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Federal E-NewsMarch/April 2008
Feds Hold Tax Roundtable on Governmental Plans; Increased Scrutiny, “Meaningful IRS Presence” in the Works for Public Pension Systems The Internal Revenue Service (IRS) held its first “Governmental Plans Roundtable” on April 22, 2008, in Washington, D.C. to discuss the tax qualification requirements of governmental plans, and NCTR was there. It is clear that the IRS intends to increase its review and enforcement efforts related to public plans, and a new IRS questionnaire is in the works to help the IRS learn about public plans and what our “issues” are with the Federal tax code. While officials stressed that it was not their intention to scare anyone, the next step is “to evolve to compliance." The Roundtable was ostensibly to assist governmental plans that the IRS felt had previously been “underserved” by the agency’s Tax Exempt and Government Entities Division (TE/GE Division). The stated intent was to gather interested representatives from the governmental plan community in order to raise awareness in the governmental plan sector of the need to comply with tax qualification requirements, and to begin a dialogue on how to ensure that governmental plans succeed. In other words, “We’re from the IRS and we’re here to help.” No joke: they actually said this! Of course, they were joking too…. I think. But for some, the real purpose of the Roundtable appeared to be to press public plans to seek determination letters, and to announce a new questionnaire program – a program designed for governmental plans to effectively self-identify problem areas for the IRS to address in what will be a new level of enforcement activity. The day began with a brief address by Steven Miller, IRS Commissioner for the TE/GE Division. He expressed his concern that governmental plans have not previously received the assistance that they deserved from the IRS. Mr. Miller said that the time was right to address this inattention since the IRS began accepting determination letter applications for individually designed defined benefit and defined contribution plans from Cycle C submitters, which includes governmental plans, on February 1, 2008. (This is part of the IRS’ new staggered remedial amendment process; Cycle C ends January 1, 2009.) However, Miller went on to say that the IRS is also concerned with the “risks” that governmental employees may not “get the pension benefits they are entitled to.” He specifically referred to the current economic challenges confronting states and it subsequently became clear, as the day progressed, that the funded status of public plans was a major concern. Even when confronted with the fact that governmental plan funding was not under the jurisdiction of the IRS, and that governmental plans (unlike their private sector counterparts), were not synonymous with the employer, Service officials pointed to press reports on underfunding problems and expressed their general concern with the overall “health” of our retirement systems. The rest of the morning and the early afternoon was consumed with a number of presentations by TE/GE Division staff on why governmental plans must be tax compliant; how governmental plans must be timely amended and submitted for determination letters; how the IRS’ voluntary compliance program can help plan sponsors “find, fix, and avoid” plan errors; and how the IRS will evaluate plan compliance levels and enforce the requirements of Federal law. While everyone agreed that a dialogue between the various levels of government was important to pursue, and the overall session was not confrontational, the discussion was pointed at times. This was particularly true when the new IRS tools and programs that are being developed “to assist governmental plans in achieving compliance” were discussed. These IRS efforts center on a new questionnaire. It is being developed because IRS officials admit that they “don't know a whole lot about the government plans sector." However, it is also clear that the questionnaire will go beyond basic data requests and will also include qualitative questions so that the IRS can “get a good feel” for the issues and barriers regarding governmental plans. The questionnaire is still being worked on, and IRS officials said that they intend to use a focus group in its development. They also promised to let the questionnaire be reviewed by stakeholders in the governmental community. While the IRS also said that they appreciated the need for assurances that the information provided will not be used against plans, they also made it very clear that a failure to reply could trigger a compliance check/audit. IRS officials said that they plan initially to send out the questionnaire to a small group (20 to 40), probably some time this summer. Then, using the results from this sample, a more comprehensive questionnaire will be prepared and sent to about 200 government plans. The agency hopes to send the final questionnaire out to all plans beginning in 2009. Dave Stella, head of the Wisconsin Retirement System and Chairman of NCTR’s Legislative Committee, and Leonard Bumbaca, member of the Board of Trustees of the Educational Employees' Supplementary Retirement System of Fairfax County, Virginia, and a member of NCTR’s Executive Committee, attended the Roundtable representing NCTR. NASRA, NCPERS, GFOA and NAPPA also had representatives in attendance, as did a number of individual public plans. Steve Yoakum, executive director of the Public School Retirement System of Missouri and NASRA President, commented after the Roundtable, “I heard ‘what.” I’m not sure I really heard ‘why.’” And this is indeed an important question. It could be, as represented, that having finished their enforcement focus on 403(b) and 457 plans, the governmental DB plans community was the natural place for the IRS to turn to next. It could also be that the Cycle C determination letter process was an obvious trigger. However, it was also very clear from the Roundtable that the entire issue of plan funding was very much in the minds of the IRS. And this, as we know, is a common focus of opponents of DB plans. The more cynical among us might suggest that this new interest in enforcement for governmental DB plans reflects a belief by the Grover Norquists of the world that it is best to get such a process underway now at the Treasury and the IRS before the Bush Administration leaves town and a new White House, possibly in the control of the Democrats, takes over. After all, new press stories highlighting potential tax compliance problems for governmental DB plans could provide yet one more tool with which to distort the true record of public pensions. (The sudden interest on the part of the Bush Administration in providing a biogenerics process at the FDA – see January/February 2008 NCTR Federal e-News – is another possible example of this kind of political decision-making.) In any case, the IRS is definitely gearing up for an increased enforcement effort targeting governmental plans. NCTR will be working closely with the IRS to ensure that the unique nature of our retirement systems, and our commitment to retirement security, is fully understood and appreciated as they move forward. After all, we’re from the government, too, and we’re also here to help ensure that public employees will get the retirement benefits to which they are entitled! IRS
