October 6, 1993
Mr. J. Richard Futrell, Jr. State Budget Officer Office of the State Budget and Management Raleigh, North Carolina
RE: Advisory Opinion; §125 of the Federal IRS Code and State Laws Governing or Limiting Levels of Benefits for State Government Employees
Dear Mr. Futrell:
This letter is in response to your letter dated July 8, 1993 received by us on July 15, 1993. It also is in follow-up to the series of letters we sent you in July, August and September plus our telephone conversation on September 2nd.
As you know, A Section 125 plan (so called because of the Section of the IRS Code under which it is authorized), is also called a cafeteria plan or flexible benefit plan. A Section 125 plan, in its most simple terms, is a plan that offers employees a choice between two or more benefits. The 125 Plan provides a way of meeting changing benefit needs, reducing benefit costs and delivering tax savings to the employer and employee. For example, an employee can pay for medical and health benefits on a pre-tax salary reduction basis. Currently, premiums paid for state provided comprehensive major medical coverage is paid on a pre-tax salary reduction basis. Other Section 125 Plan benefits include: health care, (comprehensive major medical, dental, vision and prescription drug); term life insurance; dependent care; health care reimbursement accounts and some disability income continuation plans. Your particular concern involved designing the Section 125 Plan. A controlled group determination is a major factor in designing the plan.
As you indicated in your July 8th letter, "[t]he essence [of your request] is whether . . . `all government employees, as defined for purposes of planning a statewide flexible compensation program, are the employees of a controlled group and would they be tested as employed by a single employer.’" As you recognized in your letter, standards for determining common control under 26 U.S.C. §414(b) and (c), and the IRS regulations offer little guidance because common control is defined in private sector, ownership terms. The consultants, Coopers & Lybrand, hired to do the Flexible Benefit Plan Feasibility Study indicated they anticipated the IRS promulgating regulations on the control group issue as it applied to public employers. (See, Final Report, Legal Impact page 11) They also pointed out that ultimately it will be the IRS’s position on what employees belong in a Section 125 plan that will be of paramount importance. Accordingly, our office embarked on an effort to obtain IRS guidance on the control group issue. We had extensive conversations with various IRS Sections including: the Employee Plans and Exempt Organization Section of the National Office; the Employee Plans Section of the Greensboro Office; the Employee Plans Division of the Atlanta Office, the Office of the Chief Counsel, Cafeteria Plans Section and Employee Plans Section and the Employee Plans Ruling Section of the National Office. Ultimately the IRS refused to provide a private letter ruling or write a letter of the type we requested. Nonetheless, our extensive conversations confirmed Coopers & Lybrand’s opinion that the prudent approach is to attempt to include as many employees as possible in the same plan, offering them the same selection of benefits and contributions. (See, Final Report, Executive Summary, pages 2 and 3; Legal Impact, pages 10 and 11.) Basically, Kathy Fuller (IRS National Office, Office of the Chief Counsel) and Robin Erinburg (Office of the Chief Counsel, Employee Plans Section) indicated the IRS will view separate plans for groups of arguably affiliated employees with a much more critical eye than a single plan for all employees. According to both Ms. Fuller and Ms. Erinburg, the danger lies not in grouping all employees together in one plan, but in attempting to exclude certain employees, or groups of employees, from a particular plan. Ms. Fuller stated that if all employees of the various agencies are eligible to participate in the same plan, then it would not be considered discriminatory under 26 U.S.C. §125(b)(1)(A), the first of the two required discrimination tests. Ms. Fuller stressed that a discrimination determination is only necessary if the plan excludes certain employees from participation. If all employees are eligible to participate, then a discrimination determination is unnecessary; the plan by definition does not discriminate in eligibility to participate. Ms. Fuller indicated that if it were determined that the four groups of employers listed in your letter, (university, community college, public school and state) were under common control and the plan excluded one group of employees, then the plan must either meet the safe harbor in 26
U.S.C. §410(b)(2)(A)(i) or the regular facts and circumstances test. (See, Final Report Legal Impact pages 7, 8 and 9) Failing [either] Section 125 Plan test will cause the entire program to fail, resulting in taxable income to all highly compensated participants.
