GOVERNMENT REGULATION OF QUALIFIED PLANS

Qualified retirement plan receives special federal tax benefits in return for being designed in accordance with rules imposed by the federal government.We will discuss how the federal government imposes these rules. The federal rules are the most important because federal law generally preempts state and local laws in the qualified plan area.

Benefit planners need a basic understanding of the federal regulatory scheme. Planners must often interpret the significance of various official rules and interact with government organizations. These government rules and organizations must be understood in order to be effective in plan design and management.

Government regulation is expressed through the following, in the order of their importance: (1) statutory law, (2) the law as expressed in court cases, (3) regulations of government agencies, and (4) rulings and other information issued by government agencies.

Statutory Law

Theoretically, the highest level of regulatory law is the U.S. Constitution because all regulation must meet constitutional requirements, such as due process of law and equal protection for persons under the law. However, relatively few issues of federal regulation are actually resolved under constitutional law. For practical purposes, the "law" as expressed by statutes passed by the U.S. Congress is the highest level of authority and is the basis of all regulation; court cases, rulings, and regulations are simply interpretations of statutes passed by Congress. If the statute was detailed enough to cover every possible case, there theoretically wouldn't be any need for anything else. But despite the best efforts of Congressional drafting staffs, the statutes can't cover every situation.

Benefit planners should become as familiar as possible with statutory law because it is the basis for all other rules, regulations, and court cases. One of the main causes for confusion among nonexperts is a lack of understanding of the relative status of sources of information. That is, while a rule found in the Internal Revenue Code is fundamental, a statement in an IRS ruling or instructions to IRS forms may be merely a matter of interpretation that is relatively easy to "plan around."

In the benefits area, the sources of statutory law are:

• Internal Revenue Code (the Code). The tax laws governing the deductibility and taxation of pension and employee benefit programs are fundamental. These are found primarily in Sections 401–425, with important provisions also in Sections 72, 83, and other sections.

• ERISA (Employee Retirement Income Security Act of 1974), as amended, and other labor law provisions. Labor law provisions such as ERISA govern the nontax aspects of federal regulation. These involve plan participation requirements, notice to participants, reporting to the federal government, and a variety of rules designed to safeguard any funds that are set aside to pay benefits in the future. There is some overlap between ERISA and the Code in the area of plan participation, vesting, and prohibited transactions.

• Pension Benefit Guaranty Corporation (PBGC). The PBGC is a government corporation set up under ERISA in 1974 to provide termination insurance for participants in qualified defined-benefit plans up to certain limits. In carrying out this responsibility, the PBGC regulates plan terminations and imposes certain reporting requirements on covered plans that are in financial difficulty or in a state of contraction.

• Securities laws. The federal securities laws are designed to protect investors. Benefit plans may involve an element of investing the employees' money. While qualified plans are generally exempt from the full impact of the securities laws, if the plan holds employer stock, a federal registration statement may be required and certain securities regulations may apply.

• Civil rights laws. Benefit plans are part of an employer's compensation policies; these plans are subject to the Civil Rights Act of 1964, which prohibits employment discrimination on the basis of race, religion, sex, or national origin.

• Age discrimination. The Age Discrimination Act of 1978, as amended, has specific provisions aimed at benefit plans.

• State legislation. ERISA contains a broad "preemption" provision under which any state law in conflict with ERISA is preempted—has no effect. If ERISA does not deal with a particular issue, however, there may be room for state legislation. For example, there is considerable state legislation and regulation governing the types of group term life insurance contracts that can be offered as part of an employer plan. There are also certain areas where states continue to assert authority even though ERISA also has an impact, as in the area of creditors' rights to pension fund assets.

Court Cases

The courts enter the picture when a taxpayer decides to appeal a tax assessment made by the IRS. The courts don't act on their own to resolve tax or other legal issues. Consequently, the law as expressed in court cases is a crazy-quilt affair that offers some answers but often raises more questions than it answers. However, after statutes, court cases are the most authoritative source of law. Courts can and do overturn regulations and rulings of the IRS and other regulatory agencies.

A taxpayer wishing to contest a tax assessment has three choices: (1) the Federal District Court in the taxpayer's district, (2) the United States Tax Court, or (3) the United States Claims Court. Tax law can be found in the decisions of any of these three courts.

