More than seven years after working to settle questions about 457 plans at federal credit unions, the Internal Revenue Service recently announced that it plans to issue proposed regulations to clarify how they are used.
Under Section 457 of the Internal Revenue Code, FCUs would be eligible to establish executive deferred compensation plans.
The issue was first raised in 2004 when the IRS issued a private letter ruling, which stated that a FCU was not an eligible employer under Section 457 because it was a federal government instrumentality. Regulations under the section define an eligible employer as an entity that is a state or tax-exempt organization that establishes a plan. Not included is the federal government or any agency or instrumentality thereof.
The letter ruling, however, failed to say what section of the code would apply to FCUs, leaving them under a cloud of uncertainty with respect to their existing 457 plans that they had established many years before.
To address the concerns of FCUs, the IRS issued notice 2005-58 that gave relief to any FCU that had a 457 plan in effect on Aug. 15, 2005, subject to certain conditions. While the notice was helpful to FCUs with existing 457 plans, it did not address whether a FCU could set up a new 457 plan or what the consequences would be.
Since the notice was published in 2005, many FCUs have cautiously established new 457 plans, knowing that the IRS would eventually issue guidance but not knowing exactly how the IRS would rule on this issue, according to CUNA Mutual Group.
On Nov. 8, the IRS released an Advance Notice of Proposed Rulemaking announcing that it would be issuing proposed regulations which would define the term “governmental plan” under Section 414(d) of the code. The IRS pointed out that the principles set out in the 414(d) regulations would generally also apply for purposes of section 457.
“The bottom line is assuming that the regulations are finalized as is and the IRS does not change its conclusion that FCUs are not instrumentalities of the United States for retirement plan purposes, FCUs will be considered eligible employers under section 457 of the IRS code and will be able to maintain executive deferred compensation plans in accordance with the section 457 rules,” said Dave Fowler, lead attorney for CUNA Mutual’s retirement plan services.
In addition, if a FCU maintains a qualified retirement plan, such as a 401(k) plan, it will be subject to the same code and ERISA rules that apply to state chartered credit unions and private sector employers, he added.
A governmental plan is defined in Section 414(d) generally to mean “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.”
Because the IRS had previously recognized FCUs to be instrumentalities of the United States, the question remained as to whether any retirement plan maintained by a FCU would be considered a governmental plan under section 414(d). If that were the case, then FCUs would not be subject to many of the rules that apply to plans of private sector employers.
When the issue came up in 2004, representatives from CUNA Mutual and CUNA met with the IRS to address concerns with the 457 plans. Following the meeting, both entities authored a research paper for the IRS that detailed why they didn't believe that FCUs should be considered an instrumentality of the United States for purposes of the 457 plan rules and the definition of governmental plan.
Among those at the 2004 meeting was Fowler, who has also followed up with the IRS every year since then to check on the status of upcoming regulations.
“We believe that the IRS’ position that a FCU is not an instrumentality of the United States for purposes of the 457 plan rules and the definition of governmental plan is the right decision from a practical standpoint,” Fowler said. “It would have created a whole host of issues if the end result was that FCUs were subject to one set of rules and state-chartered credit unions were subject to another set of rules.”
As it relates to FCUs, Fowler said the IRS’ proposed regulations will apply a facts and circumstances test to determine whether an entity is an agency or instrumentality of the United States. The proposed regulations provide a specific example for FCUs and conclude that they are not an agency or instrumentality of the United States, he explained.
Fowler said the reasoning given was that a FCU’s board of directors is elected by its own members and the directors are not responsible to the United States, except to the limited extent set out in the Federal Credit Union Act and regulated by the NCUA.
“I believe that it was our continual interest in this issue that led the IRS to include an example aimed specifically at FCUs,” Fowler said. “We likely will be providing comments to the IRS in support of their position.”
The IRS will accept comments on its draft until Feb. 6, 2012.