Roundtable Presentations (see “Recent News”) The House of Representatives has passed its version of a package of
technical amendments to the 2006 Pension Protection Act (PPA) without
including an amendment that would protect governmental plans from per
se violations of the Age Discrimination in Employment Act (ADEA) if
they have interest crediting features that provide above-market rates
of return. The technical amendments passed by the Senate last December
also did not contain this much-needed fix. While the amendment has broad-based
support, it became ensnared in political maneuvers involving unrelated
private sector amendments, and it remains unclear if and when this serious
issue can be addressed. Currently, without this much-needed amendment, beginning in 2009 the Treasury Department's proposed regulations would limit the amount of interest that can be paid to a rate no greater than the so-called market rate, i.e. an index, a bond rate, or a fixed rate of 3% or 4%. This Federal cap could effectively amount to a cut in guaranteed benefits. However, if a governmental plan did not impose this cap and instead paid interest that exceeded the market rate, it would constitute a per se violation of ADEA, and the Equal Employment Opportunity Commission (EEOC) could pursue an enforcement action against the plan. (Per se is from the Latin for "by itself," and such a violation of law is essentially automatic, and other facts and circumstances are not taken into account.) The governmental plans amendment that NCTR has helped fashion would allow state and local governments to continue to set interest crediting rates using their applicable state and local laws. This language was specifically developed so that everyone in the public sector could agree (unions, employers and pension plans). The amendment would simply provide that rates of interest used by State or local governmental plans in accordance with their public procedures (statute, ordinance, etc.) are to be treated as permissible methods of crediting interest under this new PPA standard. It does not provide an exemption from ADEA. Sign-offs from all four Congressional Committees that had jurisdiction – House Ways and Means; House Education and Labor; Senate Finance, and Senate Health, Education, Labor and Pensions (HELP) – were also obtained last fall. However, the Treasury Department apparently convinced the Committee staff of Congressman George Miller (D-CA), who is Chairman of the House Education and Labor Committee, that the governmental plans amendment would permit age discrimination, particulalyl in the context of DROP plans. Therefore, when the PPA technicals bill was moved to the House floor for action just before the Congressional Easter recess earlier in March, the governmental plans amendment was not included. Subsequently, following further discussions with Congressman Miller’s staff, the amendment was modified to clarify that if an interest rate could still be otherwise shown to violate ADEA, then the rate would not be exempt from the law; the amendment simply would not make such a rate a per se violation. This change obtained the AARP's approval as well, and Congressman Miller now officially supports the substance of the amendment. But the delay that this created allowed others to decide to try to use the governmental plans amendment as leverage to get other more controversial amendments also included in the technicals bill. This is where the Education and Labor Committee's ranking Republican member, Congressman Buck McKeon (R-CA), became involved. He said that he had no issue with the merits of the amendment, but argued that if it was going to be included, then other “non-technical” amendments should also be allowed to be included. Mr. McKeon therefore objected at the last minute and kept the governmental plans amendment out of the PPA technicals bill that subsequently passed the House March 12th. These other amendments have nothing to do with the public sector, are not necessarily that controversial themselves, but are nonetheless potential bargaining chips for other non-related issues. For example, there have been reports that Congressman Miller, who is trying to advance 401(k) reporting and disclosure reform legislation over objections from the private sector, is trying to leverage their support for his 401(k) legislation by using some of the “non-technicals” sought by the private sector as “sweeteners” in his bill. Miller’s delay on the governmental plans amendment has thus allowed it to be linked to these other potential “sweeteners.” So the situation is still very fluid. Nevertheless, public employees and their pension plans should not effectively be held hostage while these other non-related negotiations are pursued. However, if the governmental plans amendment is not included in the PPA technicals bill, which appears increasingly likely to be the case, then it may be very difficult to find another vehicle in this election-year Congress to which to attach it. With the elections looming ever closer, the Congressional schedule is going to become more problematic as time goes on. There continues to be talk of a second PPA bill with other non-technical amendments, and there could also be a potential opportunity on the 401(k) fees bill also, which Mr. Miller has marked up, but which Ways and Means must also clear. In short, time is not on our side, and it is fast running out for this
“must-do” amendment. If you have not yet told your Congressional
representatives of the need to take action on this matter, the time
to do so is now.
