MGFOA
Spring
1997
Newsletter
IRS Pursues State and Local Government FICA Payments
Mandatory Medicare and Mandatory Social Security May be on the Horizon for all Municipal Employees
Employee Retirement Plan Options
Finance Directors For Hire
NESGFOA announces 5th Annual Training Seminar
Congratulations to the Town of Lexington
IRS Pursues State and Local Government FICA Payments
Betsy Dotson, GFOA
The Internal Revenue Service (IRS) has launched a nationwide communications
and education initiative to remind employers of their obligation
to withhold Federal Insurance Contribution Act (FICA) taxes, which
include Social Security and Medicare taxes. The IRS estimates
that noncompliance with Social Security and Medicare costs their
respective trust funds hundreds of millions of dollars annually.
Of particular interest to the IRS are state and local government
employers, which, unlike their private-sector counterparts, have
only gradually become responsible for undertaking this withholding.
Working with GFOA and other sate and local government organizations,
the IRS is attempting to provide information to public employers
who may face uncertainty as to who is covered and by which program.
In addition, the IRS is concerned about the failure to issue
Forms 1099 to independent contractors who provide services to
public entities.
Background
The withholding from paychecks to fund a nationwide retirement
program was initiated with the passage of the Social Security
Act in 1935. The act created a social insurance program designed
to pay retired workers a continuing income. Trust funds were
created for these dedicated revenues, with benefits paid out of
the trust funds to the recipients. Over the years, a number of
significant modifications and extensions of the original Social
Security Act have been made. The first change came in 1939, when
benefits were extended to the survivors and descendants of workers
covered by Social Security. In 1956, disability benefits were
added. In 1965, Medicare was created to extend health coverage
to the elderly.
State and Local Employee Coverage
These monumental undertakings in retirement and health coverage
did not reach public employees immediately because they did not
receive coverage under the original Social Security Act. Many
involved in this ground-breaking legislation believed that there
were constitutional questions inherent in such coverage regarding
the power of the federal government to tax state and local governments.
Because many governments did not have their own retirement systems,
however, congress eventually revised its thinking. Thus, beginning
in 1951, public employers were permitted to participate in Section
218 agreements. (Section 218 refers to the applicable portion
of the Social Security Act). States and their political subdivisions
(includes cities and towns) could voluntarily enter into agreements
with the Social Security Administration to allow coverage for
some or all of their employees. All 50 states have entered into
voluntary Section 218 agreements.
Section 218 agreements cover positions, not individuals; therefore,
any worker filling a position similar to a covered position must
have FICA taxes withheld. States may include positions filled
by the following types of employees under Section 218 agreements:
elected positions, part-time employees, workers paid on a fee
basis, agricultural labor, students and election workers and officials.
In 1955, the law was again changed to permit employers and their
employees (with the exception of fire fighters and police) to
agree to be covered by Social Security even in those jurisdictions
with government retirement systems. The following year, Congress
determined that state & local governments could maintain two coverage
systems, one of which could exclude those employees not desiring
Social Security coverage. In certain states, fire fighters and
police coverage was permitted.
As part of its overhaul of the Social Security system in 1983,
Congress set April 20, 1983, as the date after which any and all
public employees and their employers were prohibited from opting
out of Section 218 agreements. Mandatory Social Security was
not imposed at that time.
Mandatory Medicare coverage, however was just around the corner.
The Consolidated Omnibus Budget Reconciliation Act of 1985 provided
that employees not in continuous employment with their employer
and newly hired after March 31, 1986, became subject to Medicare-only
coverage unless specifically excluded by law. All employees covered
by SS already were covered by Medicare.) Employees who transferred
from another level of jurisdiction of government were subject
to the following determination: if the transfer was intrajurisdictional
rather than interjuirisdictional, the individual is not considered
a new hire.
In the last major revision of Social Security laws affecting state
and local government employees, as of July 2, 1991, all state
and local government employees who are not 1) covered by a public
retirement systems or 2)covered under a Section 218 agreement
are subject to mandatory Social Security withholding unless specifically
excluded. Further amendments 1994 permit optional Social Security
coverage for police and fire fighters in all states.
Key Issues Related to Coverage
A governmental unit’s determination of whether or not to withhold
for Social Security may turn on several difficult factors, the
most troublesome relating to what constitutes a qualifying public
retirement system and whether a worker is an employee or an independent
contractor. The first of these considerations is more easily
managed than the second.
Qualifying Public Retirement System.
A qualified retirement fund provides a “meaningful” retirement
benefit under the old-age portion of the Old-Age, Survivor, and
Disability Insurance (OASDR) program of Social Security. This
determination can be made by using the safe-harbor benefit formulas
established by IRS Revenue Procedure 91-40 and the IRS regulations.
(457 plans are qualified).
