PLR 1030016: Government retiree health trust receives section 115 exclusion

Plain-English summary

The IRS ruled on a trust established by a political subdivision to fund health benefits for retired public-school employees and their eligible spouses and dependents. The trust's income was excluded from gross income under section 115(1) because it served the essential governmental function of providing health benefits and its income accrued to a political subdivision. The IRS also classified the arrangement as a trust and concluded that it did not have to file an annual income tax return under section 6012(a)(4). Contributions to the trust and payments used for qualifying accident or health coverage were excluded from the gross income of the retirees and eligible family members under sections 106 and 105(b). The conclusions were limited to the provisions specifically addressed in the ruling.

Ruling snapshot

• Question: Could the governmental retiree health trust qualify for the requested income exclusion and benefit treatment?
• Outcome: Approved
• Key authorities: IRC §§ 105, 106, 115, 152, 213, 301, 6012, and 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201030016 Third Party Communication: None
Release Date: 7/30/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 106.00-00 --------------------, ID No. -------------
Telephone Number:
--------------------
---------------------------------------- Refer Reply To:
-------------------------------------- CC:TEGE:EB:HW
------------------------ PLR-146851-09
---------------------------- Date:
April 08, 2010

Legend

School Board = ----------------------------------------

District = --------------------

State = -------------

Medical Plan = ------------------------------------------------------------------

Dental Plan = -----------------------------------------------------------------

Trust = ---------------------------------------------------------------

Dear ----------:

FACTS

School Board is a political subdivision of State that operates and manages District’s
public school system. State’s Constitution enables the legislature to create district
school boards and under State’s Revised Statutes, district school boards are
established as “bodies corporate.” School Board administers and oversees the
operations of public schools in District which includes the determination as to the
number of schools to be opened and operated, the hiring and termination of
administrative personnel and teachers (and fixing of salaries), the budgeting of the use
of tax funds to defray the cost of operating schools and the establishment of all policies
with regard to the operation of public schools.
PLR-146851-09 2

School Board has adopted Medical Plan and Dental Plan (Plans) which are offered to its
current employees and its retired employees. School Board is the sole employer
participating in Plans. School Board pays 85% of the medical and dental insurance
premiums for retired employees who are responsible for the remainder. There are no
pre-tax salary-reduction elections under the plans. Participants may not salary reduce
to pay for any benefit. Neither Plan permits a cash-out of unused amounts or
conversion of unused sick leave or vacation days to retiree health benefits. School
Board currently provides benefits only for individuals who qualify as a spouse or eligible
dependent under §152 of the Internal Revenue Code (the Code).

School Board established Trust to currently fund retiree health benefits. Trust was
created and funded by School Board solely for the benefit of retirees and their eligible
spouses and dependents. The parties to the trust agreement are School Board and the
trustee of Trust. Upon termination of Trust or either of the Plans offered by School
Board, Trust funds shall be returned to School Board. Trust assets are free from claims
of creditors to fullest extent allowable under State law. In no event will Trust assets be
transferred to an entity which is not a state, a political subdivision or an entity whose
income is excluded from gross income under section 115. Trust assets are to be used
exclusively to pay for benefits provided by the plans and for the administration of Trust.
Private interests do not participate in the Trust and no part of Trust’s property may be
diverted to purposes other than the exclusive benefit of the retirees and their eligible
spouses and dependents.

School Board has exclusive authority and discretion to manage and control the assets
of the Trust, but will delegate investment management of Trust’s assets to the trustee
pursuant to the terms of the trust agreement. School Board represents that the purpose
of Trust is to vest in the trustee responsibility for the protection and conservation of
Trust property for the benefit of Plan participants, their spouses and dependents, none
of whom can share in the discharge of this responsibility for profit.

The members of Trust’s Board of Trustees include the District Superintendent of
Schools, the Director of Budget Services and the three members of the School Board’s
Budget and Finance Committee. The Superintendent and Director of Business Services
are appointed by School Board. The Board of Trustees meets annually and makes
decisions by majority vote. The Board of Trustees may take no action which jeopardizes
the exclusion of Trust’s income from gross income under section 115(1) of the Code,
and no part of the Trust’s net earnings can inure to the benefit of a member of the Board
of Trustees. The members of the Board of Trustees shall not engage in any acts of self-
dealing and shall consistently maintain their fiduciary status with the Trust and its
beneficiaries.
PLR-146851-09 3

LAW AND ANALYSIS

Section 115(1) of the Code provides that gross income does not include income derived
from any public utility or the exercise of any essential government function and accruing
to a state or any political subdivision thereof.

In Rev. Rul. 77-261, 1977-2 C.B. 45, income from an investment fund, established
under a written declaration of trust by a state, for the temporary investment of cash
balances of the state and its participating political subdivisions, was excludable from
gross income for federal income tax purposes under § 115(1). The ruling indicated that
the statutory exclusion was intended to extend not to the income of a state or
municipality resulting from its own participation in activities, but rather to the income of a
corporation or other entity engaged in the operation of a public utility or the performance
of some governmental function that accrued to either a state or municipality. The ruling
points out that it may be assumed that Congress did not desire in any way to restrict a
state’s participation in enterprises that might be useful in carrying out projects that are
desirable from the standpoint of a state government and which are within the ambit of a
sovereign to properly conduct. In addition, pursuant to § 6012(a)(2) and the underlying
regulations, the investment fund, being classified as a corporation that is subject to
taxation under subtitle A of the Code, was required to file a federal income tax return
each year.