GASB Announces Formal Review of Governmental Plans Accounting Standards The Governmental Accounting Standards Board (GASB) has now formally approved a new project to consider any needed changes to the existing standards of accounting and financial reporting for governmental plans. One possible change could be to require the disclosure of the market value of liabilities (MVL), an approach ardently advocated by some proponents of Financial Economics theory. Since MVL is not linked directly to funding methods used by governmental plans, its disclosure will only serve to create public confusion by calling into question the measurements of liabilities traditionally used by plans – and could encourage different and often competing interest groups to choose whatever number best suits their own political agendas. The new GASB project will probably take years to complete, but the potential harm to governmental DB plans requires the immediate attention of the public pension community. The decision by GASB at its mid-April meeting ends a research process that began in 2006 to gather information regarding the effectiveness of the model and standards established for pension accounting and financial reporting in Statement No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, and Statement No. 27, Accounting for Pensions by State and Local Governmental Employers, in meeting the financial reporting objectives set for them. (See September 2006 NCTR Federal e-News) The GASB staff ultimately proposed that the Board undertake a current agenda project to address pension-reporting issues and consider the possibility of amendments to existing standards “to improve accountability and the decision usefulness of reported information.” (Because the same model and similar standards also have been adopted for accounting and financial reporting for other postemployment benefits (OPEB) in Statements No. 43 and 45, the recommendation also includes consideration of potential issues relevant to OPEB reporting.) In announcing its decision, GASB said that the reasons for the project included the sharp drop in the fair values of plan assets in the years 2000–2002 and the financial effects of recent decisions by many plan sponsors, made when plans were at or near fully funded status, to either redefine benefits (the examples they cite are the granting of thirteenth checks or ad hoc cost-of-living increases, and the revision of benefit terms in ways that increased benefits, sometimes with retroactive application to past periods of service), or to defer payment of some or all annual required employer contributions. While GASB notes that “these events alone do not argue for a review of the accounting and financial reporting standards,” they also point out that the experience “raised the level of awareness and concern among some user groups, particularly taxpayers, regarding defined benefit pension plans.” As a result, GASB says that “greater attention” has been paid to the information about postemployment benefits that the GASB’s current standards require to be reported. They also note that “some commentators” believe that current accounting and financial reporting standards and the issues that they raise are among the various factors contributing to these recent developments. GASB says that its project is not concerned with factors that may have influenced policy decisions made regarding postemployment benefits, nor with governance policies or controls that arguably should or should not have been in place in specific instances. However, GASB does believe that there are several questions that “are relevant in the context of the Board’s objective of establishing and maintaining high quality accounting and financial reporting standards that provide decision-useful information to financial statement users.” These questions specifically include: · Have existing financial accounting standards enabled a faithful
representation and transparent reporting of the financial effects of
employers’ benefit obligations and actions taken in regard to
benefits and the funding of benefits, including benefit costs, accrued
benefit obligations, and plan assets? Proponents of MVL would argue that the absence of any requirement to disclose this information has resulted in an inaccurate view of the real financial effects of decisions regarded benefits and benefit funding. They would also insist that the lack of MVL disclosure and the failure to match liabilities with risk-free rates of return has resulted in interperiod inequties related to benefit funding. However, by increasing the measurement of liabilities, thereby decreasing apparent funding levels, MVL disclosure could serve to only further exacerbate the challenges that already exist in seeing that annual required contributions are adequately satisfied. Nor does MVL provide relevant information about the future potential risk profile of a plan, which is critical to the development of appropriate investment strategies. Instead, by arguing against equity and for more “bond-like” investments, MVL proponents appears to contradict modern portfolio theory’s recognition of the role of risk and the standard practices of risk management, and would have plan fiduciaries abandon decades of reliance on reasonable assumptions related to rates of return based on a range of variables using past experience and expectations for future returns for capital markets. It is true that GASB has recognized the importance of different accounting standards for the governmental sector. However, make no mistake: the MVL/Financial Economics debate will clearly have an impact on GASB’s consideration of any perceived changes that may be required to be made to Statement No.’s 25 and 27. For example, the GASB staff report explicitly notes the current controversy over this issue and includes among the major questions to be answered whether parameters regarding the basis for determination of the discount rate should continue to require the use of the long-term expected rate of return on assets, or whether another basis (for example a current risk-free rate of return, the employer’s borrowing rate, or some other) should be used. The GASB undertaking and its potential outcome are therefore critical to the future of public sector defined benefit plans. The anticipated time frame for the project is to have a formal “Invitation to Comment” issued in March, 2009, with Preliminary Views released by GASB in December, 2010, followed by a comment period, the development and discussion of responses, and the issuance of an Exposure Draft in September of 2012. This would also be followed by a comment period, with the issuance of final Statement(s) not expected until December of 2013. But this does not mean that work on this issue can afford to wait.