The safe and prudent route is therefore to lump the various employee groups together, a route which is supported by many factors. First, Michael Byrd of the IRS Atlanta Office Employee Plans Division indicated a key factor is funding considerations. Mr. Byrd indicated the IRS would look at who has authority over the funding decision for the various agencies. All of the four employee groups mentioned in your letter receive their funding, at least in part, from the General Assembly. A second factor Mr. Byrd mentioned is whether all employees are covered by the same retirement system. All four groups are covered by the same retirement plan. N.C. Gen. Stat. § 135-1(10), (11), (13), (18) and (25). Mr. Byrd’s observations on important criteria are helpful because Mr. Robert Architect of the IRS National Office, Employee Plan Rulings Section, took the position that the district office, Mr. Byrd’s office, would make a common control determination as part and parcel of the determination of whether an employee plan is a qualified plan. A third factor indicating common control is the fact that all groups are covered under one disability plan (N.C. Gen. Stat. §§ 135-100; 135-101.8, .11, .19), are entitled to a state provided death benefit (N.C. Gen. Stat. § 135-5(1)) and participate in one 401(k) plan. (N.C. Gen. Stat. § 135-92(a)(1), (6)). Fourth, all four groups are covered under one health benefits plan
(N.C. Gen. Stat. § 135-40(a)). Fifth, all four groups are entitled to membership in the State Employees Credit Union. Membership in credit unions is confined by state law to groups having either: (1) a common bond, (2) a geographic nexus or (3) a common employer. N.C. Gen. Stat. § 54-109.26. Finally, all four groups are under the common control of the State in that the State, through the Legislature, determines the terms and conditions of employment.
The six factors enumerated above indicate all four groups should be lumped together under a single statewide flexible benefits program. In view of the fact this inquiry comes at the planning stages, a cautious approach is most prudent. It, however, should be noted that careful legislative drafting must be employed. The fact all four employee groups would appropriately be grouped for maximum safety under a Section 125 Plan testing does not mean the employees of all four
groups should be considered state employees for all purposes. For example, public school personnel are not covered by the Tort Claims Act except in school bus accidents. See, e.g., Turner v. Board of Education, 250 N.C. 456, 459 (1959); See also, McBride v. Board of Education, 257 N.C. 152, 154 (1962). The Legislature has also applied somewhat different levels of personnel protection to the four groups. Generally employees are subject to the provisions of Chapter 126, the State Personnel Act [the Act]. Chapter 126 applies to all state employees not exempted. N.C. Gen. Stat. § 126-5(a)(1). Employees of Community Colleges, however, are exempt from the Act, except for Article 14, pursuant to N.C. Gen. Stat. §§ 126-5(c2)(3) and 115D-5(a). The authority to set standards has been delegated by the State, through its Legislature, to the Board of Trustees for each community college. These Boards of Trustees, however, were established by the Legislature; their powers and duties are set by statute. Public school employers are exempt from Chapter 126 except for Article 14. N.C. Gen. Stat. § 126-5(c2)(1), (c5). Most University employees are covered by all of Chapter 126. Instructional and research staff, physicians, dentists and employees whose salaries are fixed by the UNC Board of Governors are only covered by Article 6 and 7 of Chapter 126. N.C. Gen. Stat. § 126-5(c1)(8), (9). Merely calling employees of the four groups listed in your letter state employees without appropriate qualifiers, could confuse existing case law, particularly in the tort and personnel areas. A flexible benefits statute should clearly state that for purposes of a §125 Plan, employees of the four groups are state employees. A §125 Plan classification should not equate to expanded tort or personnel coverage or diminish the powers granted by the Legislature to the Community College, Public School or University Systems.
Let us know if we can be of further assistance.
Andrew A. Vanore, Jr. Chief Deputy Attorney General
Lars F. Nance Special Deputy Attorney General