Federal Credit Unions Should Be Pleased with Proposed Deferred Compensation Plan Regulations

By Rich Brock
January 17, 2012

Federal credit unions should expect good news later this year from the Internal Revenue Service, which since 2004 has been considering the tax status of nonqualified deferred compensation plans sponsored by FCUs.

As many credit union managers are aware, at issue is whether federal credit unions should be defined as “an agency or instrumentality” of the Federal Government. In 2004 the IRS issued a private letter ruling that concluded that the specific FCU 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 stepped back from the position it had taken, but only regarding FCU’s that had 457(b) plans in effect on or before August 15, 2005. The IRS decided that if the FCU 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 as of August 15, 2005 could continue to operate as a 457(b) plan until the IRS issued new guidance clarifying how FCUs would be treated for purposes of Section 457.

Recently, the IRS issued an advanced notice of proposed rules. That notice 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 a sample federal credit union, was as follows:

“[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.”

The Bottom line

Assuming there are no major changes as the IRS finalizes the rules on this topic, federal credit unions can have greater confidence that they are proper 457(b) plan sponsors, and that any excess deferrals are subject to 457(f). 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 (such as annual rather than monthly deferral elections and five-year delays for changing a benefit form of payment) can eliminate the 409A restrictions. New plans can be installed with greater confidence in the 457(b)/457(f) approach.

“Little Need” Seen For Comments

Although an advanced notice of proposed rules includes a window of time for public review and comment on the proposed regulations—the IRS will take comments through February 6—legal counsel for Burns-Fazzi, Brock advised us they see “little need” for submitting comments regarding the treatment of FCUs for 457 purposes.

After the first comment period, expect the IRS to issue actual proposed regulations with another comment period, followed with publication of the final regulations. The final regulations will be effective for plan years that begin after the final rules are published.