Governmental deferred compensation plan qualifies under section 457

Plain-English summary

A state governmental instrumentality asked whether its employee deferred compensation plan qualified under section 457(b). Participants could defer pay, subject to annual limits, and the plan held their contributions in a custodial account for their exclusive benefit. The IRS ruled that the plan was eligible, that deferred amounts and earnings would generally be included in income when paid or otherwise made available, and that the custodial account was treated as a tax exempt trust under sections 457(g) and 501(a). The ruling applied to the submitted plan and custody agreement, and significant changes could affect it.

Ruling snapshot

• Question: Does the governmental plan qualify under section 457(b), with the intended income timing and custodial account treatment?
• Outcome: Approved for the submitted plan and custody agreement
• Key authorities: IRC §§ 457(a), 457(b), 457(g), 401(f), and 501(a)

Full text (IRS public release)

INTERNAL REVENUE SERVICE

Number: 200107028
Release Date: 2/16/2001
Index No. 457.01-00 457.05-00
457.12-02

CC:TEGE:QP2 - PLR-114136-00

November 20, 2000

Entity E =

Dear

This responds to your letter of July 18, 2000 and subsequent correspondence, on behalf of Entity E, requesting a ruling concerning the deferred compensation plan (the "Plan") which E intends to be an eligible deferred compensation plan under section 457(b) of the Internal Revenue Code of 1986. E is represented to be a state governmental instrumentality 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 E in any taxable year until death, separation from service with E, attainment of age 70½, or until the occurrence of an unforeseeable emergency. The Plan also provides for an in-service distribution of $ 2,500.00 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 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

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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 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 held in trust for the exclusive benefit of the participants and their beneficiaries. Compensation deferred under the Plan is transferred to a custodial account with a financial institution pursuant to which, it is represented, all amounts invested (and all earnings accrued) are held for the exclusive benefit of the participants and their beneficiaries. Also, all amounts deferred under the Plan must be transferred to the custodial account within an administratively reasonable time period (i.e., within 15 business days after the end of the month in which such amounts were deferred). The account is intended to meet the requirements of section 401(f) and thus to 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 alienation, encumbrance, pledge, or transfer.

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 Deferred Compensation Plan to be established by Entity E is an eligible deferred compensation plan as defined in section 457(b) of the Internal Revenue Code of 1986.

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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 custodial account associated with E’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 E's Plan described above. If the Plan is significantly modified, this ruling will not necessarily remain applicable. This ruling is directed only to Entity E and applies only to the revised Plan and custody agreement as submitted on September 21, 2000. 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. 2000-1, 2000-1 I.R.B. 4, 46. However, when the criteria in section 12.05 of Rev. Proc. 2000-1 are satisfied, a ruling is not revoked or modified retroactively except in rare or unusual circumstances.

Sincerely yours,

ROBERT D. PATCHELL
Acting Chief, Qualified Plan Branch 2
Office of the Associate
Chief Counsel
(Tax Exempt and Government Entities)

Enclosure:

Copy for section 6110 purposes