Severance-or-pension choice would disqualify governmental pension plan

Plain-English summary

A governmental defined benefit pension plan asked about proposed legislation that would let affected hospital employees choose between a cash severance payment and a subsidized early-retirement benefit. The IRS concluded that this choice would be a cash or deferred arrangement because employees could select current cash instead of an additional benefit under a plan that deferred compensation. A defined benefit plan is not one of the plan types permitted to include such an arrangement, so the legislation, if effective, would cause the plan to fail IRC § 401(a). The IRS declined to rule on the resulting tax consequences for the plan and its participants because those questions involved other taxpayers and remained hypothetical while the legislation was not effective.

Ruling snapshot

• Question: Would the proposed severance-or-retirement election create a cash or deferred arrangement, disqualify the defined benefit plan, and produce specified tax consequences?
• Outcome: Mixed. The IRS ruled that the election would create a prohibited cash or deferred arrangement and disqualify the plan, but declined to rule on the tax consequences.
• Key authorities: IRC §§ 401(a), 401(k), 414(d); Treas. Reg. § 1.401(k)-1(a)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201722014 Third Party Communication: None
Release Date: 6/2/2017 Date of Communication: Not Applicable
Index Number: 401.29-00
Person To Contact:
-------------------------------------------------- ------------------, ID No. ------------------
------------------------------------------------------------ Telephone Number:
-------------- ----------------------
-------------------------------------------- Refer Reply To:
--------------------------------------- CC:TEGE:EB:QP1
PLR-131151-16
Date:
March 02, 2017

Plan = ------------------------------------------------------------------------
Statute = ------
State = ----------------------

Dear -----------------:

This is in response to your request dated August 26, 2016, in which you request a
private letter ruling regarding: (1) whether an election proposed to be offered to certain
participants in the Plan would be a cash or deferred arrangement under § 1.401(k)-
1(a)(2) of the Income Tax Regulations; (2) if so, whether the cash or deferred
arrangement would affect the Plan’s qualified status; and (3) if so, the Federal tax
consequences of the loss of qualified plan status.

The following facts and representations have been submitted under penalty of perjury in
support of the ruling requested:

The Plan is a governmental defined benefit pension plan under section 414(d) of the
Internal Revenue Code, established effective ----------------------. The Plan covers the
employees of every department and agency of the State, including its public hospitals.
The Plan’s most recent favorable determination letter is dated October 27, 2014.

In anticipation of the State privatizing or closing its public hospitals, the State legislature
enacted Statute. Both houses of the State legislature initially passed the legislation, but
the State’s governor vetoed the legislation. However, the State legislature overrode the
veto and enacted Statute. Due to a legal challenge, Statute is not currently effective,
pending the outcome of the legal challenge. Statute provides that employees of the
State’s public hospitals whose positions are being abolished or who are directly affected
by a reduction-in-force or workforce restructuring plan, including privatization, could, in
lieu of exercising their reduction-in-force rights under State law, elect one of the
following:
PLR-131151-16 2

   Voluntary severance benefit – a one-time lump-sum cash payment of a
   percentage of base salary per year of service worked, not to exceed a certain
   amount; or

   Special retirement benefit – a subsidized early retirement benefit under the Plan
   that would permit the employee to retire with an unreduced retirement benefit at
   an earlier age or with less service than previously permitted under the Plan.

Based on the facts and representations stated above, the Plan requests three rulings.
First, the Plan requests a ruling whether, if Statute becomes effective, the election
created by Statute would constitute a cash or deferred arrangement under
§ 1.401(k)-1(a)(2). Second, if the election created by Statute would constitute a cash or
deferred arrangement under § 1.401(k)-1(a)(2), the Plan requests a ruling whether that
cash or deferred arrangement would cause the Plan to fail the qualification
requirements for retirement plans under section 401(a). Third, if the existence of the
cash or deferred arrangement would cause the Plan to fail the qualification
requirements of section 401(a), the Plan requests a ruling on the Federal tax
consequences of the disqualification to the Plan and its members and beneficiaries.

With respect to your first ruling request, § 1.401(k)-1(a)(2)(i) defines a “cash or deferred
arrangement” as, except as otherwise provided, an arrangement under which an eligible
employee may make a cash or deferred election with respect to contributions to, or
accruals or other benefits under, a plan that is intended to satisfy the requirements of
section 401(a).

