WASHINGTON — State and local groups are urging the Internal Revenue Service to amend draft rules that would provide guidance on how to determine whether entities are eligible to participate in governmental retirement plans.

Six national public sector associations, including the Government Finance Officers Association, submitted comment letters to the IRS requesting the changes ahead of the agency’s July 9 public hearing on the draft rules.

Currently, section 414(d) of the Internal Revenue Code defines a governmental retirement plan as one that is “established and maintained for its employees by the government of the United States, by the government of any state or political subdivision thereof, or by any agency or instrumentality of any of the foregoing.”

If an entity fails to meet this broad definition, then it must create its own private retirement plan under the rules of the Employee Retirement Income Security Act, or ERISA, which governs private sector pension plans.

“Being a governmental plan is a big deal and you don’t want to lose your status,” said Leigh Snell, federal relations director for the National Council on Teacher Retirement and co-author of that group’s letter to the IRS.

Because the code section on governmental retirement plans is undefined and open to interpretation, the IRS in recent years has received many questions about whether various entities and their employees — including some providing services to governments under contracts — can participate in governmental plans or must create their own private plans.

As a result, the IRS, in conjunction with the Labor and Treasury Departments, have drafted regulations that would provide more guidance on which entities can participate in governmental plans.

Last November, the IRS published an advance notice of proposed rulemaking that, among other things, contains definitions of governmental plans, political subdivisions, agencies and instrumentalities. The draft regulations would require a two-tier, 13-factor “facts and circumstances” test that any state or local instrumentality could use to determine whether it is an “agency or instrumentality.”

Currently, the IRS determines whether a retirement plan is a governmental plan through a six-factor test.

The agencies published separate draft rules defining governmental retirement plans for Indian tribal governments.

But state and local groups, as well as tribal governments, told the IRS they are concerned that many of their entities would no longer be able to participate in governmental pension plans under the draft regulations.

“A basic problem with the proposed rule in our view is that the major and other factors listed do not accurately reflect the many varieties of legitimate agencies and instrumentalities of political subdivisions that exist, how they are structured and the functions they perform,” National Association of Counties executive director Larry Naake wrote in a June 18 letter.

To mitigate some of the potential consequences, NaCo, and five groups in a separate June 15 letter, suggested that once the regulations are final the IRS provide “grandfather treatment for certain entities and their employees who are participants in governmental plans, where the entities do not meet the standards.”

The groups also pushed for the IRS and Treasury Department to establish safe harbors in the final rules.

“We recommend that, if any entity satisfied any one of the following safe harbors, then for the purpose of the IRC section 414(d), the entity could establish and maintain a governmental plan for its employees and-or could participate in a multiple employer governmental plan without consideration of any other factors,” they wrote.

The groups listed seven safe harbors, including one under which an entity could participate in a governmental plan if it has been established and empowered by specific statute or ordinance to be an agent of a state or political subdivision to perform a governmental function on behalf of a state or political subdivision.

The groups also recommended the creation of transition periods. They requested that entities be given a transition period to make plan document changes and-or state legislative changes to comply with final rules. They also requested transition periods for entities that must change the status of their retirement plans under the final rules.

Under separately drafted rules, Indian tribal governments could only participate in governmental plans if they perform essential government functions that are not commercial in nature.

Robert Yoder, partner with Yoder & Langford PC who represents 35 tribes, said he is asking for more clarification from the IRS on that definition.

“For most of the tribes I represent, we’d like to see a repeal of those distinctions so there would be parity between the states and Indian governments,” he said. “We’d like that same status. We’d like to be treated governmental in the same respect that states are.”

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