PLR 1036027: IRS approved a judicial-system excess benefit arrangement under section 415(m)

Plain-English summary

The IRS ruled that an excess benefit plan for state court personnel qualified as a governmental excess benefit arrangement under IRC § 415(m). The plan would provide benefits limited by the statutory cap for governmental defined benefit plans, would be funded separately on a pay-as-you-go basis, and would not permit participants to defer compensation. The IRS also ruled that benefits would be taxable when paid or made available and that income accruing to the arrangement would be exempt under IRC §§ 115 and 415(m)(1). The ruling assumed that the underlying plan was a governmental plan and qualified under the stated provisions.

Ruling snapshot

• Question: Does the excess benefit plan qualify under IRC § 415(m), and how are its benefits and income taxed?
• Outcome: Approved
• Key authorities: IRC §§ 83, 115, 401, 402, 414, 415, and 501

Full text (IRS public release)

DEPARTMENT OF THE TREASURY 9010360 2%

INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

COMMISSIONER
TAX EXEMPT AND
GOVERNMENT ENTITIES

Uniform Issue List: 415.00-00

SE: T: EB RATS

Attention:
Legend:

| System X =
State S =
Plan X =

Excess Plan X

Dear

This is in response to correspondence dated October 20, 2006, as supplemented by
correspondence dated December 8, 2008, March 11, 2009, and September 15, 2009,
submitted on behalf of System X by its authorized representatives, in which a request for
a letter ruling was submitted with respect to the applicability of section 415(m) of the
Internal Revenue Code (Code) to an excess benefit plan (Excess Plan X) and the tax
consequences related thereto.

The following facts and representations have been submitted under penalty of perjury in
support of the rulings requested:

State S sponsors Plan X on behalf of its eligible employees, who are the justices and
judges of the State S Supreme Court, Court of Criminal Appeals, Workers’
Compensation Court, Court of Appeals and District Courts, and the Administrative
Director of the Courts. The governing provisions for Plan X are statutorily promulgated
by the State S Legislature. Your authorized representatives have represented that Plan
X is a defined benefit plan, a governmental plan as described in section 414(d) of the
Code, and is qualified under section 401(a) of the Code. System X, an instrumentality of
State S, is the administrator of Plan X. System X is governed by a Board of Trustees.

Participation in Plan X is mandatory for all eligible employees, who participate
immediately upon election or appointment.

901036022

Page 2

Employee and employer contribution rates to Plan X are established by the State S
Legislature. All Plan X participants pay a uniform contribution rate of eight percent of
compensation. State S picks up these mandatory contributions within the meaning of
section 414(h)(2) of the Code. In addition, State S contributes three percent of

compensation, an amount which increases each year after fiscal year 20. , reaching
percent in fiscal year 20.

State S statutes provide for the establishment of qualified excess benefit arrangements
within the meaning of section 415(m) of the Code. Pursuant to this authority, on May 11,
20 , System X’s Board of Trustees adopted Excess Plan X for the benefit of employees
of State S who participate in Plan X. Excess Plan X will operate in accordance with
section 415(m) of the Code as a qualified governmental excess benefit arrangement.
State S employees who participate in Plan X will become eligible for benefits from
Excess Plan X if their benefits calculated under the benefit formula are limited by section
415(b) of the Code as that section applies to governmental plans. Participation in
Excess Plan X is mandatory and automatic for all participants in Plan X whose Plan X
retirement benefit is limited by Code section 415.

Section 4.01 of Excess Plan X provides that a participant will receive a benefit equal to
the amount of retirement benefits that would have been payable to, or with respect to, a
participant by Plan X that could not be paid because of the application of the limitations
on retirement benefits under section 415(b) of the Code (“excess benefit”). An excess

benefit under Excess Plan X will be paid only if and to the extent the participant is
receiving retirement benefits from Plan X.

Excess Plan X is administered by System X’s Board of Trustees, which has established
a separate trust fund for segregation of the assets related to Excess Plan X. This trust
fund was established solely for the purpose of holding employer contributions intended
to pay excess benefits to affected Excess Plan X participants. The trust fund was
designed as a grantor trust for state law and federal income tax purposes. You have
represented that the participants will receive no property right or interest in the trust
assets, and that the trust assets are subject to the claims of State S’s general creditors

in the event of insolvency. The trustees of this separate trust fund will be System X’s
Board of Trustees.