Section 1.401(k)-1(a)(3)(i) provides that a “cash or deferred election” is any direct or
indirect election (or modification of an earlier election) by an employee to have the
employer either provide an amount to the employee in the form of cash (or some other
taxable benefit) that is not currently available, or contribute an amount to a trust, or
provide an accrual or other benefit, under a plan deferring the receipt of compensation.

The election permitted by Statute allows an employee who is already a participant in the
Plan to choose either (a) the voluntary severance benefit, or (b) a subsidized early
retirement benefit. The voluntary severance benefit provides an amount of cash (or
other taxable benefit) that is not currently available. The early retirement benefit
provides an accrual or other benefit under a plan deferring the receipt of compensation.
For this purpose, the term “other benefit” in § 1.401(k)-1(a)(3)(i) covers a wide variety of
potential benefits, and includes a subsidized early retirement benefit that is paid under a
pension plan and that an employee would otherwise not be eligible to receive.

Accordingly, if Statute becomes effective, the election granted to the State employees
under Statute with respect to the benefit they receive upon separation from service
would constitute a cash or deferred election within the meaning of § 1.401(k)-1(a)(3)(i)
because it is an election between an amount in the form of cash (or some other taxable
PLR-131151-16 3

benefit) that is not currently available, and an accrual or other benefit under a plan
deferring the receipt of compensation. Because the election would constitute a cash or
deferred election, it creates a cash or deferred arrangement within the meaning of
§ 1.401(k)-1(a)(2)(i).

With respect to your second ruling request, section 401(k)(1) provides that a profit-
sharing or stock bonus plan, a pre-ERISA money purchase plan, or a rural cooperative
plan shall not be considered as not satisfying the requirements of section 401(a) merely
because the plan includes a qualified cash or deferred arrangement.

Section 1.401(k)-1(a)(1) provides that a plan, other than a profit-sharing, stock bonus,
pre-ERISA money purchase pension, or rural cooperative plan, does not satisfy the
requirements of section 401(a) if the plan includes a cash or deferred arrangement. For
this purpose, a cash or deferred arrangement is part of a plan if any contributions to the
plan, or accruals or other benefits under the plan, are made or provided pursuant to the
cash or deferred arrangement.

In accordance with our conclusion above that Statute, if it becomes effective, would
create a “cash or deferred arrangement,” the Plan, which is a defined benefit plan (and
not a profit-sharing, stock bonus, pre-ERISA money purchase pension, or rural
cooperative plan), would not satisfy the qualification requirements of section 401(a)
because it would include a “cash or deferred arrangement.”

With respect to your third ruling request, in accordance with Rev. Proc. 2017-1, 2017-1
I.R.B. 1, §§ 6.02 and 6.12, we decline to rule on the Federal tax consequences to the
Plan and its members and beneficiaries of disqualification of the Plan, because such a
ruling would involve facts pertaining to taxpayers other than the Plan and would be
hypothetical given that Statute is not currently effective and may never become
effective.

The Plan has not been reviewed in addressing this ruling request, and this letter is not a
determination as to the whether the Plan, or any provision of the Plan not expressly
discussed, satisfies the qualification requirements of section 401(a). For more
information about the process for obtaining a determination letter, if available, from the
Internal Revenue Service, Tax Exempt and Government Entities Division, Employee
Plans, see Rev. Proc. 2016-4, 2017-1 I.R.B. 146. Except as expressly provided herein,
no opinion is expressed or implied concerning the tax consequences of any aspect of
any transaction or item discussed or referenced in this letter.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party, as specified in Rev. Proc. 2017-1, § 7.01(15)(b). This office
has not verified any of the material submitted in support of the request for ruling, and
such material is subject to verification on examination. The Associate office will revoke
PLR-131151-16 4

or modify a letter ruling and apply the revocation retroactively if there has been a
misstatement or omission of controlling facts; the facts at the time of the transaction are
materially different from the controlling facts on which the ruling was based; or, in the
case of a transaction involving a continuing action or series of actions, the controlling
facts change during the course of the transaction. See Rev. Proc. 2017-1, § 11.05.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

A copy of this letter has been sent to your authorized representative in accordance with
a power of attorney on file in this office.

                                  Sincerely,



                                  Laura B. Warshawsky
                                  Senior Technician Reviewer
                                  Qualified Plans Branch 2
                                  (Tax Exempt & Government Entities)
                                  Office of the Associate Chief Counsel