GAB Decision 651
June 3, 1985
Area IV PSRO of Michigan;
Ford, Cecilia Sparks; Settle, Norval D. (John) Teitz, Alexander G.
Docket No. 84-104; Audit Control No. 05-45047
Area IV PSRO of Michigan (appellant, PSRO) appealed a determination
by the Health Care Financing Administration (HCFA, Agency) upholding the
recommendation of the Regional Inspector General for Audit that the PSRO
refund the employer's share of a Federal Insurance Contributions Act
(FICA) refund resulting from a retroactive change in the tax exempt
status of the PSRO. The employer's share, totalling $56,393.75
including interest, was placed in a defferred compensation plan adopted
after the refund was received. The basis for the determination by HCFA
was that the employer's share of the refund was returnable to the Agency
as a refund of taxes or as an applicable credit under the cost
principles. The major issue in this case is whether the payment of the
employer's share of the FICA refund into this particular deferred
compensation plan was an allowable cost. Based on the entire record,
including a taped oral argument, we uphold HCFA's determination, except
for that part of the refund, if any, which came from State of Michigan
funds. Background Professional Standards Review Organizations (PSROs)
were established under amendments to the Social Security Act in 1972.
(Pub. L. 92-603) The purpose of the PSRO program was to see that health
care services funded under the Medicare, Medicaid, and Maternal and
Child Health Programs were medically necessary, conformed to appropriate
professional standards, and were delivered in the most effective,
efficient, and economical manner consistent with quality care. (42
U.S.C. Sec. 1320c.) PSROs were ordinarily entirely federal funded,
although appellant was at some time partly funded by the State of
Michigan. PSROs as employers originally paid FICA taxes for Social
Security for both the employer's share and the share collected from the
employees. Certain PSROs litigated payment of FICA taxes with the
Internal Revenue Service (IRS) and were eventually successful in
obtaining a determination that PSROs were entitled to be exempt from
FICA taxes under section 501(c) (3) of the Internal Revenue Code as
non-profit charitable corporations. This exemption was retroactive, and
permitted PSROs to recover FICA taxes paid by them from their
incorporation, subject to the limitation period on tax refunds. /1/
The exemption was not automatic, however, and had to be claimed by a
PSRO on behalf of those employees who elected to opt out of Social
Security coverage. There were 27 PSROs which elected to ask for FICA
refunds. All returned the employees' share to the particular employees
who had paid the FICA taxes. There was no issue here about these
refunds to the employees. Disputes did arise in several cases over the
disposition of the employers' shares of the refunds. The Board has
previously decided one case on this point: Area IX Oakland-Macomb PSRO,
Decision No. 528, April 9, 1984. In that case that PSRO disbursed the
employer's share plus accrued interest directly to the employees. We
held that the employer's share of the refund should have been returned
to HCFA as a refund of taxes or as an applicable credit under the cost
principles. The interest which had accrued on the employer's share was
not treated separately but was required to be returned to HCFA with the
principal of the refund. In Oakland-Macomb the PSRO paid the employer's
share of the refund over to the employees. Here the refund (plus
interest) was paid into a deferred compensation plan for the benefit of
the employees who had been employed during the three-year period (June
1979 through June 1982) covered by the refund. /2/
While this case was pending, the Board learned that in another case
before us HCFA had approved reinvesting the employer's share of the
refund in an employee benefit plan. San Joaquin Area PSRO, Board Docket
No. 84-168. /3/ In the San Joaquin case the brief submitted by HCFA
indicated that approximately 15 PSROs were permitted to retain the
employer's share of the refund for investment in a pension plan. The
Board thereupon invited the parties in this case (and in two other
pending PSRO appeals) to supplement their briefing "to address the
application and relevance of HCFA's approval of San Joaquin Area PSRO's
plan to reinvest the employer's contribution in an employee benefit
plan." Board letter, January 2, 1985.
