BNA Pension and Benefits Blog

Any time a legislative body as large as that of the Texas House of Representatives passes a bill of greater import than the designation of a state flower (e.g., Yellow Rose) or nut (e.g., Pecan) by a unanimous vote (i.e., 140-0), you sense that something odd may be afoot.  As your blogger drafted, the New York Times last Friday (5/18) cast light on the recent passage of a bill in the Texas House that would reject GASB's rules governing disclosure of the cost of promised healthcare benefits for retired employees of the state and its political subdivisions.  (Mary Williams Walsh, "Auditing Rule Is Put at Risk by Texas Bill," NYT, 5/18/07, C1.)

Reportedly, the Texas Senate is expected to vote before Memorial Day on a "softened" version of the House bill which would permit the affected governmental units to adopt and apply the GASB rules but not require them to do so.

The Government Finance Officers Association (GFOA), which includes folks who manage and report on general-account public funds as well as benefit plans and other trust funds, have stirred up outright opposition to the adoption of the GASB rules on grounds which on their face seem Byzantine: the GFOA would rather have the public-sector entities adhere to the more stringent FASB rules which apply to the private sector but which, unlike the GASB rules, do not require "performance audits."

Whether the unanimity in the Texas House would have been breached in a compromise for a permissive-only approach to GASB, we cannot know.  One would think that at least a few votes, if not a majority, could be mustered against "local option," as in prohibiting or allowing the sale of alcohol.  However, if GFOA had its way, the FASB standards would be Texas's. Local finance officials would then have no choice but to bite the bullet on calculating and disclosing an actuarial cost estimate of their reporting units' accrued obligations to pay post-retirement healthcare benefits.

GASB or FASB, either would nevertheless greatly displease many local officials, such as the Travis County auditor, who oppose any rule which requires some calculation of the government's accrued obligations for "other [non-pension] post-employment benefits" (OPEBs).

To maintain, as the Travis County official has been quoted to say, that those obligations are "not measurable" because different actuaries at two different valuation dates previously furnished healthcare cost estimates as wide apart as $89 million and $320 million (although they later closely converged on numbers of similar magnitudes) is ostrich-like: it is not to deny that the significant millions involved are that much greater than zero.

In a practical world, there ought to be a way for that county government and others like it to be able to avoid or lessen the risk of having their current credit ratings promptly downgraded in the wake of disclosing astronomical numbers (in the context of their finances generally) with no funding plans in place. Public officials ought to be able to find midway courses between, on the one hand, drastic cuts in public services and employee payrolls and, on the other, huge hikes in any of those relatively few tax and other revenue sources that political subdivision units have control over.

In the immediate aftermath of the Enron era scandals, when most public pension funds had taken large hits to their funded status, the legislative tack taken in a number of states entailed the adoption of credible plans, instituting step-rate increases in employer contributions -- in some cases, accompanied by temporary, defeasible employee contribution increases.  These were calibrated to make funding progress while the equity markets regained public confidence and staged an expected comeback -- sooner or later. Those efforts are by now proving themselves effective.

Granted, trying to remedy a pension plan funding deficit is not as politically daunting a task as deciding to begin funding long-term benefit payouts from scratch.

Cities and counties which have not already begun that task could be -- and some are -- banking on a pipe dream: that someday very soon, through overarching Federal action, America will enjoy universal healthcare coverage.

But before new legislation can possibly be enacted and set on a path to implementation, which could occupy the entire term of the next adminstration, realistically Congress will have had to attack the long-term funding shortfalls under both Social Security and Medicare. The truly "universal" health coverage that many now yearn for will also need to address issues of co-existence with Medicare (including the Part D program instituted just last year) and, in time, the "universal" plan's transitioning into or possibly swallowing up at least the benefits side of present-day Medicare for Medicare eligibles.

Until then, state and local governments with retiree healthcare plans will be forced to fend for themselves in quandaries of their own making.  The present values of future benefit obligations created by plan sponsors have a reality of their own, an existence independent of rule-makers.

Abbott A. Leban

Actions to Consider on Uncertain Tax Positions

So, if you have been reading all week, this posting will make sense.  If you have not read all week go down to the Tuesday post and read back through the week. Since many readers of this blog work within the benefits department of a company, are consultants or attorneys, they may not follow financial reporting standards that are not aimed specifically at compensation or benefit considerations. FASB Interpretation 48 is a general pronouncement regarding the need to measure, report and disclose uncertain tax positions. Public companies are already dealing with this.  But the standard applies to any income tax position and any enterprise – taxable or tax-exempt, that might owe income taxes. If a tax return position does not meet the more likely than not standard, the company must measure the potential impact on their tax liability and adjust their financial statements accordingly.  There is also additional financial statement disclosures required relative to this standard.  This standard applies to financial reporting periods beginning after December 15, 2006. Measurement and reporting applies to uncertain tax positions taken in any open tax year.

