Attorneys Recommend Relief for Employee Benefit Trusts

Donovan, Mentz, and Grimes raise concerns that requiring employee benefit plan trusts to follow the regulations (T.D. 8813) for classifying domestic and foreign trusts will have unintended consequences for multinational companies maintaining U.S.-qualified employee benefit plans for their U.S. subsidiaries. (For a summary of T.D. 8813, see Tax Notes, Feb. 8, 1999, p. 790; for the full text, see 1999 TNT 21-21 , Doc 1999-4587 (38 original pages), or H&D, Feb. 2, 1999, p. 1451.) Moreover, they note, there isn't any evidence that Congress intended section 7701(a)(30)(E) to apply to employee benefit trusts. As such, the attorneys suggest detailed amendments to the final regs to clarify that benefit trusts subject to section 401(a) would continue to qualify as domestic trusts despite running afoul of the U.S. person requirements.

I. RELIEF REQUESTED

[2] Employee benefit trusts established under Code Section 401(a) have historically been required to be "created or organized in the United States" and, pursuant to regulations under Code Section 401(a), "maintained at all times as a domestic trust in the United States." This requirement extends to group trusts formed in accordance with Revenue Ruling 81-100. Code Section 7701(a)(30)(E) was added to the Code in 1996 in the context of numerous amendments regarding the treatment of taxable foreign trusts with U.S. beneficiaries and U.S. grantor trusts established by foreign grantors. The legislative history to this provision does not evidence any Congressional intent to apply Code Section 7701(a)(30)(E) to trusts which qualify under Code Section 401(a). However, the final regulations issued under Code Section 7701(a)(30)(E) (the "Final Regulations") indicate that an employee benefit trust must meet the new definition of a trust that is a U.S. person under Code Section 7701(a)(30)(E) in order to qualify as a domestic trust under Code Section 401(a). This interpretation raises concerns particularly regarding the application of the control test of the Final Regulations in the case of certain employee benefit trusts where substantial decisions may be made by non-U.S. persons. Under the Final Regulations, it would be possible for trusts that had always qualified as domestic trusts under Code Section 401(a) to fail the new definition in Code Section 7701(a)(30)(E).

[3] As noted in the preamble to the Final Regulations, the Treasury Department and the IRS recognize that certain tax-exempt employee benefit trusts have long been subject to a comprehensive regulatory scheme under the Code (including Code Sections 401 and 4975), as well as under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). We suggest amendments to the Final Regulations that would permit such trusts to remain qualified as domestic trusts even if substantial decisions with respect to such trusts are made by non-U.S. persons (such as investment advisors or other fiduciaries) provided that all trustees and custodians of the trust (as defined below) are U.S. persons. Accordingly, we request relief for such employee benefit trusts, which would be issued as a replacement for the current Section 301.7701-7(d)(1)(iv) of the Final Regulations, to read as follows:

"(iv) TREATMENT OF CERTAIN EMPLOYEE BENEFIT TRUSTS. Any of the

[5] Trusts may rely on this special rule for taxable years beginning after December 31, 1996, without regard to whether the trust made an election or was eligible to make an election to continue to be treated as a domestic trust under this section or Notice 98-25.

[6] For purposes of this special rule, the term "custodian" shall mean a person holding title to a custodial account described in Code Section 401(f) or Code Section 408(h)."

II. ISSUES RAISED BY REQUESTED RELIEF

1. STATUTORY AUTHORITY: The IRS has already demonstrated that in its mind it has the statutory authority to establish a special rule for employee benefit trusts (including, for the purposes of this discussion, individual retirement accounts established under Code Sections 408 and 408A), since the Final Regulations contain such a rule in Section 301.7701-7(d)(1)(iv). The relief requested above would merely provide a more comprehensive approach to dealing with this special category of trusts that would not require an inquiry into the meaning of the term "fiduciary". Nothing in the legislative history to Code Section 7701(a)(30)(E) suggests that Congress intended for this provision to change the analysis of whether an employee benefit trust that would have heretofore qualified, should not continue to qualify as a "domestic trust." The amendments to Code Section 7701(a)(30)(E) were made in the context of reforms that intended to prevent the avoidance of tax through the use of trusts. Employee benefit trusts are already exempt from tax under the Code, provided that they satisfy the requirements of the comprehensive statutory and regulatory scheme specifically applicable to them. Therefore, it is appropriate to provide a special rule under Code Section 7701(a)(30)(E) for employee benefit trusts. This in fact was done in the Final Regulations with respect to some, but not all, such trusts.

