PLR 200032049: university medical practice sponsors a governmental plan

Plain-English summary

A medical faculty practice associated with a state university asked whether its employee annuity plan was a governmental plan. The IRS found that the practice was a state instrumentality under section 414(d), citing its role in medical education and research and the state's substantial control over its board and operations. It therefore ruled that the practice's plan was a governmental plan, assuming officials formally executed the amended and restated plan. The letter did not decide whether the plan met section 403(b)'s requirements; that issue was reserved for a separate ruling. It also expressed no opinion on whether the practice's wages were subject to federal employment tax.

Ruling snapshot

• Question: Is the medical practice a state instrumentality whose employee plan qualifies as a governmental plan under section 414(d)?
• Outcome: Approved, assuming formal execution of the amended and restated plan.
• Key authorities: IRC §§ 414(d) and 403(b); Rev. Rul. 89-49.

Full text (IRS public release)

Internal Revenue Service
Uniform Issue List: 414.07-00
Department of the Treasury
Washington, DC 20224

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Contact Person: ****************************
Telephone Number: ****************************
In Reference to: ************ [illegible]
Date: [illegible]

Attention: ****************************

Legend:

Employer = ****************************
Medical School = ****************************
University = ****************************
State A = *********
State A Board = ****************************
Head of State A Board = ****************************
Plan X = ****************************

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Ladies and Gentlemen:

This is in response to a request submitted on your
behalf by your authorized representative in a letter dated
May 23, 1997, as supplemented by a letter dated June 8,
1999, for a letter ruling concerning whether Plan X is a
governmental plan as defined in section 414(d) of the
Internal Revenue Code (“Code”) and whether Plan X meets the
requirements of section 403(b) of the Code.

The following facts and representations have been made
in support of the governmental plan ruling request.

The Employer is a medical faculty practice incorporated
as a professional service corporation under the laws of
State A and is associated with the University through the
Medical School. The Employer received a letter dated August
25, 1986, from the Internal Revenue Service recognizing it
as exempt from federal income tax under section 501 (a) of
the Code as an organization described in section 501(c) (3).
The letter also stated that the Employer is not a private
foundation under section 509(a) of the Code. The Employer
established Plan X as a tax-deferred annuity plan pursuant
to section 403(b) of the Code, effective January 1, 1996.
Plan X has been amended and restated, incorporating
Amendments One and Two, to meet the requirements of section
403 (b).

The Employer was chartered to advance the purposes of
the medical educational program and related activities of
the Medical School at the University, which is a state
university chartered as part of the State A university
System. As stated in the Employer's Charter, the Employer's
purpose is primarily to conduct medical education, medical
research, medical care, and the practice of medicine in
order to improve the Medical School and its affiliated
teaching hospitals, their teaching and research resources,
their facilities and their service opportunities. The
Employer fulfills its duties by providing physicians to
render patient care in hospitals operated in connection with
the University, furnishing assistance in the training and
education of students of the Medical School and assisting in
certain research activities of the Medical School.

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The Employer provides facilities for students and
resident physicians to see patients and to observe the
members in the practice of medicine. The activities are
required as part of the students’ curriculum at the Medical
School. The Employer will not provide care to any patients
who are uncomfortable being seen by students and resident
physicians. The medical services are carried out in a
building owned by State A. It is represented that the
Employer performs a legitimate government function by
educating students of the Medical School through clinical
instruction and research activities.

Under the By Laws of the Employer, a physician member
of the Employer must be a faculty member of the Medical
School, and, if any physician member leaves the faculty of
the Medical School, membership in the Employer terminates
automatically. Under the Private Practice Regulations of
the Employer, the appropriate department chairperson with
the approval of the Dean of the Medical School shall specify
the maximum portion of time to be devoted to medical/health
services of the Employer by physician members. The Medical
School has the authority to restrict the physician members
from participating in the medical/health practice carried on
by the Employer if such services interfere with the proper
performance of academic duties of the Medical School.

The Medical School, the University, and State A retain
control over the administration and operation of the
Employer. Under the By Laws of the Employer, the Board of
Directors is composed of the Dean of the Medical School, the
chairperson of each clinical department of the Medical
School, the President of the University, the Head of State A
Board or their designees, and three elected Directors at
large. The Directors at large must be members of the
Employer, all of whom are faculty members of the Medical
School. As set forth in the Employer’s By Laws, the Head of
State A Board was required to approve the Charter of the
Employer, its By Laws, the Agreement between the University
and the Employer, and its Private Practice Regulations. The
Employer’s By Laws may not be altered or amended without
approval of the Dean of the Medical School, the President of
the University, and the Head of State A Board.