When the Board asked for supplemental briefing on the use by various
PSROs of the refund for pension plans, the Agency submitted a
declaration by a HCFA system accountant, Robert Henderson (hereafter
Henderson declaration), outlining the disposition of the FICA refunds by
27 PSROs. /4/ From this declaration we find that the refund was handled
differently by different PSROs. Some returned the entire employer's
share to HCFA. Three PSROs returned the employer's share to the
employees. One of these PSROs was Oakland-Macomb; we held this
distribution improper in Decision No. 528. The other two are East
Central Illinois Foundation for Health Care, Board Docket No. 84-120,
and Shenandoah PSRO, Board Docket No. 84-147, both pending before the
Board.
Of the remaining PSROs, several used the refund to offset operating
expenses or as a credit to offset future tax liabilities. Here again,
we have no problem similar to the one here. The Henderson Declaration
stated that from the time of receipt of the FICA refund, HCFA would
allow a PSRO to establish a new defined contribution plan, or increase
an existing plan, in the amount of the FICA contribution rate, to
replace FICA from the receipt of the refund through December 31, 1983.
/5/ (Declaration, p. 4) The new (or existing) plan could be funded in
two ways. The first would be for the PSRO to return the FICA refund to
HCFA and draw down additional grant funds to make payments to the plan.
The second would be to use the refund for the plan, instead of going
through the extra step of returning the refund and drawing down grant
funds to fund the plan. (Id.)
The PSRO here, as distinguished from San Joaquin PSRO and the other
PSROs which used the refund for a defined contribution plan, had two
pension plans which were intended to replace FICA. One was the defined
contribution plan, which became effective immediately after the period
covered by the refund; the other was the deferred compensation plan to
cover the same period as the FICA refund covered. /6/// As to the first,
the defined contribution plan, the PSRO drew down current grant funds
for payments to the plan. As to the deferred compensation plan, this
was funded by a one-time payment of the FICA refund.
Analysis I. THE EMPLOYER'S SHARE OF THE FICA REFUND WAS RETURNABLE TO
HCFA. In Oakland-Macomb we held that the employer's share of the FICA
refund was returnable to the Agency as a refund of taxes or an
applicable credit under the pertinent cost principles. There has been
no new argument presented by the PSRO which would cause us to reconsider
Decision No. 528. The PSRO has also not brought to our attention any
factual differences which would render that decision not applicable
here. We start, therefore, with the holding that initially the refund of
the employer's share must be returned to HCFA. We consider next whether
the use of the FICA employer's refund for the purpose of funding this
deferred compensation plan was reasonable and permitted under the cost
principles; only if it was, need we reach the question of whether
payment into a different deferred compensation plan would be
permissible. The cost principles on which Decision No. 528 was based
provide that the refund shall either be turned over to the government as
a cash refund or used to reduce other allowable costs. The provision
for "Applicable Credits" in Attachment A, A.5.a., of OMB Circular
A-122
"Cost Principles for Nonprofit Organizations," states that to the
extent
such credits received by the organization relate to allowable cost,
"they shall be credited to the Government either as a cost reduction or
cash refund as appropriate." Similarly, the provision under "Taxes,"
the
alternative ground of Decision No. 528 (Attachment B, 46.b. of Circular
A-122), required that any refund of taxes "will be credited either as a
cost reduction or cash refund, as appropriate, to the Government."
Clearly a cash refund posed no problems whatever. The issue here is
whether it was reasonable for HCFA to allow some PSROs to use their
refunds to fund (or add to) a retirement pension plan, and not to permit
this PSRO to use the refund to fund this deferred compensation plan. II.
THIS DEFERRED COMPENSATION PLAN DID NOT MEET THE REQUIREMENTS OF THE
COST PRINCIPLES. Even if depositing the refund into a deferred
compensation plan generally were a permissible use of the refund, /7/
this particular plan would not qualify. To be an allowable cost,
payments of deferred compensation into a plan must meet the requirements
of the cost principles. Part 74 of 45 CFR, Appendix F, provides in
G.6.(g)(4)(b):
Deferred compensation is allowable to the extent that (i) except for
past service pension and retirement costs, it is for services rendered
during the grant/contract period; (ii) it is, together with all other
compensation paid to the employee, reasonable in amount; (iii) it is
paid pursuant to an agreement entered into in good faith between the
institution and its employees before the services are rendered . . .