2. NECESSITY OF GRANDFATHER ELECTIONS: If the requested relief is made applicable to taxable years beginning after December 31, 1996 (the effective date of the amendments to Code Section 7701(a)(30)(E)), an employee benefit trust would not need to make a grandfather election to continue to be treated as a domestic trust. A trust that has made such a grandfather election would not be adversely affected by the requested relief.

3. EMPLOYEE BENEFIT TRUSTS TO WHICH RELIEF APPLIES: The special rule set forth above clarifies that the determination of whether a trust is an enumerated employee benefit trust would be made without reference to Section 7701(a)(30)(E). For example, without this clarification, a trust that is required to be established as a "domestic trust" under Code Section 401(a) could be required to satisfy the control test of the Final Regulations in order to qualify for the special rule of the Final Regulations, and the relief of the special rule would no longer be needed. The special rule set forth above retains the list of employee benefit trusts currently found in the Final Regulations and would permit the IRS to exercise its authority under Section 301.7701-7(d)(1)(iv)(H) of the Final Regulations (as amended) to expand the list of employee benefit trusts through published guidance. The proposed list clarifies that the relief extends to all employee benefit trusts whose trustees or custodians are U.S. persons, including group trusts and trusts under Code Sections 401(a) and 501(a) established by foreign employers who may retain control over substantial decisions within the meaning of Code Section 7701(a)(30)(E). The list has been included as part of the requested relief in order to change the Final Regulations as little as possible and to apply to all types of employee benefit trusts.

4. PUERTO RICO TRUSTS: The special rule set forth above would not generally apply to Puerto Rico trusts, because such trusts would not necessarily have a trustee or custodian that is a United States person. The IRS should provide guidance on this issue separately from the general relief requested above. However, it seems apparent that Congress did not intend to override ERISA Section 1022(i), pursuant to which a Puerto Rico trust may elect to be treated as a domestic trust. Thus, perhaps the IRS could consider expanding the list of employee benefit trusts in the Final Regulations to include group trusts with participating Puerto Rico trusts that have made an election under ERISA Section 1022(i).

III. PROCEDURE

[7] We are of course interested in obtaining the relief described above in the most timely fashion possible. As discussed in our meeting on February 1, 2000, at least one of our clients has been delayed in proceeding with a product that has already received a determination letter from the IRS under Revenue Ruling 81-100. We suspect that other trusts established under Code Section 401 will be in a similar situation once they perform a complete analysis of fiduciary responsibilities under their trusts.

[8] Perhaps relief should be granted through the issuance of guidance in the form of a Notice that the IRS intends to adopt regulations containing the special rule for employee benefit trusts described above (which would require a trustee or custodian that is a U.S. person). Or perhaps Section 301.7701-7(d)(1)(iv) of the Final Regulations should simply be amended to provide the special rule set forth above. In either case, the Notice or the proposed regulation should provide that employee benefit trusts may rely on it currently, pending the issuance of final regulations.

[9] Although we considered requesting relief under Section 301.7701-7(d)(1)(iv)(H) of the Final Regulations, in the form of a Notice or Revenue Procedure, that section would require United States fiduciaries to control all substantial decisions made by trust fiduciaries. As discussed in our meeting at the IRS, a narrow definition of the term "fiduciary" by reference to Code Section 7701(a)(6) may raise issues regarding the definition of fiduciary in other areas that may raise adverse comments and create unwarranted or unforeseen consequences. Further, this solution may not be entirely satisfactory, given the language at the end of Code Section 7701(a)(6) defining fiduciary to include "any person acting in any fiduciary capacity for any person." Therefore, we have instead proposed a rule that would replace the rule in Section 301.7701- 7(d)(1)(iv) of the Final Regulations.

² 1981-1 C.B. 326.

³ See Treas. Reg. section 301.7701-7(d)(1)(iv). See also Preamble to the Final Regulations, T.D. 8813, 1999-9 I.R.B. 34, 36- 37, section B.1.