The Rundown

• IRS proposes regulations seeking clarification forFCUs.
• FCUs may be able to maintain executive deferred com plans,if regs are finalized.
• IRS seeking comment on proposal until Feb. 6,2012.

More than seven years after working to settle questions about457 plans at federal credit unions, the Internal Revenue Servicerecently announced that it plans to issue proposed regulations toclarify how they are used. Under Section 457 of the InternalRevenue Code, FCUs would be eligible to establish executivedeferred compensation plans.

The issue was first raised in 2004 when the IRS issued a privateletter ruling, which stated that a FCU was not an eligible employerunder Section 457 because it was a federal governmentinstrumentality. Regulations under the section define an eligibleemployer as an entity that is a state or tax-exempt organizationthat establishes a plan. Not included is the federal government orany agency or instrumentality thereof.

The letter ruling, however, failed to say what section of thecode would apply to FCUs, leaving them under a cloud of uncertaintywith respect to their existing 457 plans that they had establishedmany years before.

To address the concerns of FCUs, the IRS issued notice 2005-58that gave relief to any FCU that had a 457 plan in effect on Aug.15, 2005, subject to certain conditions. While the notice washelpful to FCUs with existing 457 plans, it did not address whethera FCU could set up a new 457 plan or what the consequences wouldbe.

Since the notice was published in 2005, many FCUs havecautiously established new 457 plans, knowing that the IRS wouldeventually issue guidance but not knowing exactly how the IRS wouldrule on this issue, according to CUNA Mutual Group.

On Nov. 8, the IRS released an Advance Notice of ProposedRulemaking announcing that it would be issuing proposed regulationswhich would define the term “governmental plan” under Section414(d) of the code. The IRS pointed out that the principlesset out in the 414(d) regulations would generally also apply forpurposes of section 457.

“The bottom line is assuming that the regulations are finalizedas is and the IRS does not change its conclusion that FCUs are notinstrumentalities of the United States for retirement planpurposes, FCUs will be considered eligible employers under section457 of the IRS code and will be able to maintain executive deferredcompensation plans in accordance with the section 457 rules,” saidDave Fowler, lead attorney for CUNA Mutual's retirement planservices.

In addition, if a FCU maintains a qualified retirement plan,such as a 401(k) plan, it will be subject to the same code andERISA rules that apply to state chartered credit unions and privatesector employers, he added.

A governmental plan is defined in Section 414(d) generally tomean “a plan established and maintained for its employees by thegovernment of the United States, by the government of any state, orpolitical subdivision thereof, or by any agency or instrumentalityof any of the foregoing.”

Because the IRS had previously recognized FCUs to beinstrumentalities of the United States, the question remained as towhether any retirement plan maintained by a FCU would be considereda governmental plan under section 414(d). If that were thecase, then FCUs would not be subject to many of the rules thatapply to plans of private sector employers.

When the issue came up in 2004, representatives from CUNA Mutualand CUNA met with the IRS to address concerns with the 457 plans.Following the meeting, both entities authored a research paper forthe IRS that detailed why they didn't believe that FCUs should beconsidered an instrumentality of the United States for purposes ofthe 457 plan rules and the definition of governmental plan.

Among those at the 2004 meeting was Fowler, who has alsofollowed up with the IRS every year since then to check on thestatus of upcoming regulations.

“We believe that the IRS' position that a FCU is not aninstrumentality of the United States for purposes of the 457 planrules and the definition of governmental plan is the right decisionfrom a practical standpoint,” Fowler said. “It would have created awhole host of issues if the end result was that FCUs were subjectto one set of rules and state-chartered credit unions were subjectto another set of rules.”

As it relates to FCUs, Fowler said the IRS' proposed regulationswill apply a facts and circumstances test to determine whether anentity is an agency or instrumentality of the United States. The proposed regulations provide a specific example for FCUs andconclude that they are not an agency or instrumentality of theUnited States, he explained.

Fowler said the reasoning given was that a FCU's board ofdirectors is elected by its own members and the directors are notresponsible to the United States, except to the limited extent setout in the Federal Credit Union Act and regulated by the NCUA.

“I believe that it was our continual interest in thisissue that led the IRS to include an example aimed specifically atFCUs,” Fowler said. “We likely will be providing comments to theIRS in support of their position.”

The IRS will accept comments on its draft of the regulationsuntil Feb. 6, 2012.