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Thirty Years of Church Plan Rulings Challenged

Within the past five months, two federal District Court judges have cast doubt on the validity of IRS letter rulings (and similar DOL opinion letters) issued to church-affiliated employers dating back to 1983. These federal judges – one in California and one in New Jersey – concluded that the IRS and the DOL have fundamentally misinterpreted the statutory definitions of "church plan" in the Internal Revenue Code and ERISA by finding that a plan "established" by a tax exempt church-affiliated entity could qualify as a church plan. In the views of the two judges, such entities may be allowed to "maintain" a plan established by a church but only a church can "establish" a church plan. Is it possible that two large federal agencies employing hundreds of lawyers got something so essential wrong, time and time again, over a period of 30 years? These judges certainly think so.

The Metes and Bounds of the Church Plan Exception

The cases that produced the two groundbreaking opinions (Rollins v. Dignity Health and Kaplan v. Saint Peter's Healthcare System) both presented the same basic question: whether a non-profit healthcare corporation may establish and maintain a church plan if it is controlled by or associated with a church. In that sense, as the judge in Kaplan v. Saint Peter's Healthcare System put it, the cases required the court to "determine the metes and bounds of the church plan exception." Specifically, the decisions turned on the courts' reading of the provisions under the Code and ERISA that define the term "church plan." (The provisions are virtually identical and for simplicity we will focus on the definitional provisions under ERISA.)

Section 3(33) of ERISA defines "church plan" to mean "a plan established and maintained . . . for its employees (or their beneficiaries) by a church or by a convention or association of churches which is exempt from tax under section 501 of Title 26." (Emphasis added for obvious reasons.) That portion of the definition is contained in subsection A of Section 3(33). However, as is frequently the case in any number of federal statutes, the definition is refined – arguably it is expanded – by subsequent provisions. Subsection C of Section 3(33) states:

For purposes of this paragraph –

(i) A plan established and maintained for its employees (or their beneficiaries) by a church or by a convention or association of churches includes a plan maintained by an organization, whether a civil law corporation or otherwise, the principle purpose or function of which is the administration or funding of a plan or program for the provision of retirement benefits or welfare benefits, or both, for the employees of a church or a convention or association of churches, if such organization is controlled by or associated with a church or a convention or association of churches. (More purposeful emphasis added.)

The decisions in the Kaplan and Rollins cases focus on the interplay between subparagraphs A and C of Section 3(33). The extent to which a given Catholic hospital or healthcare system can be said to be "controlled by" the Catholic Church will depend on the facts and circumstances surrounding its relationship with the church, an order of nuns, and so on. But in our experience, Catholic hospitals and healthcare systems can demonstrate fairly easily that they are "controlled by or associated with" the church. So, if the language in subsection C means what it seems to say, a retirement plan maintained by St. Peter's Healthcare System and its plan administrative committee for the benefit of its employees should be considered a church plan. Certainly, that was the conclusion reached by the examiners at the IRS when they issued a ruling granting church plan status to St. Peter's – a ruling consistent with similar rulings granted to a multitude of religious-affiliated hospitals and schools for the past 30 years.

The Gatekeeper

Applying what it described as a plain text analysis of the statute, the judge in the Kaplan case found that a tax-exempt entity purportedly controlled by or associated with a church may maintain a church plan for its employees but it may not itself establish a church plan. As explained by the judge, the key to this interpretation of Section 3(33) of ERISA "is to recognize that subsection A is the gatekeeper to the church plan exemption." Specifically, subsection A explains how a church plan is to be established – by a church or convention or association of churches – and subsection C explains that a church plan may be maintained by church controlled and church affiliated organizations. "In other words," said the judge in Kaplan, "if a church does not establish the plan, the inquiry ends there."

The Kaplan opinions goes through a painstaking explanation of this conclusion, taking up various arguments relating to the legislative history of ERISA and the church plan exemption, and it specifically addresses the question of whether 30 years worth of rulings issued by both the IRS and the DOL deserve deference in interpreting the statute that those agencies are charged to enforce. Like the California District Court in the Rollins case, the New Jersey District Court in the Kaplan concludes that the statute is unambiguous and the agencies have simply been wrong in interpreting subsection C as expanding both the establishment requirement and the maintenance requirement when all it is intended to do is allow a church controlled or church affiliated organization to participate in a plan established by a church. Ultimately, the court concludes that as a matter of law a retirement plan established solely by a church controlled or church affiliated organization cannot be a church plan.

Take Aways for Church Affiliated Employers

In assessing the impact of surprising or disappointing judicial opinions, lawyers often shrug their shoulders and say: "Bad facts make for bad law." In other words, if the facts in a case are hopelessly muddled or cry out for a certain outcome a judge will sometimes reach conclusions that may be expedient but set a bad precedent for future decisions. One is tempted to react that way to the Kaplan case, where the church affiliated health system maintained its retirement plan as an ERISA plan for years and is alleged to have sought church plan status as a means to avoid making up a substantial funding deficiency in the plan. But the judge in the Kaplan case reached his finding as a matter of law in ruling on a motion to dismiss without much attention to the facts. And the Rollins case, which reached the same legal conclusion four months earlier, involved an employer that had maintained its plan as a church plan for years (so the "bad fact" of attempting to avoid a funding obligation did not appear to be present in that case).

At this point, the Rollins and Kaplan cases must be viewed as outliers. There are, after all, many cases in which federal courts have upheld the status of church plans established by church affiliated employers. In addition, the decisions may well be reviewed and overturned on appeal. But if the statutory interpretations promulgated in the Rollins and Kaplan decisions gain traction, the most effective way to preserve the regulatory status quo may be through legislative action.

Meantime, there may not be much a church affiliated employer to do can shore up the church plan status of a retirement plan that it has established. But here are two possibilities to consider.

First, a church affiliated employer can attempt to administer its plans in a way that is consistent with the requirements of ERISA without necessarily characterizing them as ERISA plans. When it comes to reporting and disclosure requirements of ERISA, that approach would not be difficult to implement (with protective Form 5500 filings and certain similar measures). The approach would prove much more challenging – and perhaps impossible – for an employer facing significant pension plan funding deficiencies. In addition, this approach could affect other administrative matters in ways that will be unacceptable to some religious employers – for example, church affiliated employers could be required to treat same sex couples as married in the post-Windsor world.

Second, religious employers with common bonds could seek to restructure their plans and attempt to have them "established" by a common church. This approach, while extremely challenging for larger organizations, could result in having a giant retirement plan or health plan established and maintained by a Catholic archdiocese/diocese, which would cover all of the church affiliated hospitals in the archdiocese/diocese (perhaps with a separate church established plan for church affiliated schools, and so on).

No matter what, religious employers should assess their vulnerability to attacks on their plans based on the Kaplan and Rollins cases and be prepared to respond should such attacks materialize. We may have more to say on this subject as we continue to assess the these cases.

Topics: Benefit Plans of Exempt Organization, Retirement Plans