IRS SECTION 89 WHAT IT MEANS
FOR LOCAL GOVERNMENT

Included in the sweeping changes of the Tax Reform Act of 1986 was the addition of Section 89 to the Internal Revenue Service Code. The intent of this section is to encourage employers to provide equal health and life insurance benefits for all employees, regardless of the rate of pay. Thus, a primary objective of Section 89 is to promote non-discrimination through the extension of equal benefits to the lower-paid work force.

There has been a significant outcry about the impact of IRS Section 89 and on the need for local governments and special purpose districts to comply with the new IRS Section 89 provisions on certain fringe benefit programs. Several amendments have been introduced. The purpose of this article is to describe the current status of Section 89 and the impact that the law and the amendments could have on governmental employers.

CURRENT STATUS

Currently there are 13 bills before Congress to change or completely eliminate Section 89. The bill with the most bipartisan support is H.R. 634, introduced by Representative John LaFalce of New York. This particular bill calls for the repeal of Section 89 and has 309 co-sponsors out to 435 House members in total. However, on May 24, a procedural amendment introduced by Representative George Gekas that would have repealed Section 89 was defeated by a margin of 219 to 201. A total of 106 of the 309 co-sponsors of H.R. 634 voted against the procedural amendment that would have accomplished the same goal as the bill. Since the real issue is the revenues which will be generated by implementing Section 89, it is doubtful that repeal will occur.

The bill that is most likely to emerge as the discussion point for any changes to Section 89 is Representative Dan Rostenkowski's H.R. 1864. Representative Rostenkowski is the chairman of the House Ways and Means Committee which controls all tax legislation coming before the House of Representatives. His bill has the support of all Democratic members of the Committee and 6 of the Republican committee members. This bill will retain the qualifications standards and nondiscriminatory provisions tests of the current Section 89 but would change the mathematical testing provisions. Basically, a plan would pass Section 89's testing requirements if:

• at least 90 percent of all non-highly compensated employees are eligible for coverage under one or more plans that (1) provide health benefits and (2) charge employees no more than $10 per week for single coverage or $25 per week for family coverage, and

• the maximum amount of employer-provided premium that may be excluded from the income of any highly compensated employee is no more that 133 percent of the employer-provided premium in the plan made available to 90 percent of the non-highly compensated employees. For example, if an employer provides a health plan that meets the above criteria to at least 90 percent of its non-highly compensated employees at an annual cost to the employer of $1,000, the maximum amount of non-taxable benefits the employer may provide to its highly compensated employees is $1,333.

It also provides that employers who had already performed Section 89 testing under current standards will have satisfied Section 89's testing requirements and that any employer would have the option of applying either the old or new testing standards during 1989. These provisions would greatly simplify the testing requirements if it becomes law in its current form. But remember that this bill must first pass the House of Representatives and then be considered by a Joint Conference Committee with the Senate before it could become law.

THE ALTERNATIVES

Basically, employers have two alternatives: (1) do the testing now or (2) wait and see if new regulations are

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passed which are easier (they certainly can't get much harder). Because proposed regulations have already been released for Section 89, employers may elect to perform testing as the law currently stands. This would require using either the 80 percent benefits test or the three-part eligibility and benefits test. There are no indications of changes to the qualifications standards or the nondiscriminatory provisions test, so these elements should not enter into your considerations.

If employers wait, it is possible that the regulations will be easier to address. It is also possible that implementation and enforcement will be delayed until 1990. If either of those events occur, employers would be better off to wait. If, however, no agreement regarding changes is reached, your available time to perform all testing would be significantly reduced. And if employers had decided to ask someone outside their organization to do the testing for them, it may be that their time does not allow them to meet your needs.

WHAT DO EMPLOYERS NEED TO DO NOW

As it stands now, employers still have to comply with Section 89 during 1989. Employers will have to complete the mathematical testing by December 31, 1989, and need to comply with the qualifications standards by October 1, 1989. Since the October 1 deadline isn't that far away and could take a lot of work, employers should be aware of the following tests:

1. Is the Plan in Writing? Technically speaking, this requirement does not have to be met until the second testing year. However, if the master agreement with the insurance carrier is a written document, employers probably already pass this test. Employers should locate all master agreements with all of your carriers (health, life, dental, legal, etc., as appropriate) and put them in one place for easy retrieval when needed.

2. Are Employees' Rights Legally Enforceable and are Benefits not at the Discretion of the Employer? Benefits available to the employee must be clearly ascertainable from the plan document and clearly determined under established objective guidelines applied by an authorized person or committee. In other words, an employee should be able to determine from the plan if a particular claim is covered under the terms of the insurance coverage and the percentage or amount of coverage which they can expect the insurance to pay for them. In addition, the employer or someone under the control of the employer must not be able to apply discretion and deny coverage to a particular employee when coverage is normally allowed under the terms of the insurance plan.

3. Are Employees Notified of Their Benefits? Prior to October 1, 1989, all employees must have been given "reasonable notification of benefits available in the plan." Included in this notification must be summary plan descriptions and summary plan modifications if applicable. It should also contain all of the insurance options open to them; i.e. if the employer offers an employee a choice of several health plans, the employer should include a summary of each option as well as the costs of each. In many cases, insurance carriers provide employers with summary plan documents which may or may not meet Section 89's requirements. It is possible that the carrier-provided document is too generic. Without reviewing the document, however, it is hard to say if what the employer already provides is sufficient notification or not.

4. Is the Plan Exclusively for the Benefit of Employees? The plan must be "maintained for the exclusive benefit of employees." In other words, no non-government employees may be covered under the plan (retirees, spouses and dependents are not included in the discussion). Also, an employer may not be able to declare an "employee payment holiday" for one plan from the over-collection of employee contributions from another plan. If the costs of one plan go down, it may be that only those employees in that plan may benefit from any surplus of funds. The treatment of a case like this is not entirely clear from the current law but may not be an issue with anyway.

5. Is the Plan Permanent? The plan must have been established "with the intention of being maintained for an indefinite period of time." This means that the employer must not establish a plan for the purpose of satisfying Section 89. It does not mean that the employer cannot change carriers or coverage limitations or to even do away with the benefit sometime in the future if business reasons necessitate such action. In order to prevent lawsuits if benefits are terminated some time in the future, it may be that the employer would want to add to your summary plan document something such as: "Although it is not currently anticipated that we will terminate this plan, we necessarily reserve the right to terminate it at an indefinite date in the future."

Those items enumerated above are the qualifications standards which should (and in some cases must) be met by October 1, 1989. In addition, your plan must also pass the nondiscriminatory provisions test. Basically, this means that there must not be anything in the plan which obviously benefits one person or a group of persons and does not benefit employees as a whole. For example, if your plan contains language that allows for the full coverage of whooping cough, which is not a normally covered illness, and it is discovered that the reason this coverage was added was because the child of one county employee needed this special treatment, the plan would be found to be obviously discriminatory. Employers should be prepared to review their plan language to ensure nothing is obviously discriminatory.

Another thing employers could consider doing now is collecting employee data. If H.R. 1864 passes in some form or another, it may be that employers have overcollected data. On the other hand, if we must live with Section 89 as it currently stands, collection may become very difficult as December 31, 1989 nears. Employers should consider gathering employee data not later than September 1 unless employers hear that changes that require less data collection are inevitable.

This article was prepared by the staff of David M. Griffith and Associates, Ltd. DMG is a Northbrook, Illinois based firm that specializes in providing financial consulting services to state and local governments.

Page 8 / Illinois Municipal Review / October 1989