NCTR is currently in the process of finalizing a letter and comments
to the American Academy of Actuaries and the Society of Actuaries, who
are being heavily pressured to weigh in on the side of MVL proponents.
A formal position in favor of MVL disclosure from these two organizations
will not go unnoticed by GASB, and NCTR’s goal is to ensure that
the adequacy of the current efforts to date by the Academy and the Society
to explore the issues surrounding this matter are called into question
and their processes re-examined. (See
January/February 2008 NCTR Federal e-News) GASB
Staff Recommendations on New Accounting Standards Project (see “April
2008” papers) NCTR, Other Public Sector Groups Seek Delay of Final IRS “Normal Retirement Age” Regulations
In May, 2007, the IRS issued final regulations dealing with in-service distributions after normal retirement age. The new regulations permit a pension plan to pay benefits upon an employee’s attainment of “normal retirement age,” even if the employee has not yet had a severance from employment with the employer maintaining the plan. For the purposes of in-service distributions, the new regulations provide that “normal retirement age” under a plan must be an age that is “not earlier than the earliest age that is reasonably representative of the typical retirement age for the industry in which the covered workforce is employed.” Several safe harbors are provided. For example, pursuant to a change made in the 2006 Pension Protection Act, a normal retirement age of at least age 62 is deemed to meet this new “typical retirement age” standard; for plans with normal retirement ages between ages 55 and 62, there will be a presumption that they are acceptable based on a “good faith determination of the typical retirement age for the industry in which the covered workforce is employed that is made by the employer.” For a normal retirement age that is lower than age 55, there is a presumption that it does not meet the new standard “absent facts and circumstances that demonstrate otherwise.” (For plans where substantially all of the participants in the plan are qualified public safety employees, a normal retirement age of age 50 or later is deemed to meet the new standard.) These new regulations raise a number of worrisome issues for governmental plans. For example what about plans with different normal retirement dates for different classes of employees or different normal retirement dates for different participants in the same class of employees? Then, in August of last year, the IRS issued Notice 2007-69, which underscored that the new regulations also do not provide a safe harbor with respect to a retirement age that is conditioned (directly or indirectly) on the completion of a stated number of years of service. However, as we know, defined benefit plans of state and local governments
often define their normal retirement age or normal retirement date as
the date or age when participants qualify for normal or unreduced retirement
benefits under the plan, and this is often conditioned, in whole or
in part, on the completion of a stated number of years of service. Other
governmental pension plans do not specifically define normal retirement
age. Therefore, as part of its August, 2007 notice, the IRS also requested
comments from sponsors of governmental plans on whether normal retirement
age under such a plan may be based on years of service. As these joint comments pointed out, requiring governmental pension plans to specifically define normal retirement age, or redefine normal retirement age so that it is not based wholly or partly on years of service, is particularly problematic where attainment of normal retirement age entitles participants to rights that are protected by constitutional guarantees. As the 2007 NCTR/NASRA joint comments pointed out, any time a State or local retirement system is required to be amended, it generally requires a State legislative initiative or enabling authority since pension plans of States and localities are established by these governments acting in their sovereign capacity and generally are adopted by and subject ultimately to popularly-elected governmental bodies. “The benefits provided by many public employee retirement systems are also subject to state constitutional or statutory provisions that bar public employers from taking back or reducing benefits once they have been established,” the comments stressed. However, the IRS has yet to respond by making modifications to the final regulations. Therefore, on April 30, 2008, NCTR, NASRA and 17 other public sector organizations -- including employer and employee representatives -- filed a formal request for an extension of the effective date for governmental plans “in order to permit the IRS to fully consider and respond to public sector concerns with the Final Regulations, provide clarification with regard to unsuitable or unclear definitions, provide ample time for State and local governing bodies to respond, and to avoid confusing and potentially harmful actions.” The request pointed out that unless changes to the final regulations are made for governmental plans, the IRS will essentially be placing States and localities in the position of either being out of compliance with Federal regulations or incurring enormous financial and administrative costs and violating their own constitutional, statutory or case law protections. Furthermore, the letter notes, without the clarifications requested by NCTR and NASRA with regard to inappropriate or unclear definitions, it is hard to see how governmental plans could reasonably be expected to follow the final regulations should they try. Finally, the letter concludes, it would also be impossible for most elected governmental bodies to amend State or local governing statutes in time to meet the required effective date. Given the very serious disruptions that would result should the effective
date for governmental plans remain unchanged, not to mention the significant
financial impacts on the plan and plan sponsor that would accompany
changing something as fundamental as the age at retirement, this issue
is a top NCTR priority for 2008. Based on earlier discussions with the
IRS and Treasury staff in 2007 concerning this issue, it would appear
that some relief in connection with the final regulations is likely.
