Members of the Florida legislature recently proposed a change to the state's stamp tax law that would specifically exclude its application to participant loans from ERISA-covered retirement plans ("participant loans"). This proposal, and the exploration of its revenue impact, suggests that the Florida legislature is aware of the confusion for retirement plans created by the state's stamp tax.
Background. Florida state law establishes a "stamp tax" on loans that are made, executed or delivered in Florida. (SeeChapter 201.08(1) of the Florida Statutes.) The applicable tax rate on loans is $.35 for each $100 borrowed, or $175.00 on a $50,000 loan. The Florida Department of Revenue ("DOR") has previously confirmed that the stamp tax applies to participant loans. (See Tax Information Publication # 00B04-06.) The Florida stamp tax statute specifically provides that in the event any party to a covered transaction is exempt from paying the stamp tax, the tax must be paid by the nonexempt party.
Financial Impact of Exemption. At a Revenue Estimating Conference that took place on February 20, 2014, the Florida legislature reviewed the financial impact of the proposed exemption. It was estimated that this exemption would result in a first-year loss in revenue to the state of approximately $6,200,000.00.
NOTE: This estimate was not based on any historical data of actual collections of stamp tax revenue attributable to retirement plan loans. Rather, the estimate was based on national averages of plan assets and outstanding retirement plan loans.
Enforcement of the Stamp Tax. The Florida DOR does not have a viable means of enforcing the law as applied to participant loans. Documents associated with participant loans are not public record. Moreover, because there is no state individual income tax in Florida, there is no related disclosure on a state income tax form of receipt of a participant loan or the default of a participant loan. Absent the Florida DOR's unprecedented audit of a retirement plan, it is unlikely that the existence of a participant loan would be discovered.
Consequences of Noncompliance with Stamp Tax. Among the consequences of the failure to comply with Florida's stamp tax is that the loan is unenforceable in Florida state courts. Therefore, the failure to pay the stamp tax on a participant loan may result in a prohibited transaction and/or tax qualification failure, as well as a deemed distribution due to the potential inability of the plan to enforce its rights in court in the event of a default, in violation of the enforceable agreement requirement articulated in applicable IRS regulations. (See Treas. Reg. Section 1.72(p)-1.)
Because a participant loan is generally limited to 50% of a participant's plan account balance and secured by the participant's remaining account balance, which may be foreclosed upon on default and after the participant's severance from employment, without court intervention, it would seem a participant loan is adequately enforceable regardless of whether court intervention is precluded due to failure to pay the Florida stamp tax. In any event, plan sponsors are extremely unlikely to pursue relief for a plan loan default in court.
ERISA Preemption. Various opinions exist as to whether ERISA preempts the Florida stamp tax statute with respect to participant loans. Since this issue has yet to be litigated, there is no clear guidance.
Courts have previously held that ERISA preempts a state law that specifically and exclusively targets ERISA-covered plans. However, courts have been hesitant to find that ERISA preempts state laws more general in nature. In fact, state laws of general applicability with only a tangential impact on ERISA plans (and even state laws specifically, but not exclusively, related to ERISA plans) have commonly been found to not be preempted by ERISA. A recent example of this would be a California law that established an unrelated business income tax that was determined by the Second Circuit Court of Appeals to not be subject to preemption by ERISA despite its application to ERISA-covered retirement plan trusts. (See Hattem v. Schwarzenegger, 2d Cir., No. 05-3926-cv, 5/23/06.)
Courts have articulated that the purpose behind ERISA's preemption clause is to "enable employers to establish a uniform administrative scheme, which provides a set of standard procedures to guide processing of claims and disbursement of benefits." Thus, it may be reasonable to conclude that because the stamp tax may apply in a non-uniform manner to some plans (as the tax would apply to some borrowing participants (i.e., Florida residents) but not others (i.e., non-Florida residents)), that it should be preempted by ERISA. It can be argued that while ERISA preemption might prevent assessment of the stamp tax on the plan, the plan sponsor or plan administrator, it does not prevent its assessment on the borrowing participant.
Conclusion. It is reasonable to conclude that, based on the general applicability of the Florida stamp tax statute and recent jurisprudence related to ERISA preemption, participant loans from ERISA-covered retirement plans are subject to the Florida stamp tax. If you think this tax applies to your plan or a participant in your plan, please contact us for assistance.