Qualifying as a separate line of business for nondiscrimination pension plan rules.

• Author: Knight, Ray A.

The IRS recently issued final regulations for determining whether or not an employer can be treated like a SLOB (T.D. 8376, December 2, 1991). As negative as the acronym -- "SLOB -- may sound, many employers are striving to be regarded by the IRS as operating as "qualified SLOBs," or qualified separate lines of business.

The SLOB regulations are critical for purposes of testing minimum coverage and participation requirements for qualified retirement plans under sections 410(b) and 401(a)(26) of the Internal Revenue Code, respectively. In general, sections 410(b) and 401(a)(26) require employers to compare participation by, and the level of benefits provided to, highly compensated employees with that of nonhighly compensated employees on an employer-wide basis. If the SLOB criteria are met, however, these tests are applied separately to each of the employer's qualified separate lines of business instead of to the employer as a single entity.

Under the final regulations, the employer is allowed to exercise its discretion in determining the separation of its lines of business. Additionally, the employer is provideed with greater freedom to compete effectively with similar industries in the areas of employee compensation without the danger of discrimination against a group of employees who are employed in a separate division of the employer's operations. Finally, the constraints placed upon the employer to qualify for SLOB treatment are more objective than previous requirements under section 414(r) because the regulations contain more definitive and numerical guidelines.

This article discusses the general criteria established by the IRS in the final section 414(r) regulations, illustrates the application of some of the criteria to an employer's organization to establish qualification under the SLOB rules, and reviews the advantages and disadvantages that an employer faces with the promulgation of these provisions.

1. SECTION 414(r): SPECIAL RULES FOR

   SEPARATE LINES OF BUSINESS

   Section 414(r) provides guidance regarding special rules for qualifying for separate line of business treatment. Generally, the employer must have "bona fide business reasons" for operating these separate lines of business. (1) (*) All property and services provided by the employer to its customers must be available exclusively through the lines of business with no remainder of the employer's operations existing outside of the separate lines. (2)

3. GUIDANCE PROVIDED BY TREAS.

   REG. [section] 1.414(r)

   In order to meet the standard established by section 414(r), an employer must meet the specific requirements contained in Treas. [subsection] 1.414(r)-1 through 1.414(r)-11, as well as rules provided under sections 410(b), 401(a)(26), and 129(d)(8). (3) The regulations apply to plan years and testing years beginning on or after January 1, 1992. (4) For plan years beginning before this date but after 1986 (when section 414(r) was enacted), an employer qualifies as operating separate lines of business if the employer "reasonably determines" that it meets the requirements of section 414(r) (other than the requirements of administrative scrutiny under section 414(r)(2)(C)), or complies with the terms of the regulations under that section (with the same exception of the administrative scrutiny requirement). (5)

   In general, the tests presented in Treas. Reg. [section] 1.414(r) for the satisfaction of these requirements are three-tiered:

   (1) The employer must designate its lines of business.

   (2) The employer must prove the organizational and operational independence of each line of business.

   (3) The employer must meet three statutory requirements:

   (a) each line of business must employ at least 50 employees;

   (b) the employer must notify the Secretary of the Treasury of its intentions for operations under separate lines of business; and

   (c) each line must survive administrative scrutiny, which includes six safe harbor rules, or the employer must obtain an individual determination from the IRS Commissioner.

   A flowchart of these major provisions is provided in the regulations. (See Table 1 on page 123.)

3. TEST 1: DESIGNATING SEPARATE

   LINES OF BUSINESS

   The first test of separateness of business lines provides the employer with more breadth and flexibility than any of the others. It is a more subjective process, because it contains no specific numeric or other restrictive requirements. In a two-step process, the employer designates its lines of business by first identifying all of the services and property it provides to customers during the testing year and then determining what portion of the property and services is provided by each line of business. (6) The "testing year" referred to in the regulation is the calendar year. (7)

   1. Identification of Property and

      Services Provided to Customers

      The provisions relating to the identification of all property and services provided to customers are relatively straightforward. Property provided to customers may be real or personal, tangible or intangible, and it is provided during the testing year in one or more transactions representing a sale, lease, license, loan, exchange, or other consideration. (8) Services are considered to be provided to customers if during the testing year the services are rendered by the employer to or on behalf of the customer for consideration. (9) The property and services must be provided to persons acting in the capacity of customers (other than the employer) in the ordinary course of business. (10) The provisions of this step can be viewed as a reinforcement of the definition of "bona fide business reasons" for operating separate lines of business.

   2. Assigning Property

      and Services to

      Lines of Business

      After all products and services provided by the employer to customers are identified, the employer may apportion these products and services among its lines of business in a manner of its discretion. The regulations allow the employer much freedom of organization and operation in determining its lines of business, and the employer is not bound in any testing year by the manner in which it designated its lines of business in any previous year. (11) In addition, the employer is not required to combine similar business activities in the same designated line, nor is it required to separate dissimilar products or services. Furthermore, the employer is not forced to segregate products from services as separate lines. (12) Therefore, the same products and services could be offered by more than one line of business.

      The flexibility of the regulations is quite favorable, since the employer is able to determine its lines of business in a fashion best suited for the company's future operational structure. For example, geographical locations may be the best manner for a particular company to delineate its activities. Employee compensation (including benefits) generally varies among different geographical regions, and the ability of an employer to separate its lines of business according to location without the danger of discrimination in its retirement programs will likely enhance an employer's ability to compete in difference markets. Other grouping distinctions that could be made include wholesale or retail operations, different transaction types such as sales or leases, and different customer bases such as governmental or private.

      The single restriction placed upon an employer's chosen method of designating its different lines of business is a test of reasonableness. (13) The regulations provide examples of unreasonableness, such as an employer's delineating separate lines of business for products and services that are not offered separately to customers. Similarly, the segregation of business lines would be unreasonable if the provision of the separate products or services are ancillary or incidental to one another or are regularly associated with one another. (14)

4. TEST 2: PROVING "SEPARATENESS" OF

   ESTABLISHED LINES OF BUSINESS

   The second test provides guidance on determining the organizational and operational independence of individual lines of business from the remainder of the...