(iv) the benefits of the plan are vested in the employees or their
designated beneficiaries and no part of the deferred compensation
reverts to the employer institution. . . .
As we note below, it is clear that the employees of Area IV PSRO have no
vested rights in the plan. The cost principles cited state that the
benefits of the plan must be "vested in the employees or their
designated beneficiaries" and also, that "no part of the deferred
compensation reverts to the employer institution." /8/
The plan (Exhibit IV, Q, PSRO Appeal File) states just the opposite.
Until distribution, "the interest of each Participant and Beneficiary
therein is contingent only." Section 4.2(a). It might be argued that
this may not mean exactly what it seems to say because the conditions
for forfeiture are only if the PSRO has to reimburse the federal
government for the FICA payments, or if the employee is discharged for
embezzlement of corporate funds. Section 4.5. The next section of the
plan, however, makes it plain that the funds in the plan belong to the
PSRO and there is no vested right of any employee.
Section 4.6 Nothing contained herein shall be deemed to create a
trust of any kind or create any fiduciary relationship. Funds invested
hereunder shall continue for all purposes to be a part of the general
funds of PSRO, and no person other than PSRO shall, by virtue of the
provisions of this Plan, have any interest in such funds. To the extent
that any person acquires a right to receive payments from PSRO under
this Plan, such rights shall be no greater than the right of any
unsecured general creditor of PSRO. If this were not enough to show that
the employees had no vested interest in the funds in the plan, section
6.1 provided that the Board of Directors of the PSRO may amend the plan
in whole or in part from time to time. This particular deferred
compensation plan therefore clearly did not meet the requirements of the
cost principles for making contributions to it allowable costs. Even
without the cost principles, a pension plan where the beneficiaries
never have any vested rights in the funds, and where in bankruptcy they
would stand no better than a general creditor, would not be recognized
so that contributions to it are allowable. We therefore hold that even
if the contributions of the FICA refund might have been allowable if
made to a qualified pension plan, payments to this deferred compensation
plan as it was drawn were clearly not allowable. /9/
III. REFUND OF FICA PAYMENTS MADE WITH MICHIGAN FUNDS DO NOT REVERT TO
HCFA. In its opening brief the PSRO claimed that some of the money used
to pay the FICA taxes which were refunded came from a grant from the
State of Michigan. /10/ The Agency did not reply to this contention. At
oral argument the Agency acknowledged that if the refund consisted in
part of funds from grants to the PSRO by Michigan, then that part of the
refund would not belong to the Agency. The parties should attempt to
agree on the exact amount involved.
CONCLUSION The determination by HCFA that the refund of the
employer's share of the FICA tax refund should be repaid to HCFA as a
refund of a tax or an applicable credit is sustained, except for any
part of the refund which was derived from payments made from funds
furnished the PSRO by the State of Michigan. The parties should attempt
to determine this amount by agreement; if they are unable to do so, the
PSRO may return to us on this one issue within 15 days from HCFA's
adverse written determination. As we noted above, the PSRO may wish to
explore with HCFA whether it is possible now to amend the deferred
compensation plan to meet HCFA's objections. /1/ The issue was limited
to a brief time period, since by amendment to the Social
Security Act all PSROs became subject to paying FICA taxes effective
January 1, 1984. /2/ In Oakland-Macomb the Board referred to the
suggestion of a HCFA employee that the employer's share could be used
"to offset future payment into a retirement fund," although it could
not
be returned to the employees. It appeared that such a solution was
"impractical, if not impossible" because only nine of the original
35
employees were still employed by the PSRO, and in any event such a
payment would exceed the guidelines on fringe benefits. Oakland-Macomb,
p. 14. /3/ The San Joaquin PSRO case came before the Board
because HCFA claimed that the part of the refund of the FICA tax which
was interest should be returned to it, even though HCFA approved placing
the principal part of the refund in a pension plan. /4/ The
declaration was not sworn to as an affidavit. However, it was stated to
be under penalty of perjury, and there has been no question of the
accuracy of the facts stated. The PSRO did object to the conclusions
drawn in the declaration, but we do not rely on those conclusions by
themselves here. /5/ The Henderson declaration presumably treats
the date of the receipt of the refund as a significant date, the
implication being that the PSRO could use the employer's share of the
FICA refund to pay into (or add to) a pension fund from the date of
receipt of the refund until December 31, 1983. During the oral argument
the Agency admitted that some PSROs were permitted to apply the refunds
to pension plans covering periods prior to receipt of the refund. We
therefore do not treat the date of receipt of the refund as having any
significance here. /6// In a defined contribution plan only the
contributions to the plan are certain, or defined. The amount of the
pension benefits is uncertain; it will depend on the pension fund
accumulation and its earnings. A defined benefits plan, on the other
hand, states, or defines, the amount of benefits to be received on
retirement (as, for instance, in federal civil service). A deferred
compensation plan is an arrangement where specified portions of an
employee's compensation are payable in the form of retirement benefits.
