PLR 200002017: Municipal deferred compensation plan qualifies under section 457

Plain-English summary

A municipality asked whether its revised deferred compensation plan met section 457's requirements. The plan held deferred amounts in an annuity contract for participants and their beneficiaries and limited elections and distributions as described in the letter. The IRS ruled that the plan was an eligible section 457(b) plan, that participants would include deferred amounts in income when paid or otherwise made available, and that the annuity contract was treated as a tax exempt trust. The ruling applied only to deferrals made after the letter's date and to the submitted plan and contract terms.

Ruling snapshot

• Question: Does the revised municipal plan qualify under section 457, and when is deferred compensation taxed?
• Outcome: Approved: the plan qualifies and deferrals are taxed when paid or made available.
• Key authorities: IRC §§ 457(a), 457(b), 457(g), 401(f), 501(a).

Full text (IRS public release)

INTERNAL REVENUE SERVICE
Index No. 457.01-00 457.05-00
457.12-02
Number: 200002017
Release Date: 1/14/2000

CC:EBEO:1 - PLR-110453-99
October 12, 1999

Municipality M =

This responds to your letter of March 29, 1999 and subsequent correspondence, on behalf of Municipality M, requesting a ruling concerning the proposed amended and revised deferred compensation plan (the "Plan") which M intends to be an eligible deferred compensation plan under section 457(b) of the Internal Revenue Code of 1986, as amended under sections 1447 and 1448 of the Small Business Job Protection Act of 1996. M is represented to be a municipal governmental entity described in section 457(e)(1)(A) of the Code.

Under the Plan an employee may elect to defer compensation that would have been received for services rendered to M in any taxable year until death, separation from service with M, attainment of age 70½, or until the occurrence of an unforeseeable emergency. The Plan also includes a provision providing an automatic in-service distribution of $5,000.00 or less to be paid to a participant from his or her account in certain limited circumstances set forth thereunder and in section 457(e)(9)(A). The Plan does not provide that a loan may be made from assets held by the Plan to any participant or beneficiary under the Plan.

The participant’s election to defer compensation not yet earned under the Plan must be filed prior to the beginning of the month in which his or her salary reduction agreement becomes effective. The Plan provides for a maximum amount that may be deferred by a participant in any taxable year and also provides for a catch-up computation for amounts deferred for one or more of the participant's last three taxable years ending before he attains normal retirement age under the plan. The amounts that may be deferred under the annual maximum limitation and the catch-up provision are within the limitations of section 457 including the section 457(c) coordinated deferral provision.

With certain limitations, a participant may elect the manner in which his deferred amounts will be distributed. The election generally must be made prior to the date any -2-

PLR-110453-99

such payment must commence to the participant. If the participant fails to make a timely election, distribution will commence at the time and in the manner set forth in the Plan. The Plan also includes a provision permitting a one-time additional election by a participant to further defer commencement of his distributions under the Plan after the first permissible payout date if distribution from his account had not already commenced. The Plan provides that the manner and time of benefit payout must meet the distribution requirements of sections 401(a)(9) and 457(d)(2) of the Code.

The Plan provides that amounts of compensation deferred thereunder are to be transferred to and invested in one or more annuity contracts for the exclusive benefit of the participants and their beneficiaries. Also, all amounts deferred under the Plan must be transferred to the annuity contract within an administratively reasonable time period. The annuity contract is represented to meet the requirements of section 401(f) and thus will be treated as a trust pursuant to section 457(g)(3). The rights of any participant or beneficiary to payments pursuant to the Plan are nonassignable and not subject to encumbrance, pledge, transfer or alienation.

Section 457 of the Code provides rules for the deferral of compensation by an individual participating in an eligible deferred compensation plan as defined in section 457(b).

Section 457(a) of the Code provides that in the case of a participant in an eligible deferred compensation plan, any amount of compensation deferred under the plan and any income attributable to the amounts so deferred shall be includible in gross income only for the taxable year in which such compensation or other income is paid or otherwise made available to the participant or beneficiary.

Section 457(g) provides that a plan maintained by an eligible governmental employer shall not be treated as an eligible deferred compensation plan unless all assets and rights purchased with such deferred compensation amounts and all income attributable to such amounts, property, or rights of the plan are held in trust for the exclusive benefit of participants and their beneficiaries. Section 457(g)(3) states that custodial accounts and annuity contracts described in section 401(f) shall be treated as trusts under rules similar to the rules under section 401(f).

Based upon the provisions of the Plan summarized above, and the documents presented, we conclude as follows:

1. The amended and revised Deferred Compensation Plan established by Municipality M is an eligible deferred compensation plan as defined in section 457(b) of the Internal Revenue Code of 1986 as amended under -3-

PLR-110453-99

sections 1447 and 1448 of the Small Business Job Protection Act of 1996.

2. Amounts of compensation deferred in accordance with the Plan, including any income attributable to the deferred compensation, will be includible in the recipient’s gross income for the taxable year or years in which amounts are paid or otherwise made available to a participant or beneficiary in accordance with the terms of the Plan.

3. The annuity contract associated with M’s section 457(b) Plan is treated under section 457(g) as a trust which is treated as an organization exempt from taxation under section 501(a).

No opinion is expressed concerning the timing of the inclusion in income of amounts deferred under any deferred compensation plan other than M's amended and revised Plan described above. In addition, this ruling applies only to deferrals made after the date this ruling is issued. This ruling is directed only to Entity M and applies only to the amended and revised Plan submitted in October 1999, and to the annuity contract submitted on March 29, 1999 as revised by the amendments submitted on July 29, 1999. If the Plan is significantly modified, this ruling will not necessarily remain applicable. Section 6110(k)(3) of the Internal Revenue Code provides that this ruling may not be used or cited as precedent.

Temporary or final regulations pertaining to one or more of the issues addressed in this ruling have not yet been adopted. Therefore, this ruling may be modified or revoked if the adopted temporary or final regulations are inconsistent with any conclusion in the ruling. See section 12.04 of Rev. Proc. 99-1, 1999-1 I.R.B. 6, 47. However, when the criteria in section 12.05 of Rev. Proc. 99-1 are satisfied, a ruling is not revoked or modified retroactively except in rare or unusual circumstances.

Sincerely yours,

ROBERT D. PATCHELL
Assistant Chief, Branch 1
Office of the Associate
Chief Counsel
(Employee Benefits and
Exempt Organizations)