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Although the Employer was not created under any
specific statute of State A, implied statutory authority was
necessary for the creation and use of the Employer. The
Employer was created by the State A Board. The State A
Board was established pursuant to State A statute. The
State A Board has the authority to do all things necessary
for the creation, proper maintenance, and successful and
continuous operation of the State A university system. The
Employer was created to benefit the Medical School, which is
a part of the State A university system.

Under the Employer's Charter, no part of its net
earnings shall inure to the benefit of its members,
trustees, officers or other private persons, except that the
Employer shall be authorized to pay reasonable compensation
to its employees for services rendered, including physician
members’ supplemental salaries, and to make payments and
distributions in furtherance of its purposes.

The Agreement between the University and the Employer
provides that the Employer may create, implement, and
operate a medical services plan. The Agreement approves of
the By Laws of the Employer. It also prohibits any
amendments to the Employer’s Charter or By Laws without the
written approval of the University and the State A Board.
Under the Agreement, the Employer, in the conduct of its
independent activities, may provide medical and health care
services and charge fees for such services. All income and
funds received for patient care activities belong to the
Employer. All gifts to, contributions, bequests, devises,
or grants negotiated with or by the Employer shall be
subject to the prior approval of the President of the
University, and, if so approved, shall belong to the
Employer. All real property acquired by gifts or bequests
or purchased with the Employer's funds shall be subject to
the approval of the President of the University, and, if so
approved, shall become the property of the Employer. In
general, Article V of the Agreement provides that total
collections of the Employer shall be applied in the
following priorities: First, [funds will be used] for
payment of all expenses of the Employer, excluding salary
supplements of the members. Second, a percentage of all




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cash receipts will be contributed to a specific fund for the
Medical School (“Fund”). Such percentage shall not exceed
3% without approval of the Employer's membership. Expenses
may be paid from the Fund subject to the annual Employer's
operating budget. Any monies remaining in the Fund at year
end will be contributed to the University for the exclusive
use of the Medical School. Third, [funds will be used for]
the salary supplements of individual members as stipulated
in their professional services agreements, pro rata based on
individual total collections. Fourth, [funds will be used]
to establish a corporate reserve. Fifth, a department's
residual income at year end (i.e., that of a clinical
department of the Medical School) will be used for
educational, research and service purposes. A portion of
residual departmental revenues at the end of the fiscal
year, such portion determined by the departmental chair, may
be redistributed to individual faculty in that department
based upon their percentage of contribution to the total
cash collected for that year. The Dean of the Medical
School must approve such distribution.

The Employer shall keep financial records in accordance
with generally accepted accounting principles and the
accounting system of the Employer shall be subject to the
approval of the University, the State A Board and the
Comptroller of the Treasury of State A. Financial records
shall be audited annually by a certified public accountant
recommended by the Employer and approved by the University.
The University, the State A Board, and the Comptroller of
the Treasury of State A shall have access to financial or
other records of the Employer at any time.

Copies of the Employer's audited financial statements
for the 1995 and 1996 years were submitted with the ruling
request. The statements show that the Employer is funded
primarily from patient service revenue, and most of the
expenses are wages, salaries and benefits.

Under the Employer’s By Laws, the Employer may be
dissolved by the Head of the State A Board subject to the
approval of the State A Board. The Charter of the Employer
provides that upon dissolution the Board of Directors shall,
after paying or making provision for payment of all




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liabilities, distribute the remaining assets of the Employer
to the University for the benefit of the Medical School. In
the event that the University ceases to be an exempt
organization as an agency of State A, then all remaining
assets shall be distributed to the State A Board. In the
event the State A Board ceases to be an exempt organization
as an agency of State A, then all remaining assets shall be
distributed to State A.

Separate payrolls are maintained by the Employer and
the University. The physicians employed by the Employer
receive Income Tax Form W-2s from the Employer as well as
from the University. It has been represented that the
physicians are considered to be employees of both the
Employer and the University. It has also been represented
that the Employer has always paid FICA tax with respect to
its employees.

