Comments on proposed QSLOB regulations under section 414(r).

• Position: Qualified separate lines of business

On January 31, 1991, the Internal Revenue Service issued proposed regulations under section 414(r) of the Internal Revenue Code, providing the exclusive rules for determining whether an employer operates qualified separate lines of business. The proposed regulations (EE-147-87) were published in the Federal Register on February 1, 1991 (56 Fed. Re3g. 4023) and in the March 4, 1991, issue of the Internal Revenue Bulletin (1991-9 I.R.B. 15). A public hearing on the proposed regulations was held on May 16, 1991. (1)

BACKGROUND

Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 4,700 members represent more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promote the uniform and equitable enforcement of tax laws, and to reduce the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the separate line of business regulations.

OVERVIEW

The proposed qualified separate line of business (QSLOB) regulations are one of a series of regulatory projects interpreting the employee benefit provisions of the Tax Reform Act of 1986. Under sections 414(b) and 414(c) of the Internal Revenue Code, all employees of corporations that are members of the same controlled group of corporations and all employees of trades or businesses that are under common control are generally treated as employed by a single employer for purposes of the employee benefit provisions of the Code. Similarly, section 414(m) provides that all employees of members of an affiliated service group are treated as employed by a single employer. Consequently, all eomployees of a single employer (determined after the application of the foregoing provisions) are taken into account in applying the minimum coverage requirements of section 410(b) and the minimum participation requirements of section 401(a)(26) to a qualified retirement plan maintained by an employer.

Section 410(b)(5) provides an exception to this general rule for purposes of section 410(b) if the employer operates QSLOBs under section 414(4). If an employer operates QSLOBs, the employer may apply the minimum coverage requirements separately to the employees of each QSLOB. A similar exception is provided for purposes of the minimum participation requirements of section 401(a)(26) and the 55-percent average benefits test of section 129(d)(8).

According to the preamble, Congress was concerned about the economic disadvantage that employers could face if the average benefit percentage test were applied on an employer-wide basis in those situations where the level of benefits varied significantly among the employer's separate lines of business for competitive market reasons. (2) Congress did not intend, however,k to give employers a "bye" with respect to the nondiscrimination rules. Rather, under section 410(b)(5), all plans must satisfy a nondiscriminatory classification test on an employer-wide basis. Regrettably, in the QSLOB regulations the IRS took what was intended to be a facts-and-circumstances test (3) and transmutted it into several rigid "bright-line" tests that apply to all situations. The result is a set of regulatory hurdles so high that they deny relief to employers reasonably falling within the ambit of QSLOB rules.

In short, the facts-and-circumstances approach envisioned by Congress for implementing section 414(r) has not been adhered to by the IRS in crafting the proposed regulations. TEI believes that the regulations fail to appreciate the extent to which employers operate distinct, separate lines of business and the legitimate non-tax motivations for adopting disparate, independent benefit plans for each line. If the IRS wishes to use brightline tests for guidance, it should promulgate several flexible, optional tests to accommodate the "real world," market-driven judgments made by business managers when organizing operating units. A healthy dose of common sense will remedy many of the ills inherent in the definition of "separate lines of business."

We similarly believe that the recordkeeping requirements set forth in the regulations should be tempered. In their current form, the regulations will force taxpayers to redesign and reprogram information systems to capture data solely for the purposes of ensuring compliance with the QSLOB regulations. We submit that such a result is unnecessary and inappropriate.

In the comments that follow, TEI discusses its specific suggestions on how the IRS should amend the proposed regulations to make the QSLOB tests more workable by both adopting additional safe harbors and reducing certain data collection requirements. Our goal is to facilitate the promulgation of final regulations that expand the availability of section 410(b)(5) relief while fully serving congressional intent.

DETERMINATION OF SEPARATE

LINES OF BUSINESS

Prop. Reg. [section] 1.414(r)-3 states the general rule that a separate line of business (SLOB) is a line of business that is organized and operated separately from the remainder of the employer. Subsection (b) of Prop. Reg. [section] 1.414(r)-3 prescribes five requirements that must be satisfied to establish the "separateness" of a line business.

1. Prop. Reg. [section] 1.414(r)-3(b)(3):

   Separate Financial

   Accountability

   Under Prop. Reg. [section] 1.414(r)-3(b)(3), a separate line of business must be a separate profit center and must maintain books and records providing separate revenue and expense information that is used in internal planning and control. The preamble defines separate financial accountability to include a profit-and-loss statement. (4) Without more guidance, however, an employer may be unsure which financial statements are necessary and what degree of detail will be required.

   Prop. Reg. [section] 1.414(r)-1(b)(2)(iii) defines a separate line of business to include "corporations, partnerships or divisions." Corporations and partnerships are juristic entities with legal rights and claims to assets and legal obligations represented by liabilities and capital. Financial accounting and reporting can, but need not, be rigorously limited and defined to represent such an entity. "Divisions," however, are more nebulous and amorphous operating units. A division may represent a part of a larger legal entity. Alternatively, a division may encompass a number of corporations or partnerships, or portions of either. Divisional profit-and-loss statements may have multiple formats within a single business line that crosses over multiple partnerships or corporations, some of which may not be controlled. As a result, the financial records created and maintained at the division level may be either more or less comprehensive than those created and maintained by a subsidiary or partnership.

   More fundamentally, the level of detail in reporting income and expense will vary dramatically from division to division (or "business unit" to "business unit"), with the required level of detail depending on the scope of the business manager's accountability. For example, some business unit profit-and-loss statements will include corporate general and administrative (G & A) expense (overhead) allocations; other business unit profit-and-loss statements will exclude G & A expense and focus instead on direct costs of production, distribution, and marketing; still other business unit profit-and-loss statements will allocate some G & A expenses but not others. In sum, management devises its "business unit" or "divisional" profit-and-loss statements with a view to capturing the information deemed necessary to manage the line of business.

   TEI recommends that the final regulations clarify the definition of profit-and-loss statements to provide that a pretax profit-and-loss statement (determined before interest income and expense and, at the election of the controlled group for each testing period, either before or after corporate overhead) will satisfy the requirements of separate financial accountability.

2. Prop. Reg. [subsection] 1.414(r)-3(b)(4)

   and 1.414(r)-3(c)(2): Separate

   Employee Workforce

   In order for a line of business to be a "separate" line of business, Prop. Reg. [section] 1.414(r)-3(b)(4) requires that 90 percent of the employees who provide services to a line of business provide their services exclusively to that line of business. Prop. Reg. [section] 1.414(r)-3(c) requires the employer to ascertain whether employees provide services (exclusively or otherwise) to each line of business. Subparagraph (2)(ii) of Prop. Reg. [section] 1.414(r)-3(c) provides that if more than a negligible (5) portion of an employee's services are attributable to a line of business, then that employee's services are deemed to be provided to that line of business. An...