However, absent any indication to date as to what this may look like,
an extension of the effective date is therefore essential. As Pension Investments in Them Continue to Grow, Hedge Funds Once Again Are Focus of Attention in Washington
According to the GAO, the number of hedge funds has grown from about 3,000 in 1998 to more than 9,000 in 2007, and assets under their management increased globally from $200 billion to more than $2 trillion. U.S. pension funds have accounted for much of this growth, with defined benefit pension plans’ investments in hedge funds growing from $3.2 billion in 2001 to $50.5 billion in 2006, the GAO reports. Furthermore, hedge fund assets reported by DB plans included in the 200 top U.S. funds increased 51% to $76.3 billion for the 12-month period ending September 30, 2007, according to Pensions & Investments’ annual survey of the 1,000 largest U.S. retirement plans. This pension fund involvement in hedge funds has not gone unnoticed by the Congress. For some time now, both the House and Senate have been concerned with governmental plans’ activities in this area, and there have been clear indications from Congressional leaders that there may need to be Federal legislation to either (1) protect plans from their own ignorance and gullibility, or (2) protect their participants from the plans’ reckless desire to chase returns. Most recently, this paternalism surfaced in connection with proposed changes in the taxation of hedge fund managers’ income in 2007, when some argued that public plans needed to be protected from investment losses if private equity’s taxes were increased. (See July/August 2007 NCTR Federal e-News) While the subprime crisis and the ensuing economic problems that it helped to engender have pushed such tax issues as carried interest to the back burner for now, a recent GAO report has served to underscore the continued Congressional nervousness with pension investments in hedge funds, particularly those involving public plans. The new GAO study was released February 25, 2008, by Congressmen Barney Frank (D-MA), Chairman of the House Financial Services Committee, Paul Kanjorski (D-PA), Chairman of its Subcommittee on Capital Markets, and Michael Capuano (D-MA). According to Congressman Kanjorski, Congress needs “to ensure that we have adequate knowledge of this sector of our capital markets and effective market discipline, especially as the pension assets of more and more Americans are invested in hedge funds.” However, the GAO’s examination of hedge fund regulations actually contains several items favorable to pension plan investors, including governmental plans. For example, while the GAO found that investments by DB plans in hedge funds have increased, the share of total pension plan assets invested in hedge funds has remained small. Furthermore, the GAO’s research indicates that hedge fund advisers have improved disclosure and become more transparent about their operations, including risk management practices, “partly as a result of recent increases in investments by institutional investors with fiduciary responsibilities, such as pension plans.” The report also states that “Recently, hedge fund advisers have increased their level of disclosure in response to demands from institutional investors.” For example, according to the GAO, “hedge fund advisers have responded to the requirements of these clients by providing disclosure that allows them to meet fiduciary responsibilities.” Nevertheless, the GAO report also found that “not all investors have the capacity to analyze the information they receive from hedge funds.” In addition, the three Congressmen note that the GAO is expected to release a more extensive report examining the scope of public and private pension funds’ exposure to hedge funds in the coming months in response to a request made by Senators Chuck Grassley (r-IA) and Max Baucus (D-MT), the leaders of the Senate Finance Committee. Accordingly, Congressmen Frank, Kanjorski, and Capuano will ask the GAO to conduct a subsequent review. According to their press release, “These additional GAO reports and their findings will help to determine whether further legislative and regulatory reforms, if any, should be pursued.” In the meantime, two private-sector committees established by the President's Working Group (PWG) on Financial Markets released two reports on hedge fund “best practices” on April 15, 2008: one for hedge fund investors and one for asset managers. The PWG includes the heads of the Treasury Department, the Federal Reserve, the Securities and Exchange Commission and the Commodity Futures Trading Commission. The Investors’ Committee of the PWG consists of senior representatives from major classes of institutional investors including public and private pension funds, foundations, endowments, organized labor, non-US institutions, funds of hedge funds, and the consulting community. The Investors’ Committee report addresses the decision to invest in hedge funds and the management and oversight of hedge fund investments. It contains both a Fiduciary’s Guide, which provides recommendations to individuals charged with evaluating the appropriateness of hedge funds as a component of an investment portfolio, and an Investor’s Guide, which provides recommendations to those charged with executing and administering a hedge fund program once a fiduciary has decided to add hedge funds to the investment portfolio. Corresponding guidelines were promulgated by the Asset Managers’ Committee of the PWG, which identified best practices for the alternative investment industry with respect to the management and administration of hedge funds, including practices regarding disclosure, valuation, and risk management systems. The Investors’ Committee report stresses that before making a hedge fund investment, investment staff “should engage in a due diligence evaluation that is appropriate and effective in light of the risk tolerance of the institution or individual they represent.” Once a hedge fund investment is made, the report notes that staff should continue to monitor the investment to identify any newly introduced risks and to weigh them against the potential impact on overall portfolio risk and the expected effect on portfolio returns. Both the Investors’ and the Asset Managers’ Committees are soliciting public comment on their Reports. The comment period is open until Friday June 13, 2008, and comments may be submitted on each Report separately through the Committee’s page on their website (see links below). New
