Governmental Plan Determination Letters

Qualified governmental plans (Internal Revenue Code Section 401(a) governmental plans) that would like to have the IRS review the form of their plan document to ensure compliance with the applicable tax qualification requirements may file for a determination letter during Cycle E until January 31, 2011. Under Revenue Procedure 2007-44, the remedial amendment cycle for a governmental plan that is not a pre-approved plan is Cycle C. More than 1700 governmental plan sponsors submitted their plans for a determination letter under Cycle C, which closed on January 31 2009.

Although not mandatory, there are a number of advantages to filing a determination letter request. This article discusses the special relief that allows IRC Section 401(a) governmental plans to file for a determination letter under the current Cycle E, as well as the benefits and the scope of a determination letter, and some of the specific issues we have encountered in reviewing Cycle C applications.

We also invite you to subscribe to Governmental Plans Updates and receive free periodic e-mail updates about recent developments for governmental plans.

Special Relief for Filing a Determination Letter Request

Pursuant to special relief provided by Revenue Procedure 2009-36, IRC Section 401(a) governmental plans have a one-time opportunity to submit determination letter applications during the current Cycle E, which opened February 1, 2010, and does not close until January 31, 2011. IRC Section 401(a) governmental plans that do not file by January 31, 2011, will not have another opportunity to file “on-cycle” until the next Cycle C, which does not open until February 1, 2013. The November 8, 2008 Special Edition of Employee Plans News discussed the availability of Cycle E submissions to governmental plan sponsors.

Why File for a Determination Letter?

Although submitting a request for a determination letter is voluntary, there are compelling reasons for requesting a favorable determination letter, including:

I. minimizing the risk that a plan will be disqualified on audit because the form of the plan document does not satisfy the     
   applicable tax-qualification requirements; and

II. the availability of certain self-correction programs under the Employee Plans Compliance Resolution System (EPCRS).

I. Minimizing the Risk of Plan Disqualification on Audit

A favorable determination letter indicates that, in the opinion of the IRS, the terms of the plan (i.e., the form of the document) conform to the tax-qualification requirements contained in the Internal Revenue Code (Code). Accordingly, a favorable determination letter provides a plan sponsor with protection from the risk that the IRS, upon audit of the plan, will determine that the written terms of the plan for the period covered by the determination letter do not satisfy the applicable tax qualification requirements. Without the benefit of the favorable determination letter:

• The plan could be retroactively disqualified back to the date of the defective amendment(s) and eliminate the tax benefits applicable to tax-qualified plans for all affected years; or
  
  
• The plan sponsor would have to enter into a special closing agreement with the IRS and agree to pay relatively expensive sanctions.

It should be noted, however, that to be a qualified plan under IRC Section 401(a), a plan must satisfy the qualification requirements in both form and operation. A favorable determination letter generally does not cover operational issues. For additional information, please see Publication 794, Favorable Determination Letter.

II. Taking Advantage of EPCRS Programs

EPCRS permits plan sponsors to correct certain compliance failures on a voluntary basis that might otherwise result in plan disqualification or other sanctions. In many cases, these self or voluntary correction programs require the payment of no fees or sanctions, or only a relatively modest fee. However, a favorable determination letter may be a prerequisite for taking advantage of certain correction programs under EPCRS (for example, to self-correct a significant operational failure under the Self-Correction Program (SCP)).

Scope of a Determination Letter

As noted above, a determination letter generally expresses an opinion on the form, not the operation, of the plan. Additionally, the determination letter covers the new items that apply to IRC Section 401(a) governmental plans listed on the applicable Cumulative List of Changes in Plan Qualification Requirements (Cumulative List), which is published annually as a Notice around mid-November of each year. A IRC Section 401(a) governmental plan must ensure that its plan document contains all of the applicable items listed on the Cumulative List prior to filing the determination letter application.

A plan sponsor may not rely on a determination letter for any qualification changes that become effective, any guidance published, or any statutes enacted, after the issuance of the latest Cumulative List or any changes in the law first listed on a subsequent Cumulative List.

A plan sponsor may also not rely on a determination letter as to certain specified issues or plan features. The recently updated Publication 794 identifies some of those items most relevant to IRC Section 401(a) governmental plans including:

• Whether an Entity Is Eligible To Sponsor a Governmental Plan
  An IRC Section 401(a) governmental plan may only be established and maintained by a governmental entity. A favorable determination letter does not address, and cannot be relied upon with respect to, the issue of whether an employer is eligible to sponsor a governmental plan. Rather, the plan sponsor must represent in its application for a determination letter that it is a governmental entity eligible to sponsor a governmental plan. If the IRS subsequently determines that there is a misstatement or omission of material facts in the application for a determination letter (for example, if the application indicates that the plan is a governmental plan, and it is not, or that the plan sponsor is a governmental entity, and it is not), the determination letter cannot be relied upon.
  
  
• Employer Pick-up Arrangements
  If certain requirements are met, Code §414(h)(2) permits governmental plan sponsors to pick up contributions that would otherwise be employee contributions under the plan. Such pick-up contributions are treated as employer contributions for federal income tax purposes. A favorable determination letter does not express an opinion regarding whether a pick-up arrangement satisfies the requirements of IRC Section 414(h)(2). A plan sponsor that would like a ruling on this issue may request a private letter ruling (PLR) under Revenue Procedure 2012-4 (or any successor procedure).
  
