or instrumentality of a State or of a political subdivision of a State.

Cheiron Observation: Where a State plan covers employees of municipalities and other entities (especially those created by the municipalities), the State may want to ascertain whether the other entities would be considered agencies or instrumentalities of the municipality under the draft regulations. This may require a careful review of governing statutes and legal powers. As discussed more below, the coverage of employees of a non-government entity will apparently cause the plan to lose its governmental status. At a minimum, comments as to appropriate transition rules or periods may be in order.

Established and Maintained

Under the draft regulation, a plan is established and maintained for the employees of a governmental entity if:

- The plan is established and maintained by an employer within the meaning of the pension regulations;

- The employer is a governmental entity; and

- The participants covered by the plan are employees of that governmental entity.

Under the draft regulation, if an employer becomes a government entity, or a governmental entity becomes the employer under the plan, the plan will be treated, for purposes of the regulation, as being established by that governmental entity on the date of the change. In general, if an employer ceases to be a governmental entity, or a private entity becomes the employer under the plan, the plan is treated as being established by the non-governmental employer on the date of that change.

Under the draft regulation, an employee means a common law employee of the employer. Thus, it appears that the draft regulation will not count leased employees, or employees of a contractor, as employees of the government entity. It follows then that a plan covering governmental employees and non-governmental employees will not be a governmental plan. This conclusion is supported by an example illustrating that a governmental plan that is amended to permit participation of employees of a supplier to a governmental entity causes the plan to cease to be a governmental entity because it provides benefits to employees of a non-governmental employer.

Cheiron Observation: The definition of "established and maintained" and the illustrative example underscore the importance of reviewing the status of the employers participating in the plan. The example has implications for proposals that have been made to allow small or non-profit employers to participate in plans covering employees of State or local governments. The draft regulation does not permit existing practices where a governmental plan includes a small percentage of non-governmental employees and can still qualify as a governmental plan. However, comments were requested as to situations and circumstances where that practice should be allowed especially where the non-governmental employees were previously employees of the sponsoring governmental entity.


The ANPRM's standards for being considered a government plan are much tighter than the standards applied in many past Private Letter Rulings issued by the IRS. If the ANPRM or something close to it is eventually adopted, the result will be that many plans that believed they were governmental plans will lose their governmental status and be governed by the full panoply of health and pension rules of the Code and the Employee Retirement Income Security Act of 1974. Accordingly, potentially affected plans and sponsors should carefully study the regulations and submit comments.

Cheiron is an actuarial consulting firm that provides actuarial and consulting advice. However, we are neither attorneys nor accountants. Therefore, we do not provide legal services or tax advice.

1 Administrative guidance was issued by Revenue Ruling 89-49, which was not comprehensive or definitive, and was used as a basis to issue private letter rulings.