In Rev. Rul. 90-74, 1990-2 C.B. 34, the Service determined that the income of an
organization formed, funded, and operated by political subdivisions to pool various risks
(casualty, public liability, workers’ compensation, and employees’ health) is excludable
from gross income under § 115 of the Code. In Rev. Rul. 90-74, private interests
neither materially participate in the organization nor benefit more than incidentally from
the organization.

School Board is a political subdivision of State that is enabled by State’s Constitution
and established pursuant to statute to carry out the essential government function of
public education including the budgeting of the use of tax funds to defray the cost of
operating schools and establishment of all policies with regard of operation of public
schools. School Board offers medical and dental coverage to its retired employees.
Providing health benefits to current and former employees constitutes the performance
of an essential government function. Trust was established by School Board to help
fund the benefits offered its retired employees. Based upon Rev. Rul. 90-74 and Rev.
Rul. 77-261, Trust performs an essential governmental function within the meaning of
§ 115(1) of the Code.
PLR-146851-09 4

No private interests participate in or benefit from the operation of Trust. Any distribution
of remaining funds in Trust to participating retirees upon the dissolution of Trust satisfies
an obligation the participating employer has assumed with respect to providing health
benefits to its employees. The benefit to the participating employees is incidental to the
public benefit. See Rev. Rul. 90-74.

Section 61(a)(1) of the Code and § 1.61-21(a)(3) of the Income Tax Regulations provide
that, except as otherwise provided in Subtitle A of the Code, gross income includes
compensation for services, including fees, commissions, fringe benefits, and similar
items.

However, section 106(a) of the Code provides that gross income of an employee does
not include employer-provided coverage under an accident or health plan.

Section 1.106-1(a) of the regulations provides that the gross income of an employee
does not include contributions which his employer makes to an accident or health plan
for compensation (through insurance or otherwise) to the employee for personal injuries
or sickness incurred by him, his spouse, or his dependents, as defined in § 152. The
employer may contribute to an accident or health plan either by paying the premium (or
a portion of the premium) on a policy of accident or health insurance covering one or
more of his employees, or by contributing to a separate trust or fund (including a fund
referred to in § 105(e)) which provides accident and health benefits directly or through
insurance to one or more of his employees. However, if the insurance policy, trust or
fund provides other benefits in addition to accident or health, § 106 applies only to the
portion of the contributions allocable to accident or health benefits.

Coverage provided under an accident and health plan to former employees and their
spouses and dependents is excludable from gross income under § 106. See Rev. Rul.
62-199, 1962-2 C.B. 32; Rev. Rul. 82-196, 1982-2 C.B. 53.

Section 105(a) provides that, except as otherwise provided in § 105, amounts received
by an employee through accident or health insurance for personal injuries or sickness
shall be included in gross income to the extent such amounts (1) are attributable to
contributions by the employer which were not includible in the gross income of the
employee, or (2) are paid by the employer.
PLR-146851-09 5

Section 105(b) provides that except in the case of amounts attributable to (and not in
excess of) deductions allowed under § 213 (relating to medical expenses) for any prior
taxable year, gross income does not include amounts referred to in subsection (a) if
such amounts are paid, directly or indirectly, to the taxpayer to reimburse the taxpayer
for expenses incurred by him for medical care (as defined in § 213(d)).

Section 301.7701-1(b) of the Procedure and Administration Regulations provides that
the classification of organizations that are recognized as separate entities is determined
under §301.7701-2; §301.7701-3 and §301.7701-4, unless a provision of the Code
provides for special treatment of that organization.

Section 301.7701-4(a) of the Procedure and Administration Regulations provides that,
in general, an arrangement will be treated as a trust if it can be shown that the purpose
of the arrangement is to vest in trustees responsibility for the protection and
conservation of property for beneficiaries who cannot share in the discharge of this
responsibility and, therefore, are not associates in a joint enterprise for the conduct of
business for profit.

Section 6012(a)(4) provides that every trust having for the taxable year any taxable
income, or having gross income of $600 or over, regardless of the amount of taxable
income, shall make a return with respect to income taxes under subtitle A.

Based on the information submitted and representations made, we conclude as follows:

(1) The income of Trust is derived from the exercise of an essential governmental
function and will accrue to a state or a political subdivision thereof for purposes of
§ 115(1). Accordingly, Trust’s income is excludable from gross income under § 115(1)
of the Code.

(2) Trust is classified as a trust within the meaning of §7701(a) of the Code and
§ 301.7701-4(a) of the regulations. Trust is not required to file an annual income tax
return under § 6012(a)(4) of the Code.

(3) Contributions paid to Trust and payments made from Trust pursuant to the Plans
which are used to pay for the accident or health coverage of retired employees, their
spouses and dependents (as defined in § 152 of the Code) are excludable from the
gross income of retired employees and retired employees’ spouses and dependents
under §§ 106 and 105(b) of the Code.
PLR-146851-09 6

No opinion is expressed concerning the Federal tax consequences of Trust or Plans
under any other provision of the Code, other than those specifically stated herein. This
ruling is directed only to the Taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                   Sincerely,



                                   Harry Beker
                                   Branch Chief, Health and Welfare Branch
                                   Office of Division Counsel/Associate
                                   Chief Counsel
                                   (Tax Exempt & Government Entities)