Tax Casualty? Maui Memorial Hospital

by Tom Yamachika, President, Tax Foundation Hawaii

This week our series of tax news returns to Maui, where we have an update on the efforts to help with Maui Memorial Hospital workers and other employees of our state health system.

As we have written before, our state-run hospitals in Maui County, including Maui Memorial Medical Center, Kula Hospital & Clinic, and Lanai Community Hospital, have been losing vast quantities of money over an extended period. Act 103 of 2015 allowed Maui Memorial’s operations to be privatized. The government employees’ union sued to block the transition, and simultaneously efforts were made at the Legislature to give those employees a special severance package.  The Governor vetoed the bill providing the severance benefits, SB 2077, citing concerns that the bill would disqualify the whole of our Employees’ Retirement System from tax-exempt status. The Legislature overrode the veto, making the bill law immediately. (Act 1, 2nd Special Session 2016.) To prevent disaster, the ERS sued in First Circuit Court to block implementation of the law until it could obtain a letter ruling from the IRS to see if its concerns were well-founded, and the court granted a preliminary injunction to this effect in September 2016.

On March 9, 2017, the IRS issued the letter ruling. The Service explained that a “cash or deferred election” is any direct or indirect election by an employee to have the employer provide either cash (or some other taxable benefit) that is not currently available, or to have the employer provide a benefit under a plan deferring the receipt of compensation. Act 1 allowed an employee to choose between a cash voluntary severance benefit, or a subsidized early retirement benefit under the ERS plan. Thus, Act 1 gave an employee a cash or deferred election.

Then, the Service explained that only certain types of retirement plans, namely profit sharing, stock bonus, pre-ERISA money purchase pension, or rural cooperative plans, are allowed cash or deferred elections. The ERS plan is a governmental defined benefit plan, and is not one of the above. Therefore, if Act 1 became effective, the ERS plan would not satisfy the requirements to be a qualified plan under the Internal Revenue Code. (Which is what ERS counsel advised last year.)

Finally, ERS had asked the IRS to rule on what would happen to the members and beneficiaries if the ERS plan were disqualified. IRS declined to do so, given that the members and beneficiaries were not asking for the ruling, and the question may be entirely academic because Act 1 did not take effect and may never become effective.

Even with this ruling, the wrangling continues. HB 233 and HB 234 provided for separation benefits but were not heard by the Senate Ways and Means Committee. The House Finance Committee gutted SB 207 and replaced it with language allowing affected employees to purchase credited service to qualify for, or increase the percentage of, benefits under the state retirees’ health plan, known as EUTF. The HGEA union wasn’t happy about SB 207, however, objecting that the proposal was “dramatically antithetical to the dialogue of the past two entire legislative sessions” and “does not comport to prior legislative intent.”

But didn’t the IRS just say that the prior legislation, namely Act 1, would have disqualified the plan for everyone, not just the Maui hospital workers?

We do not live in a vacuum, especially when it comes to complex, federally regulated retirement plans. We see some displaced workers and it is understandable to want to help them, but we need to beware of unintended consequences that may make life worse for everyone.

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PDF: HGEA Cries a River April 4, 2017

August 16, 2016: Full Text: ERS Files Suit to Stop SB2077 ‘Catastrophe’

August 23, 2016: ERS Saved: Judge Grants Restraining Order Against SB2077

PDF: IRS Letter Ruling