Guest post written by Tom Telford, Executive Vice President, Burns-Fazzi, Brock
A pending IRS rule has some credit unions worried about the fate of their deferred compensation plans.
For some eight years now, the IRS has been considering the tax status of nonqualified deferred compensation plans offered by federal credit unions (FCUs). At issue is whether FCUs are entities of the federal government. In its analysis, the IRS concluded that FCUs are not because they are not federal instrumentalities. The IRS also had the option of finding that FCUs are eligible to offer these compensation plans because they are tax exempt organizations.
These plans have historically been an additional option for retirement planning above and beyond traditional 401(k) plans.
A brief history of the dispute:
- In 2004, the IRS issued a private letter that said a credit union that requested the ruling was an “instrumentality of the federal government” and, therefore, not eligible to sponsor 457(b) deferred compensation plans.
- In a subsequent notice, the IRS attempted to clarify the private ruling by stepping back from that position, but only to the extent the credit union’s 457(b) plan was in effect on or before Aug. 15, 2005.
- The IRS said that if the credit union had consistently taken the position that it was a non-governmental, tax-exempt organization for all employee benefit plan purposes, then any plan in effect on Aug. 15, 2005, could continue to operate as a 457(b) plan until the IRS issued new guidance clarifying how credit unions will be treated for purposes of section 457.
Good News On the Way
Recently, the IRS issued an advance notice of proposed rulemaking that includes a new facts-and-circumstances test for determining if an entity is a “governmental entity” or an “instrumentality of a governmental entity.” The conclusion, as applied to an example credit union, was:
“[The FCU] is not an agency or instrumentality of the United States because its 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 forth in the Federal Credit Union Act and regulated by the NCUA. Thus, [the FCU] is not a governmental entity within the meaning of … this section.”
We think credit unions can take away the following interpretations from the IRS advance notice:
- Assuming there are no major changes as the IRS finalizes the rules on this topic, credit unions can have greater confidence that they are proper 457(b) plan sponsors and that any excess deferrals are subject to 457(f), a rule that requires excess deferrals from tax-exempt plans to be distributed no later than April 15 following the close of the taxable year.
- Further, the move by the IRS should mean few, if any, adjustments to current plans will be required, and 457(b) plans designed to meet 409A requirements, which subject deferred compensation arrangements to IRS scrutiny (such as annual rather than monthly deferral elections and five-year delays for changing a benefit form of payment).
- New plans can be installed with greater confidence in the 457(b)/457(f) approach.
Credit unions and their board members should consider this information and the potential outcome of the IRS’ final issuance as they consider adopting a 457(b) deferred compensation plan. They may wish to consider whether there is a compelling reason to adopt the plan immediately in light of this advanced notice; or if delaying until final issuance would have a significant impact on their organizational objectives.