Worker Status
The determination of whether an individual is an employee or an
independent contractor is more problematic. The methods by which
the IRS, and therefore an employer, makes this distinction are
not clear-cut, and both the IRS and Congress continue to grapple
with various definitions and tests to make this determination
easier. The general rule is that anyone who performs services
under the direction and control of an employer is an employee.
Independent contractors are regarded as those in business for
themselves.
The IRS has adopted a series of 20 common-law factors used to
assist in determining whether a worker is an employee. They help
indicate whether sufficient control is present to establish an
employer-employee relationship. A state or local government employer
may request a determination on the status of a worker from the
IRS by filling out form SS-8.
Because no Social Security or Medicare taxes are withheld from
Independent contractors, payors are required to file a Form 1099-Misc-Miscellaneous
Income-if at least $600 is paid during the year. Government payors
are subject to penalties for their failure to file 1099 forms
or for providing inaccurate taxpayer information.
IRS Outreach Efforts
A task force comprised of officials from the IRS and Social Security
Administration, along with representatives from the National Conf.
of Sate SS Administrators and GFOA is coordinating a communication
strategy to address concerns that public employers may not be
complying with SS and Medicare withholding and payment requirements.
The intent of the IRS, which is of great interest to local govt.
organizations like GFOA, is to make IRS enforcement activities
unnecessary by ensuring that public employers comply with SS and
Medicare requirements. GFOA participates as part of its ongoing
effort to help ease compliance burdens. The dissemination of
accurate and understandable information should further compliance
and avoid penalties resulting in budgetary burdens on local government,
while maintaining the SS and Medicare trust funds for present
and future beneficiaries.
Mandatory Medicare and Mandatory Social Security May Be on the Horizon for All Municipal Employees
Six months ago the MGFOA joined (with about 27 other organizations
across the country which participate in public retirement systems)
an organization called OPPOSE. Organization for the Preservation
of the Public employee retirement industry and Opposition to Social
Security Expansion to such industry. Many of our members may
not be aware that Massachusetts is one of only a few states in
which all municipal employees participate in state, local and
county retirement systems and not in social security. The MGFOA
executive board has voted $500 to support OPPOSE’s fight over
legislation proposed in 1996.
[Excerpts from OPPOSE report January 22, 1997]
Social Security reform was the subject of a great deal of publicity
in 1996. There was one major Commission, several sets of hearings,
a number of bills, and a number of academic studies. Medicare,
and to a lesser extent, Social Security, were the subject of scare
politics, with Democrats claiming Republicans were going to destroy
these systems in order to save money. These factors have created
the current situation. There is a substantial appetite for study
and concern, but it is not certain that there are the necessary
elements to bring about action.
The Report of the Social Security Advisory Council was issued
1/7/97. There is no majority opinion. There does appear to be
general agreement on some points, including mandatory coverage
of all public employees hired after 12/31/97. (Other points of
general agreement included increasing the period over which the
average wage base is calculated to 38 years; taxing all social
security benefits in the way that other retirement income is taxed;
and, increasing the normal retirement age.)
The main reason given by the Council for their recommendations
on mandatory coverage is that “an effective Social Security program
helps to reduce public costs for relief and assistance, which,
in turn, means lower general taxes.” This is essentially the
Social Security as welfare argument. The Council argues that
public employees not now covered by Social Security would benefit
from indexing of benefits, which, according to the Council, is
done imperfectly at the state and local level. The Council also
asserts that spousal benefits are superior under Social Security.
Finally, the Council argues that Constitutional issues in connection
with coverage of state and local workers have now largely been
resolved against the states and their employees.
The Council estimates that mandatory coverage would raise an amount
equal to .22 percent of payroll, or about 10 percent of the amount
needed to balance Social Security. This is partly because new
hires would pay into the system long before drawing benefits out,
and partly because “under present law a high proportion of these
State; and local government employees will get Social Security
benefits anyway.” It is not clear whether the Council fails to
take into account the anti-windfall rule, or whether the Council
believes that all those covered by Social Security receive a beneficial
deal; if the latter, this is a somewhat strange argument for including
more people in the system.
In its discussion, the Council appears to assume that the current
tax treatment of Social Security benefits will be changed, so
that all workers (not just so-called high income workers) will
be taxed on their benefits. If this change is not made, it is
not clear whether including public employees in the Social Security
system would still save the same percentage of costs.
The Council also recommends that government plans should be subject
to the ERISA requirements of disclosure, fiduciary standards,
and spousal protection. The funding requirements, however, would
not apply under the recommendation.
Although the context of the Council’s report implies that all
members of the Council support mandatory coverage a footnote reveals
that “three members oppose the inclusion of currently uncovered
State and local employees because of the financial burden that
would be placed on workers and employers who are already contributing
to other public pension systems.”
