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Union plan is tax exempt as labor organization.

In Morganbesser, 2d Cir., 1993, the International Union of Operating Engineers Local Union 478, A-C-D-E Pension Plan has come up with a unique, and so far successful, response to the IRS's denial of the plan's tax qualification. The union argued successfully that in the years the plan was found not to be a tax-exempt plan, the trust was exempt as a "labor organization" under Sec. 501(c)(5). If this decision stands, multiemployer plans will have a great deal less incentive to correct plan deficiencies or settle with the Service over qualification issues. Of course, the plan would still remain liable for Employee Retirement Income Security Act of 1974 (ERISA) violations, and the tax status of employer deductions for plan contributions and the plan participants' tax status under Sec. 402(b) remain open questions. (The court did not mention whether ERISA liabilities had arisen from the defects that disqualified the plan, and the majority opinion did not address the issues of the tax status of plan participants and contributing employers.)

The A-C-D-E plan was established in 1958 as a result of a collective bargaining agreement between the union and a number of construction firms. The board of trustees administering the trust is comprised equally of employer and employee representatives. The plan, funded solely by employers, covers approximately 4,000 construction workers.

Before ERISA was enacted, the trust was granted an exemption by the Service as a qualified pension plan. Following the enactment of ERISA, which imposed more stringent rules on tax qualified plans, the plan was amended a number of times; however, the plan did not request a new IRS determination letter until 1984. The Service found that the trust failed to satisfy several ERISA requirements and, therefore, was not exempt for fiscal years 1983, 1984 or 1985. The IRS determined that, if the trust retroactively adopted certain amendments, it could become exempt for fiscal years 1984 and 1985. The trust adopted those amendments, but the Service contended that the trust still was liable for over $3 million in taxes and interest for 1983. The trust paid the 1983 taxes and filed for a refund.

The plan argued that it was exempt under Sec. 501(c)(5) as a labor organization for the 1983 year--and even if it were not, the IRS abused its discretion by refusing to grant retroactive relief. The district court granted summary judgment, finding the plan to be a labor organization under Sec. 501(c)(5), and refused to address the abuse-of-discretion issue. The Service appealed.

The Second Circuit freely acknowledged that there was little guidance on what constituted a labor organization under Sec. 501(c)(5). The court relied on a series of IRS General Counsel Memoranda, specifically quoting GCM 37942, which stated: We [IRS] have always considered it significant that the organization was in some way connected with more traditional types of labor organizations.... We think one of the most reliable indicators of a "labor organization" is that it is ... formed as a result of ... representation [of a union], or is connected with or supplements or supports in some way organizations which do perform that role.

The Service argued that the trust could not rely on the GCMs because they have no precedential value. In rejecting that response, the court said:

In view of the dearth of case law in this area, the only real guidance for what qualifies as a labor organization is found in the GCMs issued by the IRS. While we are not giving precedential value to the GCMs, in this case of first impression it becomes necessary to rely on them for interpretive guidance. If the IRS finds that the term labor organization is too broad, then, through future GCMs or regulations, it should restrict the definition, but it should not do so retroactively. The court also rejected the Service's assertion that the trust could not be a labor organization because it was jointly administered by employers and employees.

The court cited revenue rulings allowing entities that carry out the function of a labor organization to be jointly administered by employers and employees and still qualify as a labor organization for the purposes of a Sec. 501(c)(5) exemption; see Rev. Ruls. 59-6 and 75-473.

The court used these factors to support the view that the trust was a labor organization, qualifying for a Sec. 501(c)(5) exemption. The court did address the IRS's concern about permitting the trust to avoid ERISA requirements and still claim a tax exemption as a labor organization. The Service had stressed that this could cause other plans to execute an "end run" around ERISA. But the court said, in effect, that the IRS had only itself to blame if this happened. The "floodgates" argument did not mitigate the fact that the Service's prior pronouncements supported the view that the trust was a labor organization. In the court's view, if the GCMs were to be given any consideration, it would be unjust to retroactively apply standards that contradict prior IRS pronouncements.

The court found the Service's argument, that allowing the trust to be exempt under Sec. 501(c)(5) would undermine the legislative intent of ERISA, "a weak one." The court noted that a plan can qualify for more than one exemption, citing Regs. Sec. 1.501(c)(4)-1(a)(2)(i). Because an ERISA exemption is more advantageous than a Sec. 501(c)(5) exemption, the court thought it unlikely that plans will be encouraged to circumvent the ERISA requirements.

Only the dissenting opinion recognized that when a plan fails to satisfy the ERISA tax qualification requirements, the employer's contributions will not be immediately deductible under Sec. 404(a) and the employees will be taxable on contributions made on their behalf under Sec. 402(b). Moreover, because the trustees are elected by the plan participants or appointed by the contributing employers, it is unlikely that trustees whose actions result in increased taxes to both employees and employers will retain their position as trustees very long.
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Author:Cvach, Gary Q.
Publication:The Tax Adviser
Date:Jun 1, 1993
Words:1004
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