PLR 200329046: Governmental excess benefit plan and its trust receive requested tax treatment

Plain-English summary

A state retirement system proposed a separate arrangement to pay benefits that its qualified plan could not pay because of the limits in § 415. Employers would fund a separate trust each year, and participants could not choose to defer compensation. The IRS ruled that the arrangement qualified as a governmental excess benefit arrangement under § 415(m). Benefits paid to participants or beneficiaries would enter their income when paid or otherwise made available. Income accruing to the trust would be exempt from federal income tax under §§ 115 and 415(m)(1).

Ruling snapshot

• Question: Does the proposed arrangement qualify under § 415(m), and how are its benefits and trust income taxed?
• Outcome: Approved; the arrangement qualifies, benefits are taxable when paid or available, and trust income is exempt.
• Key authorities: IRC §§ 415(m), 115, 83, 402(b), 451.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

UIL 415.00-00
APR 23 2003

LEGEND:
System A:

State M:

Dear

This is in response to your request for a private letter ruling, dated June 12, 2001, as supplemented by letters dated May 8, 2002, and February 26, 2003, concerning the applicability of section 415(m) of the Internal Revenue Code to an excess plan and the tax consequences of certain related transactions. You have submitted the following facts and representations in support of your request.

System A is a defined benefit plan created by the State M legislature and set forth in the State M statute. System A is a governmental plan as described in Code section 414(d), and meets the requirements of Code section 401(a). System A is administered by a nine-member board (“System A Board”). It includes an employer contribution and a mandatory employee contribution feature, which may be picked up by the employer.

State M has enacted legislation which authorizes the System A Board to establish a qualified governmental excess benefit arrangement within the meaning of Code section 415(m). In accordance with this legislation, the System A Board has adopted and is planning to implement a qualified governmental excess benefit arrangement (“Proposed Arrangement”) pursuant to the provisions of Code section 415(m). The System A Board proposes to establish a trust fund (“Trust Fund”) to hold all assets of the Proposed Arrangement, with the System A Board acting as trustees. The Trust Fund will be separate and apart from the System A funds administered by

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the System A Board. The Trust Fund will be a grantor trust pursuant to state law and for Federal income tax purposes.

The Proposed Arrangement will operate in accordance with Code section 415(m). Under the

Proposed Arrangement, a participant will be paid that part of a retirement benefit that would otherwise have been payable by System A except for the limitations of Code section 415. Under no circumstances will a participant be given any election to defer compensation under the Proposed Arrangement, either directly or indirectly. The excess benefit to which the participant is entitled under the Proposed Arrangement will be paid after the retirement benefit payable to a participant under System A has reached the applicable Code section 415(b) limit for a calendar year. The excess benefit shall be paid for the remainder of that calendar year, but only for so long as the participant would have been entitled to receive retirement benefits from System A.

The Arrangement is part of System A, but no assets from System A will be used to pay any excess benefit under the Proposed Arrangement. The System A Board, upon consultation with the actuary for System A, shall determine the required contribution to pay Proposed Arrangement benefits for the plan year. The required contribution for each plan year shall be the aggregate of the excess benefits payable under the Proposed Arrangement to all participants for the plan year and an amount determined by the System A Board to be a necessary and reasonable expense of administering the Proposed Arrangement. This required contribution shall be paid into the Trust Fund. The Trust Fund assets shall not be accumulated to pay benefits payable in future years; rather, the Proposed Arrangement’s benefit liabilities shall be funded on a plan year to plan year basis. Any assets of the Trust Fund not used for paying benefits for a current plan year, together with any income accruing to the Trust Fund, shall be used to pay the administrative expenses of

the Proposed Arrangement for the plan year.

All contributions to the Proposed Arrangement necessary to pay the required supplemental pension payments shall be paid by the employers; there will be no employee contributions to the Proposed Arrangement.

The Trust Fund shall be maintained separately from System A. The Trust Fund shall not accept contributions or transfers from System A, and shall not pay System A benefits.

All participants, retired participants and beneficiaries of System A will automatically be participants in the Proposed Arrangement if their benefit exceeds the dollar limits of Code

section 415. Participation in the Proposed Arrangement will cease for any plan year in which the retirement benefit of a participant or beneficiary of the defined benefit plan maintained by System A is not limited by Code section 415.