  
• Excess Benefit Arrangements
  If certain requirements are met, IRC Section 415(m) states that benefits provided under a qualified excess benefit arrangement are not taken into account in determining whether a governmental plan satisfies IRC Section 415 limitations on contributions and benefits. An excess benefit arrangement is generally a program maintained by a governmental employer in order to provide benefits for certain employees in excess of the IRC Section 415 limitations. A favorable determination letter does not express an opinion regarding whether an arrangement that purports to be an excess benefit arrangement meets the requirements of IRC Section 415(m). A plan sponsor that would like a ruling on this issue may request a PLR under Revenue Procedure 2010-4 (or any successor procedure).

Common Governmental Plan Issues and Questions

In reviewing the Cycle C determination letter applications filed by IRC Section 401(a) governmental plans, certain common issues or questions have been identified. Following is a short discussion regarding some of these topics that may prove helpful to plan sponsors preparing Cycle E determination letter applications for IRC Section 401(a) governmental plans.

1. Section 415 Limitations on Contributions and Benefits

As stated earlier, a plan sponsor must update the plan for all of the statutory, regulatory and other changes identified in the applicable Cumulative List before applying for a determination letter. For example, among the changes listed in the Cumulative List for Cycle E are those applicable to the limitations on contributions and benefits under IRC Section 415. Final IRC Section 415 regulations were issued in 2007. Plan documents should accurately reflect these new rules, including the definition of compensation for purposes of IRC Section 415, as of the applicable effective dates.

2. Normal Retirement Age and Vesting - Profit-Sharing Plans

A qualified profit-sharing plan that is an IRC Section 401(a) governmental plan must generally provide for:

• Full vesting of an employee’s account balance upon the attainment of a stated age, and
• The employee’s right to a distribution of his or her account balance at that time.

More information regarding these requirements may be found in Revenue Ruling 66-11, 1966-1 C.B. 71.

While it is best to have plan language that explicitly satisfies the above requirements, the IRS will treat a profit-sharing plan that is an IRC Section 401(a) governmental plan as meeting the requirements if the plan provides for:

• Full and immediate vesting, and
• Distribution of benefits upon termination of employment.

3. Plans with Multiple Benefit Structures

IRC Section 401(a) provides that the key elements of how benefits are determined, such as contribution rates, allocation formulas, benefit formulas or actuarial assumptions, must be definitely determinable under the written terms of the plan. A plan provision that simply provides that a board of trustees or other person will from time to time determine such key elements violates the definitely determinable requirement of IRC Section 401(a). A governmental plan sponsor whose plan provides for multiple benefit structures that are subject to change due to legislative or administrative developments might consider one of the following strategies:

• Attach an appendix to the plan document specifying any information that varies from one group of participants to another. The information stated in the appendix should be adopted prospectively, and not be subject to the discretion of a board of trustees or other person. The appropriate section of the plan document should reference the appendix. The plan sponsor may timely amend the appendix as circumstances require.
• The relevant plan provisions must be appropriately and timely amended and maintained in a manner that satisfies the definitely determinable requirement. For this purpose, the plan document may incorporate collective bargaining agreements or other relevant documents by reference, but should affix the applicable portions of such documents to the plan document.
• Each contributing employer might separately adopt a plan document that satisfies the definitely determinable requirement.

4. Plans That Provide for Refunds of Employer Contributions

An IRC Section 401(a) plan must have a provision stating that it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees and their beneficiaries, for any part of the corpus or income to be used for, or diverted to, purposes other than for the exclusive benefit of employees and their beneficiaries. Generally, a qualified plan may not permit reversions or refunds of employer contributions. However, there are some exceptions. A defined benefit plan may allow an employer to reserve the right to recover at termination of the plan any balance remaining in the trust that is due to erroneous actuarial computations. In addition, Revenue Ruling 91-4, 1991-1 CB 57, provides that, in accordance with IRC Section 403(c)(2) of the Employee Retirement Income Security Act of 1974, as amended (ERISA), refunds of employer contributions are permitted under certain very limited circumstances relating to mistakes of fact, initial qualification of the plan and disallowed deductions. An IRC Section 401(a) governmental plan must explicitly permit a reversion or refund of employer contributions in order for any such reversion or refund to be permitted.

5. Cross-referencing Plan Sections

Some plan document provisions satisfy statutory or regulatory requirements by cross-referencing other plan provisions. When a plan sponsor restates a plan document, the numbering of plan provisions may change such that the cross-referencing in the document is no longer accurate. When the plan sponsor submits the plan for a determination letter, any cross-referencing inaccuracies may unnecessarily slow down the processing of the application. A plan sponsor’s careful review of the entire plan document before submission will reduce the number of these errors and accelerate the processing of the application.

More Information

Employee Plans is interested in interacting with the governmental plan community in order to promote compliance with the qualification rules that apply to IRC Section 401(a) governmental plans. You may submit specific questions or comments to our dedicated e-mail address: governmentalplansdialogue@irs.gov. Please regularly visit the governmental plan Web pages and subscribe to Governmental Plans Updates to receive free e-mail updates about recent developments for governmental plans.