The Council is a non-political organization. OPPOSE made efforts
to work with the labor members of the Council, but were unable
to raise the issue of mandatory coverage to the level of serious
dispute within the Council This may be because some Council members,
with whom labor might normally be expected to align itself are
strongly in favor of universal coverage. It may also be the case
that labor members of the Council were focused primarily on one
issue, opposition to privatization of the system, as indicated
by an interview by Gerald Shea, reported in The Washington Post.
In summary, the issue of Social Security reform has not yet entered
the political process in any serious way. But it is disturbing
that several public studies, and several Congressional bills include
mandatory coverage as part of their solution.
It does not seem likely that Social Security reform will occur
in 1997, although there will be bills and hearings, and perhaps
additional studies. One objective for the coming year may be
to have our friends in Congress present our side of the question,
and introduce reform bills which do not include mandatory coverage.
There is some reason to hope that Medicare reform will be limited
to proposals taking care of funding problems for only the next
few years. If this is the case, mandatory coverage may not be
proposed. One important milestone will be the introduction of
President Clinton’s budget proposal. At that point, or soon after,
it will be clear whether we will have to fight on this issue in
1997.
Employee Retirement Options
Lee Leiner, Scholarship winner
With the aging of the baby boomer generation, retirement planning
has become a big concern for society. This concern extends to
employers eager to reduce the expenses of retirement plans. In
the old days there was the pension. Generally viewed as stodgy
dinosaurs, pensions fall into the category of defined benefit
plans. A formula based on the employee’s years of service and
salary level was used to determine a monthly amount to be paid
to the employee for life. This type of plan has several drawbacks.
First is a lack of portability. In today’s world, employees
no longer spend long careers with a single employer. But the
defined benefit plan is employer specific. It is not possible
for a mobile employee to take his benefits with him when he changes
jobs. Starting a new pension at each new job puts the employee
at a distinct disadvantage because of the importance of the high
salary years in the calculation of benefits. The benefits do
not grow after separation.
Second is uncertainty for the employer. The actual amount of
funding that will be necessary to insure the delivery of the promised
benefits must be estimated and re-estimated continuously. This
uncertainty can make an already difficult budget process more
so because the level of funding must be conservatively estimated
to avoid the problem of unfunded liabilities. Also the administration
of a defined benefit plan can be expensive. Lastly the pension
does not allow the employee any flexibility. There is no mechanism
to change the investment mix to take advantage of time to retirement.
In fact these types of plans benefit an older, less mobile workforce
much more than a young, mobile one.
More recently there has been a trend to move to defined contribution
plans. The most common of these being 401(k) plans or savings
and thrift plans. With these plans, the retirement benefit is
not specified. The employer makes a contribution to an account
in the name of the employee, who can also contribute. The amounts
are typically a percentage of compensation with the employers
share a matching dollar amount or percentage. These plans have
the advantage of budget predictability for the employer. Most
expenses are known up front and the plans are much cheaper to
manage. They are also portable for the employee.
Any number of defined contribution plans can be started over a
lifetime with no effect on the ability of the contributed funds
to continue to grow. These plans can easily be rolled over into
Individual Retirement Accounts or annuities with no tax liability.
These plans also allow a great deal of flexibility to the employee.
The money can be borrowed for critical needs and recently the
federal government has been considering the expansion of this
allowance for education and health care expenses. These plans
also give responsibility for investing the funds to the employee.
This is both an advantage and disadvantage. The employee who
has knowledge of the financial marketplace and is a savvy investor
can greatly increase his benefits over a novice or risk-averse
employee. Many critics of defined contribution plans are calling
for employee investment education to help them maximize their
returns.
The future of retirement plans may be the Cash-balance plan, a
sort of hybrid between the defined benefit and contribution plans.
In this plan, the employer contributes a percentage of compensation
to an account with a guaranteed return typically equal to the
Treasury rate. The employee can receive a lump-sum or annuity
upon separation, even if well before retirement age. The funds
would be completely portable. There is no fast increase at the
end of a career like a defined benefit plan but there is continuous
growth over the length of employment. The costs are lower to
the employer in line with defined contribution plans because the
contribution is based on the employee's current salary not the
final high pay years. Also employees who no longer want to work
will not be rewarded for hanging on for a higher benefit. The
benefits are easy to understand and predictable for both employee
and employer, and the employee is relieved of making the investment
decisions.
The makeup of the workforce and the local political environment
are the strongest factors in deciding which type of plan to use.
An older, less mobile, or highly unionized workforce will be
most happy with the defined benefit plan. A younger, mobile and
market-smart workforce will prefer the flexibility and control
of the defined contribution. The cash balance plan is also preferred
by younger workers but this plan combines some of the benefits
of both other plans. Lastly the presence of public pension plans
may influence how the new plan is viewed and what the true consequences
are.