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Based on the above facts and representations, you have requested the following rulings:

1. The Proposed Arrangement is a qualified governmental excess benefit arrangement within the
   meaning of Code section 415(m);

2. The benefits payable under the Proposed Arrangement will be includible in gross income for
   the taxable year or years in which amounts are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of the Proposed Arrangement; and

3. Income accruing to the Trust Fund established to hold assets of the Proposed Arrangement is
   exempt from federal income tax under Code sections 115 and 415(m)(1) as income derived from the exercise of an essential governmental function.

Code section 415(m) sets forth the treatment of qualified governmental excess benefit arrangements. Code section 415(m)(1) provides in part that, in determining whether a governmental plan (as defined in section 414(d)) meets the requirements of section 415, benefits provided under a qualified governmental excess benefit arrangement shall not be taken into account.

Section 415(m)(3) defines such an arrangement as a portion of a governmental plan which meets the following three requirements: (A) such portion is maintained solely for the purpose of providing to participants in the plan that part of the participant's annual benefit otherwise payable under the terms of the plan that exceeds the limitations on benefits imposed by section 415 ("excess benefits"); (B) under such portion no election is provided at any time to the participant (directly or indirectly) to defer compensation; and (C) excess benefits are not paid from a trust forming a part of such governmental plan unless such trust is maintained solely for the purpose of providing such benefits.

With respect to your first requested ruling, the Proposed Arrangement is a portion of System A, which your authorized representative has stated is a governmental plan as described in Code section 414(d). According to the terms of the Proposed Arrangement, its only stated purpose is to provide participants in System A that portion of a participant’s benefits that would otherwise be payable under the terms of System A except for the limitations on benefits imposed by Code section 415. The Proposed Arrangement does not allow participants to defer compensation. The terms of the Proposed Arrangement limit participation to System A participants for whom benefits would exceed the Code section 415 limits. Therefore, we have determined that the Proposed Arrangement is a portion of a governmental plan which is maintained solely for the purpose of providing to System A participants that part of the participant’s annual benefit otherwise payable under the terms of System A that exceeds the section 415 limits, and, as such, meets the requirements of section 415(m)(3)(A).

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Your authorized representative has stated in accordance with the terms of the Proposed Arrangement that participation is automatic for System A participants for whom benefits are limited by Code section 415. Thus, we have determined that no direct or indirect election is provided at any time to participants to defer compensation, and, accordingly, the requirements of section 415(m)(3)(B) are met.

Code section 415(m)(3)(C) requires that the trust from which excess benefits are paid must not form a part of the governmental plan (in this case, System A) which contains the excess benefit arrangement, with a certain exception for trusts maintained solely for the purpose of providing such benefits. In the present case, the Trust Fund is a grantor trust and it is maintained separately from System A. Contributions to the Trust Fund consist only of the amount required to pay the excess benefits for the plan year and the amount required to pay administrative expenses. Funds are not accumulated to pay benefits in future plan years. Any assets of the Arrangement Fund not used for paying benefits for a current plan year shall be used for the payment of the administrative expenses of the Arrangement for the plan year. Therefore, we have determined that the requirements of section 415(m)(3)(C) are met.

Since the Proposed Arrangement satisfies all of the requirements of Code section 415(m)(3), we conclude with respect to your first requested ruling that the Proposed Arrangement is a qualified governmental excess benefit arrangement within the meaning of Code section 415(m).

With respect to the second requested ruling, section 415(m)(2) provides that "for purposes of this chapter, (A) the taxable year or years for which amounts in respect to a qualified governmental excess benefit arrangement are includible in gross income by a participant, and (B), the treatment of such amounts when so includible by the participant, shall be determined as if such qualified governmental excess benefit arrangement were treated as a plan for the deferral of compensation which is maintained by a corporation not exempt from tax under this chapter and which does not meet the requirements for qualification under section 401."

Ruling 1 has already determined that the Proposed Arrangement meets the legal requirements of section 415(m) of the Code for qualified governmental excess benefit arrangements. Accordingly, the tax treatment of the amounts distributed under the Proposed Arrangement to the participants is determined as if such qualified governmental excess benefit arrangement were treated as a plan for the deferral of compensation which is maintained by a corporation not exempt from tax under this chapter and which does not meet the requirements for qualification under section 401. State M has represented that the trust established in connection with the Arrangement is a grantor trust pursuant to State M law and for Federal tax purposes.