The good news is that the required disclosure is not specific by item. The bad news is that the auditor needs to examine each significant uncertain tax position and draw a conclusion regarding the certainty of success on that position. Auditor’s work papers are not subject to privilege. So the action point is to anticipate these issues and be prepared or help your clients get prepared to defend those tax positions that might otherwise be considered uncertain. If this work is done now, well in advance of when the auditor shows up, everyone is likely to be a lot more comfortable through the implementation of this new standard.

Benefit Plan Issues under FIN 48

We started this discussion in explaining that FIN 48 related to uncertainties in income taxes.  So the obvious question is:  Why worry about a tax-exempt benefit plan?

Well, the good news is, at least in my opinion; you generally will not need to worry about issues that would cause the plan to lose its exempt status.  FIN 48 includes a provision for recognized administrative systems that would permit the client’s tax position, even though it might otherwise appear uncertain. In my opinion (as far as it has developed to date), EPCRS should constitute such an administrative scheme. There is a recognized system to allow a plan to retain its exempt status in spite of potentially questionable practices, so it the majority of plans there should not need to be any estimate of a tax liability based upon qualification violations.

That doesn’t get benefit plans totally off the hook from analysis under this standard, however. Consider:

1. Funded welfare benefit plans:  Are the assumptions made about any reserve for incurred by not reported medical claims or post-retirement benefits reasonable or is an unrelated business income tax due?
2. Any funded benefit plan: 
   1. Is the trust invested in assets that could be considered to generate unrelated business income taxes?
   2. If the trust is invested in assets that trigger unrelated business income taxes, are there any material uncertain tax positions taken by such pass-through entities such as partnerships or trusts?
3. ESOPs of S corporations:
   1. Are the securities held by the ESOP qualifying employer securities? 
   2. Are the assumptions used in measuring synthetic equity for purposes of the broadly held test of IRC Section 409(p) reasonable?

Remember, if a plan has more than 100 (120) eligible participants, it is subject to audit.  Those plans are going to have to deal with this new standard, just like the plan sponsor. But, the measurement of materiality is generally lower for the benefit plan audit, than it is for the sponsor’s audit.  Thus, though these issues may be less frequently encountered in plans, when encountered they will likely be more significant.

Tomorrow we will talk about what this stuff really means to the client.

Executive Compensation Considerations

This section highlights the frustration of any blog. This discussion is based on the prior discussion of new FASB Interpretation 48 – Accounting for Uncertainty in Income Taxes.  So, you need to read that section before you read this discussion. These postings are aimed at raising the awareness of the readers to compensation matters which may be considered “uncertain” under the new financial reporting rules and, as such, should trigger questions from the employer.

FIN 48 focuses attention on tax return positions. To sign a tax return, the position only needs a realistic possibility of success. That is a one in three standard.  FIN 48 requires more likely than not, which is something better than a 1 in 2 chance of success. This focuses a lot of attention on tax return positions that involve a degree of subjective decision making.  Those issues are very common when it comes to executive compensation.

1. IRC Section 162(m) generally limits the deduction of compensation for certain persons employed by a publicly traded enterprise to $1 million. That is an objective standard.  But there are many areas under Section 162(m) that are subject to judgment:
   1. Where equity compensation is included was the fair value actually determined at grant date? Was the determination of fair value reasonable?
   2. Has there been sufficient disclosure of the terms of the option plan?
   3. Can the performance pay exception be relied upon?
2. IRC Section 280G imposes very significant limits on the deduction of compensation triggered by a change in control. Like, 162(m), this includes objective and subjective criteria.
   1. Are amounts paid properly classified as reasonable compensation for services rendered following the change in control?
   2. Has base year compensation been measured properly?
   3. Has the exception for a small business corporation been properly applied?
3. Equity compensation takes many forms – options, restricted stock, phantom stock, stock appreciation rights and others.
   1. Was a transfer actually made?
   2. Was the date that the property was no longer subject to a substantial risk of forfeiture properly determined?
   3. Was the property valued correctly?
   4. Have any lapse or nonlapse restrictions been identified and considered?
4. Cash deferred compensation should be easy, but even here there are issues to consider.
   1. If services during the deferred period were rendered to multiple entities – who gets the deduction upon payment?
   2. Is it deferred compensation or a restricted property award? There are somewhat different deduction timing rules under Section 404 versus Section 83.
   3. When did “vesting” occur relative to payment? Is the payment truly deferred compensation?

Please do not assume that this is a comprehensive list. It would be nice if the readers would add other issues to this list to expand the idea of the kind of compensatory devices that are subject to evaluation under this standard.

Tomorrow, we will cover how the standard applies to benefit plans that are subject to a financial statement audit.