Lawsuits Threaten ‘Church Plans’
The ultimate outcomes of recent court cases that claim health care organizations’ retirement plans do not fall under the definition of “church plans” according to the Employee Retirement Income Security Act (ERISA) could reverse 30 years of Internal Revenue Service (IRS) and prior court rulings.
These cases are not the first efforts to try to protect retirement assets for employees in plans that have been designated as church plans by the IRS.
The pension plan for the Hospital at Orange in New Jersey was originally covered by ERISA and protected by the Pension Benefit Guaranty Corp. (PBGC). However, in 2003, after the hospital became affiliated with Cathedral Healthcare System Inc., the IRS granted the pension plan church plan status, which removed it from the PBGC’s protection. Coincidentally, the hospital began winding down its operations and laying off employees soon after that.
If a retirement plan is designated as a church plan, it is not subject to ERISA rules such as discrimination and reporting requirements, and, in the case of defined benefit (DB) plans, funding requirements. One threat for participants is that if the plan sponsor cannot fund the plan and it terminates, the plan receives no protection from the PBGC.
Over several years, at the request of the Pension Rights Center, the PBGC worked with the hospital’s former staff and the IRS to revisit that designation. After negotiations and an eight-year internal review, the IRS reversed its designation in 2013, and the PBGC now covers the pensions. About the reversal of its decision, the IRS said the hospital’s circumstances were unique and the agency was not setting a precedent.
While negotiations were underway with the Hospital at Orange, another church plan facing a lawsuit had its status as a church plan confirmed by a federal court. In the case of Thorkelson v. Publishing House of the Evangelical Lutheran Church in America, d/b/a Augsburg Fortress Publishers, the plaintiffs alleged that the pension plan of Augsburg was not a church plan and that the defendants breached their duties under ERISA and state law by failing to: adequately fund the plan; prudently and loyally manage the plan’s assets; disclose necessary information to co-fiduciaries and participants; and meet their contractual and trust-law duties to the participants.
Nonetheless, in 2011 the court ruled that the statutory language of ERISA defining a “church plan” as one that is established and maintained by a church or by a convention or association of churches, as well as the precedent of IRS determinations and various court decisions, supported a finding that the plan is a church plan.
Fast forward to December 2013. A federal court decision in the case of Rollins v. Dignity Health dismissed the 2011 legal and regulatory precedent. The court declined to defer to IRS private letter rulings interpreting whether plans qualify as church plans exempt from ERISA and stated it is not persuaded by other court rulings but by this principle: “[Congress] says in a statute what it means and means in a statute what it says there.”
Prior to last December’s decision, the United States intervened in the five current cases, saying, “Federal Rule of Civil Procedure 5.1(c) permits the attorney general to intervene in an action when, as here, the constitutionality of a federal statute has been challenged.” However, the U.S. is not filing a brief in the cases at this time because the courts have a duty “to resolve plaintiffs’ threshold statutory claims before adjudicating their constitutional contention.” The attorney general will decide when and if the office will address the constitutionality claims depending on further developments in the cases.
Massive Tax Penalties
With the Rollins decision, any 501(c)(3) entity that is not known as a steeple church, such as a health plan or school, is in danger of having its retirement plan’s—whether defined benefit or defined contribution (DC)—“church plan” status revoked. If the Rollins court is right, and all this time these plans have not been church plans, the potential liabilities and tax penalties will be massive.
All plans would be tax disqualified, and all would be required to file Form 5500s and ERISA notices. Further, if a plan were disqualified, its participants would have to report benefits as income. The plans could possibly correct under the IRS voluntary compliance program, but what would the IRS require to fix plan qualification?
ERISA Section 3(33)(D) permits any plan maintained by a church that fails to meet the standards of the section to retroactively correct those standards once a failure has been deemed to have occurred. This was argued in the Augsburg case, but since the court agreed the publisher’s plan was a church plan, it did not need to address the correction in that case.
Of course, the other district courts handling these cases and the appellate court for Rollins may still agree with the Augsburg court. However, if they do not, and if all the courts go the way of the Rollins ruling, the more pressing question will be: Will plan sponsors decide to put the time, money and effort into correcting—or will they just let their plans be disqualified and issue 1099s to participants?
Of note, following the Augsburg case, the IRS issued Revenue Procedure 2011-44, which modified the procedures for plans filing a request for a determination letter of church plan status. The revenue procedure provides that plan participants and other interested parties be notified of the letter request.
In addition, following the filing of the first of the current church plan lawsuits in 2013, Senators Ben Cardin, D-Maryland, and Rob Portman, R-Ohio, introduced a bill in Congress to help resolve what they term as “an unfortunate application of our current pension rules on church pension beneficiaries.”
Established by a Church
Meanwhile, another court recently rejected a pension’s church plan status. On April 4, a federal court refused to dismiss a lawsuit against Saint Peter’s Healthcare System, holding that its retirement plan is not a church plan under ERISA. U.S. District Judge Michael A. Shipp of the District Court of New Jersey determined that a church plan must be established by a church, per ERISA Section 3(33)(A).Shipp also found case law used by Saint Peter’s in its arguments to be unpersuasive and said the court could not defer to an IRS private letter ruling that had determined the pension plan to be a church plan.
Shipp said it is clear Congress intended for a church plan to be established by no entity other than a church. He pointed out that ERISA Section 3(33)(A) says “[t]he term ‘church plan’ means a plan established and maintained … by a church or by a convention or association of churches.” Shipp noted that in Subsection C(i), Congress expanded the maintenance requirement outlined in Subsection A to include plans maintained by a tax-exempt organization; however, the statute still requires that the plan be established by a church or a convention or association of churches.
“In other words, if a church does not establish the plan, the inquiry ends there,” Shipp wrote in his opinion. “If, on the other hand, a church establishes the plan, the remaining sections of the church plan definition are triggered.” According to Shipp, if the court were to accept Saint Peter’s interpretation, any tax-exempt organization could establish its own pension plan, maintain it and then employ the church plan exemption by purporting to be controlled by or associated with a church. “Defendants’ contention in this regard is unreasonable,” Shipp said. “The court cannot conclude that Congress intended to create this slippery slope, especially considering that the point of enacting ERISA was to promote the interest of employees and their beneficiaries.”
Shipp found that the case law relied upon by Saint Peter’s—the Augsburg case—was unpersuasive. In the Augsburg case, the plaintiffs made the same arguments: The benefit plan for defendant Augsburg Fortress Publishers (AFP), a nonprofit publisher for the Lutheran Church, was not a church plan because it was sponsored by AFP. Nevertheless, the Augsburg court concluded that AFP’s plan was a church plan exempt from ERISA.
Shipp said the Augsburg court focused its statutory analysis on whether the plan was sponsored by a tax-exempt entity that is controlled by or associated with a church and did not apply ERISA Section (33)(A), which requires a plan to be established by a church.
Shipp found the court’s ruling in the Rollins case is in accord with his decision. In that case, the U.S. District Court for the Northern District of California applied the same reasoning as Shipp to rule that the Dignity Health pension plan is not a church plan.
Saint Peter’s argued that Augsburg is in alignment with 30 years of judicial decisions, but Shipp replied that none of these previous decisions undertook as detailed a statutory analysis of the church plan definition as the judge did in the Rollins decision.