GAO Hedge Funds Report NCTR Files Joint Comments on Implementation of 3% Withholding Tax on State and Local Government Payments to Contractors
Despite the fact that neither the House nor the Senate included a similar provision in their original versions, the Tax Increase Prevention and Reconciliation Act (TIPRA, P.L. 109-222), signed by President Bush on March 17, 2006, (extending current capital gains and dividend treatment another two years) contained a new requirement (Section 511) that all states and many local governments, as well as certain instrumentalities thereof, withhold three percent on all payments to persons providing them with property or services. It was added as a revenue-raiser, and is expected to provide approximately $7 billion over the first 10 years for the Federal government. Political subdivisions of states (and any instrumentalities thereof) with less than $100 million in annual expenditures for such properties or services would be exempt. In addition, other specific exemptions are made, such as for payments of interest; payments for real property; and intra-governmental payments. The provision would apply to payments made after December 31, 2010, and also imposes information-reporting requirements on such payments (the withheld amounts will be a credit against the tax liability of the recipient, and will be shown on an information return after the end of the tax year, similar to backup withholding or withholding on wages). The Statement of Conferees specifically notes that payments under government programs to provide health care or other services that are not based on the needs or income of the recipients would be subject to such withholding, including programs where eligibility is based on the age of the beneficiary. Although there is no specific discussion of where public pension plans would fit under this new law, it would certainly appear possible that, depending upon the specific circumstances of their establishment and governance, retirement systems could qualify as governmental entities subject to this new requirement. If so, the withholding requirements would appear to apply to a number of plan activities, such as consultant contracts, fees paid to money managers, and payments to healthcare providers where the plan administers health benefits. This new requirement, if implemented, will impose a massive unfunded mandate on State and local governments and will cause significant administrative burdens. Furthermore, the costs for doing business with state and local governments and their instrumentalities will increase, and the private sector companies will pass those costs along. Accordingly, NCTR has consistently supported the repeal of Section 511. (See November 2006 NCTR Federal e-News) While the House of Representatives recently voted to delay the 3% withholding requirement until 2012, the bill (H.R. 5719) has been threatened with a White House veto for other unrelated resons (see story below on HSAs). In developing their anticipated guidance, the Treasury and Service said they were particularly interested in: · How to apply the withholding requirements to purchases made
with credit cards or other forms of payment cards; The NCTR joint comment letter points out that, in addition to being an unfunded mandate, the law is “wrought with unanticipated complexities making its implementation nearly impossible to achieve, particularly without specific guidance by 2011. Furthermore, sophistication levels of systems to capture and report the required data vary greatly between governments and some entities do not have the capacity or staff to undertake the additional reporting, let alone withholding and remittance.” The comment letter also underscores that at least two years will be
needed to allocate resources for the purchase, design, testing and modification
of system components, in addition to sufficient time to issue vendor
notices and Federal agencies will also be required to comply with Section 511, and they are beginning to register their dismay with the provision as well. For example, the Department of Defense (DoD) has prepared a report for Senate Armed Services Committee Chairman Carl Levin (D-MI) and House Armed Services Committee Chairman Ike Skelton (D-MO) which assess the impacts of compliance with Section 511. According to this report, the DoD anticipates their costs to comply will be significant – over $17 billion for the first five years. This estimated cost impact includes the costs for DoD to implement and manage section 511 within DoD and the additional costs escalation DoD will pay its contractors as a result of section 511. Finally, the DoD is concerned that section 511 “may limit the number of companies willing to enter into the government market, thereby reducing competition and access to new technologies, and may cause other unintended consequences.” Nevertheless, the provision was added to the law as a revenue-raiser, and its repeal will require that the $7 billion in new revenues over 10 years that would be lost will have to be offset under the Congressional PAYGO rules. While it has been argued that $6 billion of this “increase” actually represents an acceleration of tax receipts and is not a real revenue increase, perhaps the additional costs to DoD and other Federal agencies that would be avoided by repeal will provide the real impetus for reconsideration. Such a cost-savings could significantly enhance the likelihood of relief from this onerous provision. NASACT/NCTR