SOURCES
Joseph J. Jankowski, Jr., Defined Contribution Plans can be Win-Win
Solutions for the Public Sector, Public Management, Feb. 1997:
14.
Bethany McLean, The Latest Twist: Cash-Balance Plans, Fortune,
28 Oct. 1996: 234.
U.S. Bureau of Labor, Factors Affecting Retirement Income, Monthly
Labor Review, Mar. 1993: 29-33.
Finance Directors For Hire
Over the past several months Todd Hassett and Mike Daley have
resigned from their positions as Finance Directors in the towns
of Foxborough and Plymouth. Their actions have not taken them
far from the government finance duties and activities that have
consumed each of their lives for over a decade. Via the expansion
of their consulting practice they have remained in the government
finance profession as private sector employees. Actually Todd
is not totally free from town official status. He is the Town
Accountant for Wrentham on a part time basis.
The move to the private sector has been stressful, yet it has
been entertaining and enjoyable. Their migration process actually
began in 1994 when Todd and Mike first decided to formalize the
limited consulting work they each had been performing on a solo
basis. Financial Advisory Associates, Inc. (FAA) was created
and their business began to grow. FAA has never advertised itself.
Quietly, through personal referrals FAA’s client list has grown
to a level where both partners are now fully employed.
Their days in the trenches are still very similar. The only difference
is that these fellows need a date book to figure out which trench
they are in today. Some of the most testing days have been involved
with the opening of their new office. Since much of the work
they do is at the client’s location, the start up tasks associated
with opening a new business office requires precision scheduling.
We all know how difficult that can be.
Do you ever think a plumber would be required to install a telephone
system? These guys needed one! The plumber was not part of the
original plan. However, when the NYNEX was bringing the phone
lines into the basement of FAA’s new Buzzards Bay office, they
broke a water pipe. As the NYNEX employee, Mike Daley and several
other office remodeling contractors watched the water pouring
into the basement, they realized that the shut off valve was in
the basement of the landlord’s condo unit next door. Mike was
the only one who knew that the engineers who work next door were
in the field that day. No one was home to turn off the water!
By the end of the day FAA had found out that NYNEX is very customer
focused FAA had temporary phones, a fixed water pipe and a very
clean basement by the time Mike headed out to Franklin for that
night’s Finance Committee meeting. FAA also found out that their
office key fits their landlord’s office door!
The move to the consulting side or our profession was attractive
to Todd and Mike because it offered them an opportunity to simplify
their hectic lives. Their firm’s corporate mission is to help
simplify the lives of other government finance and executive officials.
The ability to contract with a finance officer to fix that defective
system you can’t ever seem to get to or to do that special project
you’ve wanted done for so long is an opportunity for all of the
MGFOA’s members.
Both Todd and Mike have been active with many of the state-wide
professional associations including our own. They have also been
very active in the New England State Government Finance Officers
Association. Todd is currently President. Presently they are
very busy with organizing the NESGFOA’s annual meeting in Plymouth
this September.
If any members want to become involved with the NESGFOA’s conference
host committee, want to say hello or just want to wish FAA’s partners
good luck; you can contact Todd and Mike at Financial Advisory
Associates, Inc. They are located at 258 Main Street, Suite A-2
in Buzzards Bay, Massachusetts. The zip code is 02532. Their
phone number is 508-759-0700. Their E-Mail address is faaince@capecod.net.
NESGFOA announces 5th Annual Training Seminar
The New England States GFOA is proud to announce its 5th ANNUAL
two-day Training Seminar to be held on May 8 and 9, 1997 at the
Sheraton Tara Hotel, Framingham, Massachusetts. It is offered
to provide education and professional training to its members
and other interested parties. This program is in addition to
the Annual Conference that will be held in Plymouth, Massachusetts
from September 11-14, 1997.
On Thursday, the first session will be a discussion of I.R.S.
income Reporting, employee relation requirements, and tax deferred
programs available to public sector employees, followed by a discussion
of the new I.R.S. private activity bond requirements. The second
session will be a presentation by Nick Perna, Chief Economist
for Fleet Bank, giving us his second annual “Economic Update and
Forecast.”
On Friday, the morning program will begin with a discussion of
how to develop a pension asset strategy in a high market, followed
by a review of the advantages and disadvantages of defined benefit
and defined contribution pension plans. The afternoon program
will be a discussion of managed care medical insurance programs
- the wave of the future.
If you have not received a brochure with registration information
please contact Marc Waldman (617)430-1019 X260.
Congratulations to the Town of Lexington
On March 13, 1997, GFOA’s Distinguished Budget Presentation award was granted to the Town of Lexington. This is the first time Lexington has won this honorable distinction.
