Battered San Diego Fund Also Finds Potential Tax Woes

July 5, 2006 (PLANSPONSOR.com) - In addition to its many other legal problems, the city of San Diego's pension system is expected to seek city council approval to pay a surprise $33.8-million federal tax bill and change the way it pays retirees with benefits of more than $13,000 per month.

They were two of the five separate potential problems with the Internal Revenue Service (IRS) code officials have found that stem from the way the $4-billion San Diego City Employees’ Retirement System takes in and puts out the cash, the Voice of San Diego reported.


Discovered after an internal city review, the violations come as part of an era in which the deficit-plagued pension system became a focus of the Justice Department and the Securities and Exchange Commission (SEC).

Tax attorneys for the system were expected to file a bundle of corrective actions in the hopes of rectifying the five tax violations it has self-reported to the IRS.

The move is one of a laundry list of items the pension system and the city council must finish to sort out the numerous legal and accounting irregularities that sprout from the pension crisis.

“There are easily two dozen issues or more that are recommended remediation or changes, all of which are being closely tracked by the mayor’s administration,” Fred Sainz, spokesman for Mayor Jerry Sanders, told the newspaper.

Paying a Health Care Benefit

Paying the $33-million bill would make up for past tax violations related to the retiree health care benefit, the news report said.

The problem stems from the city’s move in 1982 to grant a health care allowance to retirees. But rather than set up a separate fund and cover the cost from the city’s annual budget, officials began siphoning off the retirement fund’s investment earnings and using them to pay a part of the retiree health care benefit, among other things.

For tax purposes, the city should have set up a separate trust to handle the distribution of the benefit, and the benefits should have been paid for from a source other than investment earnings, the news report said. Investment earnings were used in part to pay the benefit from 1985 until 1992 and then again from 1997 until 2005.

Administrators set up a trust in 1997, which provided the fund with the proper structure to administer the benefit under the tax code, the report said.

But attorneys for the pension system have ruled that the city owes $8.2 million in backlogged costs because the pension system – not the city paid for the benefit. Not only that, the pension system should also bill the city $1.5 million for the administrative costs of handling the city’s work, attorneys said. Because the costs were incurred beginning in 1982, the price tag for interest is $24.1 million.

Other self-reported IRS violations include technical aspects of administering the pension system. One also touches on the presidential leave benefits, and it was thought to have violated the IRS code because it allowed unions to pay contributions into the pension fund. Typically, only the city would pay such employer contributions.

Another part of the IRS code forbids pension systems from paying out pension benefits above a certain level, which one official calculated at about $13,000 a month or $156,000 a year.

However, with employees sometimes making six-figure salaries and spending three decades working for the city, reaching such a level is hardly unattainable. As such, officials said they will likely have to ask the city to either set up a separate fund to pay any benefits above and beyond this level or simply pay the annual sum from the appropriate city budget.

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