Joint Comment Letter Commissioner of Social Security: “Disability
is our Most Pressing Challenge” Approximately 2.5 million people apply for Social Security disability benefits each year, and it takes an average of three months for a decision to be made. While one-third of the applications are approved upon initial application, those who are denied must appeal the decision to the hearing level. “It can take a long time to receive a decision – much too long, in my opinion,” according to Commissioner Astrue. Pending hearings have doubled since 2001, and currently, Mr. Astrue reports that there are more than 750,000 cases waiting for a hearing, with the time to get a hearing decision averaging 499 days. Part of the reason for this state of affairs is that Social Security’s disability programs have grown significantly over the last seven years and the agency believes that they will likely continue to do so at an increasing rate “as aging baby boomers reach their most disability-prone years,” Mr. Astrue warns. At the same time, he notes that Congress has added new and non-traditional workloads to Social Security’s responsibilities. “As a result, the agency is struggling to balance those new responsibilities with its core workloads under tight resource constraints,” Astrue concedes. In addition to hiring 175 new Administrative Law Judges (ALJs), the largest group of new ALJs ever hired by Social Security in a single year, the Commissioner has also instituted several new initiatives which he says should “eliminate the hearings backlog and prevent it from recurring.” These include: · Quick Disability Determination (QDD), a process based on a
computer model that allows the screening of cases with a high potential
for approval; When it comes to eliminating disability backlogs, Commissioner Astrue acknowledges that “there is no single magic bullet.” However, he believes that his new initiatives provide a significant step in the direction of improving the disability process and waiting times. Hopefully, the actual experience of applicants matches this rhetoric. Commissioner Astrue’s “Social Security Update” Article
White House Says House-Passed Tax Bill Would Impose New Administrative Burdens on Trustees of HSAs; Veto Threatened The "Taxpayer Assistance and Simplification Act of 2008,” which the House of Representatives approved in April, contains a provision that would impose a new “substantiation” requirement for payments from Health Savings Accounts (HSAs) and would also require the trustee of an HSA to report to the Treasury and the account beneficiary any unsubstantiated amount paid from an account for the preceding calendar year. The Bush Administration says that the provision threatens to undermine the flexibility of HSAs and would impose unnecessary and costly new burdens on HSA administrators. If the legislation were presented to the President with these provisions, his senior advisors say they would recommend he veto the bill. On April 15, 2008, after barely surviving a motion to recommit the bill to the House Ways and Means Committee for further deliberations by a tie vote of 210 to 210, the "Taxpayer Assistance and Simplification Act of 2008,” H.R. 5719, passed the House by a vote of 238 to 179, with nearly all Republicans opposed and virtually all Democrats in favor of the legislation. In addition to other provisions, such as the repeal of the authority of the Internal Revenue Service to enter into private-debt-collection contracts, the legislation also contains a requirement that, for amounts coming out of HSAs after Dec. 31, 2010, trustees must substantiate qualified medical expenses in a way similar to the method used for flexible-spending arrangement (FSA) expenditures. Otherwise, distributions from an HSA for qualified medical expenses would not be excludable from income. The stated goal is to reduce the number of taxable distributions that are not being reported. For example, the Congressional Budget Office (CBO) estimates that the provision would result in an additional $308 million in revenue over the next 10 years. However, opponents argue that it would restrict the use of debit cards and check cards, thereby threatening the cost structure for HSAs. The American Benefits Council, for example, warns that the provision “will unnecessarily increase administrative costs and complexity and adversely affect individuals who depend on high deductible health plans, coupled with HSAs, for health coverage." Other supporters of HSAs argue that the provision is a version of sour grapes. As The Wall Street Journal puts it, “Having lost the policy argument when HSAs were created, Democrats are now trying to kill them with regulatory subterfuge.” But Democrats argue that HSAs are nothing more than tax shelters for the rich and are being used “for everything from body shop repair to fast food restaurants," according to Congressman Earl Pomeroy (D-ND). The controversy now moves to the Senate, where Republicans are expected
to be able to deny the bill a vote using their filibuster powers. Even
if the bill could somehow be passed, a threatened Presidential veto
is unlikely to be overturned, given the partisan split on the measure.