Section 83(a) of the Code provides that the excess (if any) of the fair market value of property

transferred in connection with the performance of services over the amount paid (if any) for the property is includible in the gross income of the person who performed the services for the first taxable year in which the property becomes transferable or is not subject to a substantial risk of

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forfeiture.

Section 1.83-3(e) of the Income Tax Regulations provides that for purposes of section 83 the term "property" includes real and personal property other than money or an unfunded and unsecured promise to pay money or property in the future. Property also includes a beneficial interest in assets (including money) transferred or set aside from claims of the transferor's creditors, for example, in a trust or escrow account.

Section 402(b) of the Code provides that contributions made by an employer to an employee's trust that is not exempt from tax under section 501(a) are included in the employee's gross income in accordance with section 83, except that the value of the employee's interest in the trust will be substituted for the fair market value of the property in applying section 83. Under section 1.402(b)-1(a)(1) of the regulations, an employer's contributions to a nonexempt employee's trust are included as compensation in the employee's gross income for the taxable year in which the contribution is made, but only to the extent that the employee's interest in such contribution is substantially vested, as defined in the regulations under section 83.

Section 451(a) of the Code and section 1.451-1(a) of the regulations provide that an item of gross income is includible in gross income for the taxable year in which actually or constructively received by a taxpayer using the cash receipts and disbursements method of accounting. Under section 1.451-2(a) of the regulations, income is constructively received in the taxable year during which it is credited to a taxpayer's account, set apart or otherwise made available so that the taxpayer may draw on it at any time. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions.

Various revenue rulings have considered the tax consequences of nonqualified deferred compensation arrangements. Rev. Rul. 60-31, Situations 1-3, 1960-1 C.B. 174, holds that a mere promise to pay, not represented by notes or secured in any way, does not constitute receipt of income within the meaning of the cash receipts and disbursements method of accounting. See also Rev. Rul. 69-650, 1969-2 C.B. 106, and Rev. Rul. 69-649, 1969-2 C.B. 106.

Under the economic benefit doctrine, an employee has currently includible income from an economic or financial benefit received as compensation, though not in cash form. Economic benefit applies when assets are unconditionally and irrevocably paid into a fund or trust to be used for the employee's sole benefit. Sproull v. Commissioner, 16 T.C. 244 (1951), aff'd per curiam, 194 F.2d 541 (6th Cir. 1952), Rev. Rul. 60-31, Situation 4. In Rev. Rul. 72-25, 1972-1 C.B. 127, and Rev. Rul. 68-99, 1968-1 C.B. 193, an employee does not receive income as a result of the employer's purchase of an insurance contract to provide a source of funds for deferred compensation because the insurance contract is the employer's asset, subject to claims of the employer's creditors.

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Accordingly, with respect to your second requested ruling, we conclude that the benefits payable under the Proposed Arrangement will be includible in gross income for the taxable year or years in which amounts are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of the Proposed Arrangement.

With respect to your third requested ruling, Code section 415(m)(1) provides that "[I]ncome accruing to a governmental plan (or to a trust that is maintained solely for the purpose of providing benefits under a qualified governmental excess benefit arrangement) in respect of a qualified governmental excess benefit arrangement shall constitute income derived from the exercise of an essential governmental function upon which such governmental plan (or trust) shall be exempt from tax under section 115.” Ruling 1 has already determined that the Proposed Arrangement meets the legal requirements of section 415(m) of the Code for qualified governmental excess benefit arrangements.

Accordingly, with respect to your third requested ruling, we conclude that income accruing to the Trust Fund established to hold assets of the Proposed Arrangement is exempt from federal income tax under Code sections 115 and 415(m)(1) as income derived from the exercise of an essential governmental function.

This ruling letter is based on the assumption that System A is a governmental plan as described in Code section 414(d) and that it meets all of the applicable requirements under Code section 401.

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

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

If you have any questions about this letter, please contact

Sincerely yours,

Frances V. Sloan, Manager

Employee Plans Technical Branch 3
Tax Exempt and Government Entities Division

Enclosures

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Notice 437
Deleted copy of ruling letter

Cc: