A public power group and a joint powers authority are criticizing Internal Revenue Service’s proposed regulations that would determine whether or not such organizations are eligible to participate in a governmental retirement plan.

Both the American Public Power Association and a California joint powers authority suggested that the IRS revise its definitions of “political subdivision” and “instrumentality” to be consistent with IRS definitions used in association with tax-exempt bonds.

“Given that there is one federal tax code, it is unclear why the IRS is suggesting definitions for these terms in the draft proposed regulations that are inconsistent with those developed in the tax-bond area,” the APPA wrote in a June 15 letter to the IRS. “This is of great concern, because if a utility does meet the definition, the utility will not be able to continue to participate in its governmental retirement plan.”

Some public power utilities operate governmental retirement plans independently, while others participate in governmental retirement plans operated by their respective states.

The comments are in response to the advance notice of proposed rulemaking the IRS published last November that,  among other things, define the terms governmental plan, political subdivision and agency or instrumentality. The proposed regulations also require a two-tier, 13-factor “facts and circumstances” test that would be applicable to state or local instrumentalities to be used in determining whether an entity is an “agency or instrumentality.” Currently, the IRS determines whether a retirement plan is a governmental plan through a six-factor test.

“This approach, as currently drafted, will create a significant amount of uncertainty as to whether public power utilities are eligible to participate in governmental retirement plans,” the APPA wrote.

The California JPA said in a June 13 letter that the proposed test does not include guidance on how it would be applied. The “lack of guidance” in this area is of “significant concern” and that the multiplicity of factors would “render the test’s application difficult even in the best of circumstances,” the JPA said.

One question the IRS asked in its original notice was whether a safe-harbor test should be used to determine the status of a state or local instrumentality in place of the proposed 13-factor test.

The APPA said that the rules should contain safe harbors because it would provide public power utilities and their employees assurance of their eligibility to join in governmental retirement plans. In circumstances where governmental plans are state-operated, safe harbors would provide states certainty that their plans satisfy IRS requirements, the APPA said.

The California JPA however, suggested that a bright line test would be easier to administer than the proposed multi-factor test. The JPA’s bright-line test would meet three requirements: a majority of the entity’s governing body is either controlled by one or more states or political subdivisions or is elected by voters at publicly held elections; the entity serves a governmental purpose or provides public benefits; and the entity has the authority to exercise one or more sovereign powers.

“We believe this safe harbor test captures all of the material requirements encompassed in the existing six-factor test, and therefore would be adequate to ensure that only instrumentalities that legitimately represent government interests are qualified,” the JPA wrote. If the IRS rejects this proposal, the agency should continue to use the current six-factor test, the authority said.

The APPA also urged the IRS to revise its draft proposed regulations to include “grandfather” provisions in any of the final regulations defining “governmental plan.” The provisions would apply to entities participating in governmental retirement plans on the date that the final IRS regulations are published, the APPA proposed.

If a grandfather provision was adopted by the IRS, the eligibility of an entity to participate in a governmental retirement plan would be based on existing laws on the date prior to the publication of the final regulations.

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