Nevertheless, the provision is a revenue-raiser, and could still find
its way into other legislation that might be more difficult for Republicans
to oppose, particularly as the legislative calendar grows more difficult
to maneuver as the November elections draw ever closer. Executive Compensation Issue Still Alive on Capitol Hill While the Senate has yet to act on legislation previously passed by the House of Representatives to provide investors with the opportunity to conduct an advisory vote on a company’s executive pay plans, the issue of executive compensation continues to resonate in certain quarters on Capitol Hill – most recently in connection with the subprime mortgage crisis. A hearing in March before the House Committee on Oversight and Government Reform showcased the apparent disconnects between the enormous losses suffered by certain companies in connection with the mortgage meltdown and the compensation provided their executives. Most recently, the Senate sponsor of the House-passed bill, Senator Barack Obama (D-IL), also used the example of the subprime debacle to call for prompt passage of his legislation. But it remains highly unlikely that such legislation will become law this year. On March 7, 2008, Congressman Henry Waxman (D-CA), Chairman of the House Committee on Oversight and Government Reform, conducted a hearing on CEO pay and the mortgage crisis. With the CEOs of the 500 largest American companies receiving an average of $15 million each in 2006 (a 38% raise in just one year), Congressman Waxman noted that 10% of corporate profits are now flowing to the companies’ top executives. Waxman said that he thinks there is merit to pay for performance. “But it seems like CEOs hit the lottery even when their companies collapse,” he observed. The focus of his hearing was “the debacle” with subprime mortgages, and he said that “The question we will ask is a simple one: When companies fail to perform, should they give millions of dollars to their senior executives?” But others saw the hearing in a different light. Congressman Tom Davis (R-VA) called the hearing a "sanctimonious search for scapegoats." He said it amounted to a “public flogging” of individual corporate executives, and likened it to “an island tribe sacrificing a virgin to a grumbling volcano." Mr. Davis is the ranking GOP member of the Committee, and the CEOs of Countrywide Financial Corporation, Merrill Lynch, and Citigroup were the “sacrificial virgins” to whom he referred. However, Chairman Waxman insisted that “This isn’t a hearing
about illegality or even ethical breaches.” Rather, he said, “It’s
a hearing to examine how executives are compensated when their companies
fail. And it’s a hearing to help us understand whether this situation
is good for the companies, the shareholders, and for America.”
Noting that the pay the three CEOs received from their companies and
their stock sales was extraordinary even though the firms suffered enormous
losses, Waxman said that “Any reasonable relation between their
compensation and the interests of their shareholders appears to have
broken down.” In the Senate, Barack Obama (D-IL) introduced a companion measure, S. 1181, on the same day the House bill passed. While the bill, which was referred to the Senate Banking Committee, has received no further Senate action, Senator Obama has recently returned to it as subject of one of his Presidential campaign press conferences. Speaking in Indianapolis, Indiana, on April 11, 2008, Senator Obama referred to a new study produced by USA Today that found that the top 50 CEOs made around $15.7 million last year - despite the fact that many of their companies have been falling behind. He also referred to Countrywide Financial, calling it “an outrage” that when it was sold, its top two executives got a combined $19 million. “Never mind that Countrywide is as responsible as anyone for the scandalous mortgage crisis we've got today - a crisis that's the source of many of our other economic problems,” he declared. However, Obama said that “This isn't just about expressing outrage." Instead, he said "It's about changing a system where bad behavior is rewarded - so that we can hold CEOs accountable, and make sure they're acting in a way that's good for their company, good for our economy, and good for America, not just good for themselves.” Saying that “We've seen what happens when CEOs are paid for doing a job no matter how bad a job they're doing,” the Illinois Senator and Democratic Presidential candidate said that “We can't afford to postpone reform any longer,” and called on Washington to “act immediately” to pass his legislation. But it does not appear likely that this will happen anytime soon. No hearings on his legislation have been held by the Senate Banking Committee, and none are scheduled at this time. Many believe that “Say on Pay,” as it is also called, will only happen when investors are afforded realistic and meaningful access to the proxy. But that, of course, is another story unto itself. For another view on this subject that differs from that of Senator
Obama, check out the recent remarks of Stephen M. Bainbridge, William
D. Warren Professor of Law, UCLA School of Law. These remarks were presented
to the Penn House
Hearing on CEO Pay and the Mortgage Crisis
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