All three courts are equally authoritative. Most tax cases, however, are resolved by the U.S. Tax Court, because it offers a powerful advantage: The taxpayer can bring the case before the Tax Court without paying the disputed tax. All the other courts require payment of the tax followed by a suit for refund.

Decisions of these three courts can be appealed to the Federal Court of Appeals for the applicable federal "judicial circuit"—the U.S. is divided into 11 judicial circuits. The circuit courts sometimes differ on certain points of tax law; as a result, tax and benefit planning may depend on what judicial circuit the taxpayer is located in. Where these differences exist, one or more taxpayers will eventually appeal a decision by the Court of Appeals to the United States Supreme Court to resolve differences of interpretation among various judicial circuits, but this process takes many years and the Supreme Court may ultimately choose not to hear the case. Congress also sometimes amends the Code or other statute to resolve these interpretive differences.

Regulations

Regulations are interpretations of statutory law that are published by a government agency; in the benefits area, the most significant regulations are published by the Treasury Department (the parent of the IRS), the Labor Department, and the PBGC.

Regulations are structured as abstract rules, like the statutory law itself. They are not related to a particular factual situation, although they often contain useful examples that illustrate the application of the rules. Currently, Treasury regulations are often issued in question-and-answer form.

The numbering system for regulations is supposed to make them more accessible by including an internal reference to the underlying statutory provision. For example, Treasury Regulation Section 1.401(k)-2 is a regulation relating to Section 401(k) of the Internal Revenue Code. Labor Regulation Section 2550.408b-3 relates to Section 408b of ERISA.

Issuance of regulations follows a prescribed procedure involving an initial issuance of proposed regulations followed by hearings and public comment, then final regulations. The process often takes years. Where taxpayers have an urgent need to know answers, the agency may issue temporary regulations instead of proposed regulations. Technically, temporary regulations are binding, while proposed regulations are not. However, if a taxpayer takes a position contrary to a proposed regulation, the taxpayer is taking the risk that the regulation will ultimately be finalized and be enforced against him.

Rulings and Other Information

IRS Rulings

IRS rulings are responses by the IRS to requests by taxpayers to interpret the law in light of their particular fact situations. A General Counsel Memorandum (GCM) is similar to a ruling, except that the request for clarification and guidance is initiated from an IRS agent in the field during a taxpayer audit, rather than directly from the taxpayer.

There are two types of IRS rulings—Revenue Rulings, which are published by the IRS as general guidance to all taxpayers, and Private Letter Rulings (PLRs), which are addressed only to the specific taxpayers who requested the rulings. The IRS publishes its Revenue Rulings in IRS Bulletins (collected in Cumulative Bulletins [CB] each year). Revenue rulings are binding on IRS personnel on the issues covered in them, but often IRS agents will try to make a distinction between a taxpayer's factual situation and a similar one covered in a ruling if the ruling appears to favor the taxpayer.

PLRs are not published by the IRS, but are available to the public with taxpayer identification deleted. These "anonymous" PLRs are published for tax professionals by various private publishers. They are not binding interpretations of tax law except for the taxpayer who requested the ruling, and even then they apply only to the exact situation described in the ruling request and do not apply to even a slightly different fact pattern involving the same taxpayer. Nevertheless. PLRs are very important in research because they are often the only source of information about the IRS position on various issues.

Other Rulings

The Department of Labor and the PBGC issue some rulings in areas of employee benefit regulation under their jurisdiction. DOL rulings include the Prohibited Transaction Exemption (PTEs) which rule on types of transactions that can avoid the prohibited transaction penalties—for example, sale of life insurance contracts to qualified plans.

Other Information

Because of frequent changes in the tax law, the IRS has been unable to promulgate regulations and rulings on a timely basis, and has increasingly used less formal approaches to inform taxpayers of its position. These include various types of published Notices and even speeches by IRS personnel. Finally, many important IRS positions are found only in IRS Publications (pamphlets available free to taxpayers) and instructions for filling out IRS forms. The IRS also maintains telephone question-answering services, but the value of these for information on complicated issues is minimal.