Tax-exempt group trusts cannot have certain Puerto Rico plans as participants, according to the position taken by an IRS official in a letter to Senator Arlen Specter dated September 14, 2010. Although a trust funding a plan for Puerto Rico residents that is tax-qualified in Puerto Rico (a “Puerto Rico-only” plan) may be exempt from U.S. tax under a special ERISA rule (Section 1022(i)(1) of ERISA), the letter states that Puerto Rico-only plans “are not among the qualified plans or similar arrangements that are permitted to invest in group trusts on a tax-favored basis” and that “such plans cannot pool their trust assets for investment purposes without jeopardizing the tax-favored status of all of the other plans participating in the group trust.”
No formal guidance has been issued, but the apparent change in IRS policy (the IRS had previously issued contrary guidance in private letter rulings) presents a challenge for sponsors of group trusts that are exempt from tax under IRS Revenue Ruling 81-100 and related guidance and for the advisors and managers of “401(k)” or other U.S. qualified plan assets participating in group trusts. Some group trusts already have Puerto Rico-only plans as participants. Others may have as participants plans that are currently qualified under both U.S. and Puerto Rico tax rules (“dual-qualified” plans) but that are in the process of making a transfer to a Puerto Rico-only plan by December 31, 2010 to take advantage of tax relief provided by the IRS in a 2008 ruling.
The IRS is reportedly being asked to reconsider its Puerto Rico plan/group trust analysis, but as of November 10, 2010 no formal guidance has been provided.
The IRS letter can be found here.