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Starting to Crack the Code on Governmental Plans

This article originally ran on March 30, 2015.

Editor’s note: NTSA has been closely watching this issue since many of our members work with charter schools, and, in fact, did file a comment letter requesting that the Section 414(d) definition not preclude charter schools from sponsoring governmental plans. The guidance (not yet finalized) does provide those assurances as long as the posted guidelines are met.

By Linda Segal Blinn, J.D.

When is an employer-sponsored plan considered to be a governmental plan?

If the employer is a charter school, we may be getting a better understanding of the answer to that question, based on the IRS’ recently released Notice 2015-07. 

This notice is part of a larger IRS initiative (in coordination with the Department of Labor and the Pension Benefit Guaranty Corporation) to define a governmental plan within the meaning of Internal Revenue Code (IRC) Section 414(d). In November 2011, the IRS issued an advanced notice of proposed rulemaking defining “governmental plan” under IRC Section 414(d). In the draft proposed regulations that accompanied the advanced notice of proposed rulemaking, the IRS proposed criteria for determining whether an employer was a governmental entity, focusing in particular on whether its board of directors were publicly appointed and could be publicly removed.

During the comment period that followed, members of the charter school community submitted more than 2,000 comments on that guidance. Among the concerns raised was whether the IRS guidance would preclude charter schools from participating in state and local retirement systems, affecting charter schools’ ability to provide retirement security for their employees and to attract and retain educators.

In response, Notice 2015-07 would create a special set of criteria for determining whether charter schools would be considered to be sponsoring governmental plans. The IRS’ rationale was based on “the special and unique nature of public charter schools, the governance structure associated with these schools, the structure of many public school systems that permit or encourage public school teachers to move between public charter and traditional public schools, and the relationship between the public charter schools and the agencies authorized by the State or political subdivision of the State…that hold these schools accountable for academic results.”

The IRS notice would establish five factors that, if satisfied, would enable charter schools to be considered governmental: 

1. The charter school must be a nonsectarian independent public school that provides tuition-free elementary or secondary education, or both (thus serving a governmental purpose).

2. The charter school is established and operated pursuant to a specific state law authorizing the granting of charters to create independent public schools or authorizing the establishment of independent public schools.

3. Participation in the state or local retirement system by the charter school’s employees is expressly required or permitted under applicable law.

4.The charter school either:

  • Has a governing board or body controlled by a state, political subdivision or agency (for this purpose, either the state, political subdivision or agency must have the power to nominate, appoint, remove and replace a majority of the members of that board; or a majority of the members of the entity’s governing board or body must be publicly nominated and elected); or
  • Meets the following requirements:      

    • The primary funding of the charter school comes from a state or a political subdivision or agency;
    • The rights of charter school employees to their accrued benefits under the state or local  retirement system are not based on whether the school continues to participate in the system, and the governmental entity has responsibility for the accrued benefits of the charter school’s employees; and 
    • The charter school is part of a local educational agency and is subject to significant regulatory control and oversight by a state or its political subdivision or agency (including specific regulatory requirements detailed in the advance notice). 
    5. All financial interests of ownership in the charter school are held by a state or its political subdivision or agency. If the charter school were to be dissolved or liquidated, its governing documents would require that the school’s net assets to be distributed to another charter school or to the state, political subdivision or agency.

    The IRS guidance, once finalized, could have an impact beyond charter schools’ ability to participation in state and local retirement systems. If the Notice becomes effective, charter schools meeting the criteria could potentially be considered a public school eligible to sponsor a 403(b) plan and a governmental 457(b) plan.  The Notice indicates that “The IRS and Treasury Department, in developing the guidance under consideration …, consulted with the Department of Labor (DOL)….” If the guidance ultimately were to be part of the final IRC Section 414(d) regulations without further modification, it appears that the plans of such charter schools could be:

    • exempt from ERISA as a governmental plan, given the IRS’ objective to develop a uniform definition that could be also leveraged by the DOL; and 
    • fall under the governmental plan rules that deem such plans to satisfy the IRS nondiscrimination requirements for 401(a) plans and employer contributions to 403(b) plans in accordance with the Taxpayer Relief Act of 1997. In other words, only employee pre-tax deferrals and Roth contributions to a 403(b) plan must continue to pass nondiscrimination (by complying with the universal availability requirement). 
    The IRS cautions that Notice 2015-07 is not currently effective, but will be included in the proposed regulations defining a governmental plan under IRC Section 414(d). The proposed regulations, which are listed in the Department of Treasury 2014-2015 Priority Guidance Plan, will be subject to public comment. 
    Linda Segal Blinn, J.D.*, is vice president of Technical Services for Tax-Exempt Markets at Voya Financial. In this capacity, Blinn leverages her nearly 25 years of experience administering and designing defined contribution plans to provide general legislative and regulatory information to assist public and non-profit employers in operating their retirement plans. 

    This material was created to provide accurate information on the subjects covered. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. These materials are not intended to be used to avoid tax penalties, and were prepared to support the promotion or marketing of the matters addressed in this document. The taxpayer should seek advice from an independent tax advisor. 

    * Linda is not a practicing attorney for Voya Financial.