See FASB Accounting Standards, Original Pronouncements, APB8, Appendix
B. /7/ Deferred compensation is defined in 45 CFR Part 74,
Appendix F, G.6.(g)(4)(a) (1980): As used herein, deferred compensation
includes all renumeration, in whatever form, for which the employee is
not paid until after the lapse of a stated period of years or the
occurrence of other events as provided in the plans . . . It includes
(i) contributions to pension and annuity plans, (ii) contribution to
disability, withdrawal, insurance, survivorship, and similar benefit
plans. . . . By definition, the payments to FICA, and hence of the FICA
refund, are contributions to either pension and annuity plans, or to
disability, insurance, survivorship, and similar benefit plans.
Payments into a deferred compensation plan which met the requirements of
the cost principles would therefore ordinarily be an allowable cost.
/8/ The Agency also argued that the deferred compensation plan
was not "reasonable" (HCFA brief, p. 12), because the total of all
payments into all pension funds of the PSRO was unreasonable. HCFA
contended that there were three pension funds of the PSRO, and that
payments into them totalled 22% of salary. The PSRO always had a
defined contribution plan with Massachusetts Mutual, and payments of
8.5% of compensation to it were always allowed. The PSRO set up a new
"defined contribution plan," with payments of 6.7% compensation, which
were also allowed. HCFA argued that permitting paying the FICA refund,
at the rate of 6.7% into the new deferred compensation plan would mean
the PSRO would have three pension plans with payments of 22% of salary
(actually 21.9%). The difficulty with this argument, as the PSRO
pointed out in briefing and in oral argument, is that the defined
contribution plan and the deferred compensation plan did not overlap in
the time period covered, so that for no one time period did
contributions to pension plans exceed 15.2% (8.5% plus 6.7%), an amount
which had previously been allowed. Another contention of HCFA was that
the cost principles required that deferred compensation had to be paid
pursuant to an agreement entered into "before the services are
rendered." This was clearly impossible and no bar to considering this an
allowable cost, since at the time the FICA payments were made no one
knew that they would be refunded, and this deferred compensation plan
was a substitute for FICA payments. /9/ The parties have not
considered whether the deferred compensation plan could be amended
retroactively so that it could come within the cost principles by giving
the employees of the PSRO vested rights in the plan. Since the
directors of the PSRO have the right by its terms to amend the plan,
conceivably they could now amend it to vest the interests of the
eligible employees, and remove any right of further amendment without
the consent of the employees. The PSRO may wish to explore this further
with HCFA. Even if the plan can be amended satisfactorily, there is
still a question whether the PSRO can retain for the plan more than
approximately $18,000. (See Henderson declaration, p. 5) The
declaration is unclear as to the reason for this limit on the amount.
Any discussions between the parties as to amendment of the plan should
also consider this apparent limitation. /10/ The CPA Audit
Report for the grant budget year ended June 30, 1983 states that the
PSRO began providing services for the State of Michigan Medical Service
Administration's Second Surgical Opinion Program on December 15, 1980,
and received funds from this program. (Exhibit V, X, p. 1)
JULY 18, 1985