Based on the foregoing, your authorized representative
has requested the following ruling:

That the Employer, through its affiliation with the
University and direct oversight by State A, is an
instrumentality of State A under section 414(d) of the Code
and, consequently, that Plan X, which is sponsored by the
Employer, is a governmental plan as that term is defined by
section 414(d) of the Code.

Section 414(d) of the Code provides, in part, that for
purposes of Chapter 1D, Part I, the term "governmental plan"
means a plan established and maintained for its employees by
the Government of the United States, by the government of
any state or political subdivision thereof, or by any agency
or instrumentality of any of the foregoing.

Rev. Rul. 89-49, 1989-1 C.B. 117, provides that a plan
will not be considered a governmental plan merely because
the sponsoring organization has a relationship with a
governmental unit or some quasi-governmental power. One of
the most important factors to be considered in determining
whether an organization is an agency or instrumentality of
the United States or any state or political subdivision is
the degree of control that a governmental entity (or




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entities) exercises over the organization's everyday
operations. Other factors include: (1) whether there is
specific legislation creating the organization; (2) the
source of funds for the organization; (3) the manner in
which the organization's trustees or operating board are
selected; and (4) whether the applicable governmental unit
considers the employees of the organization to be employees
of the applicable governmental unit.

The Employer performs a governmental function by
educating students through clinical instruction and research
activities and through observation of the physician faculty
members of the Medical School in the practice of medicine.
These educational services are performed on behalf of the
Medical School, which is part of the University, and which,
in turn, the University is chartered as part of the State A
university system.

The Employer is governed by its Board of Directors.
State A, through its representation on the Board of
Directors, substantially controls the Employer. The
Employer's Board of Directors is composed of the Dean of the
Medical School, the chairperson of each clinical department
of the Medical School, the President of the University, the
Head of State A Board or their designees, and three elected
Directors at large. As previously indicated, the at large
Directors must also be full-time employees of the Medical
School. Consequently, they must act in a manner which will
not jeopardize their employment with the Medical School and
the University in order to remain on the Board. As a
result, State A, through the State A Board, the University,
and the Medical School, exercises substantial control over
the Employer. The Head of the State A Board must approve
the Charter, the By Laws, the Agreement between the
University and the Employer, and the Employer’s Private
Practice Regulations. Under these circumstances, the
Employer is controlled and supervised by a public authority.

Implied statutory authority was necessary for the
creation and use of the Employer. The Employer was created
by the State A statute granting the State A Board such
powers, not otherwise prescribed by law, as are necessary to
carry out the Board’s responsibility for the efficient




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administration and operation of the university system. The
Employer was created to benefit the Medical School, which is
part of the State A university system.

The Employer is funded primarily by income generated
from a medical services plan. The University monitors the
Employer's finances and its expenditures. The Employer's
accounting is audited annually and is subject to approval of
the University and the Comptroller of the Treasury of State
A. The Employer may be dissolved by the State A Board. In
the event that the Employer is dissolved, all remaining
assets of the Employer shall be distributed to the
University for the benefit of the Medical School, or to the
State A Board, or to State A.

The provisions of Plan X show that the plan was
established by the Employer and will be maintained for its
employees.

Based on the information submitted, we conclude that
the Employer, through its affiliation with the University
and oversight by State A, is an instrumentality of State A
under section 414(d) of the Code and, consequently, that
Plan X, which is sponsored by the Employer, is a
governmental plan as that term is defined by section 414(d)
of the Code.

No opinion is expressed as to the federal tax
consequences of the transaction described above under any
other provision of the Code. We do not express an opinion
on whether wages paid by the Employer are subject to tax
under the Federal Insurance Contributions Act.

This ruling is based on the assumption that an official
or officials of the Employer formally execute Plan X, as
amended and restated to incorporate Amendments One and Two.

Because the request presents more than one issue and
because your authorized representative requested separate
letter rulings, a separate letter ruling will be issued with
respect to the ruling request that Plan X meets the
requirements of section 403(b) of the Code.




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This letter ruling is directed only to the taxpayer
that requested it. Section 6110(k) (3) of the Code provides
that it may not be used or cited by others as precedent.

A copy of this letter has been sent to your authorized
representative in accordance with a power of attorney on
file in this office.

Sincerely,

John G. Riddle, Jr.

John G. Riddle, Jr., Manager
Employee Plans Technical Group 4
Tax Exempt & Government Entities Division

Enclosures:
Deleted copy of this letter
Notice of Intention to Disclose, Notice 437