Excess Plan X will be funded on a pay-as-you-go basis. System X’s Board of Trustees
will determine the amount necessary to pay the excess benefits under Excess Plan X for
each plan year. The required contribution will be the aggregate of the excess benefits
payable to all affected participants for such plan year and an amount determined by the
Board to be a necessary and reasonable expense of administering Excess Plan X. The
amount so determined will be paid by State S and deposited into the trust fund. Under
no circumstances will State S’s contributions to fund the excess benefits under Excess
Plan X be credited to the trust established to fund Plan X. Any contributions not used to
pay the excess benefits for a current plan year, together with any income accruing to the
trust fund, will be used to pay the administrative expenses of Excess Plan X for the plan
year. Any contributions not so used that remain after the payment of administration
expenses will be used to fund excess benefits of participants in future plan years.

Benefits under Excess Plan X will be paid only if and to the extent that the participant is
receiving benefits from Plan X. Participation in Excess Plan X will cease for any portion

Page 3 901 036027

of a plan year in which the participant's benefit under Plan X does not exceed the
requisite limitations of section 415(b) of the Code, or if all benefit obligations under
Excess Plan X to the retiree or beneficiary have been satisfied. The form of the benefits
paid to a participant from Excess Plan X will be the same form as the participant's
retirement benefit under Plan X. A participant in Excess Plan X will be paid the amount
of the benefit that would otherwise have been payable to the participant under Plan X
except for the limitations of section 415(b). The excess benefit to which a participant is
entitled under Excess Plan X will be paid commencing during or with the month in which
all monthly payments of retirement benefits under Plan X are paid. Under no
circumstances will the participant be given any election to defer compensation under
Excess Plan X, either directly or indirectly. In addition, System X represents that there
will be no employee contributions to Excess Plan X.

Although Excess Plan X is a part of Plan X, no assets of Plan X will be used to pay any
benefits under Excess Plan X. Excess Plan X is intended to grant a participant no more
than a mere contractual right to payment of benefits under Excess Plan X. Employer
contributions to Excess Plan X’s related trust may not be commingled with assets of
Plan X’s related trust, nor may Excess Plan X receive any transfers from Plan X. Under

no circumstances will employer contributions to fund the excess benefits under Excess
Plan X be credited to Plan X.

Based upon the facts and representations stated above, the following rulings are ©
requested:

1. Excess Plan X is a qualified governmental excess benefit arrangement within the
   meaning of section 415(m) of the Code.

2. The benefits payable under Excess Plan X will be includible in gross income for the
   taxable year or years in which such benefits are paid or otherwise made available to a
   participant or a participant’s beneficiary in accordance with the terms of Excess Plan X.

3. Income accruing to Excess Plan X 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.

Pursuant to correspondence dated December 8, 20__, your authorized representatives
withdrew a previously requested fourth ruling.

Section 415(b) of the Code sets forth the limitations on benefits for participants in
defined benefit plans.

Section 415(m) of the Code sets forth the treatment of qualified governmental excess
benefit arrangements. 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) of the Code 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

Page 4 901 0360272

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, Excess Plan X was adopted by System X’s
Board of Trustees as a part of Plan X. It has been represented that Plan X is a
governmental plan as described in section 414(d) of the Code. It has also been
represented that the only purpose of Excess Plan X is to provide affected employees of
State S who participate in Plan X that portion of their benefits that would otherwise be
payable under the terms of Plan X except for the limitations on benefits imposed by
section 415(b) of the Code, as applicable to governmental plans. The terms of Excess
Plan X limit participation to participants in Plan X for whom benefits would exceed the
limits of section 415 of the Code. Therefore, we have determined that Excess Plan X is
a portion of a governmental plan which is maintained solely for the purpose of providing
to State S employees who participate in Plan X that part of the participants’ benefits
otherwise payable under the terms of the Plan X that exceed the section 415 limits, and,
as such, meets the requirements of section 415(m)(3)A).

Your authorized representatives have stated that participation in Excess Plan X is
mandatory and automatic, and that there are no employee contributions to Excess Plan
X. Your representatives also assert that no direct or indirect election to defer
compensation is provided to any participant in Excess Plan X. 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 41 5(m)(3)(B) are met.

Section 415(m)(3)(C) of the Code requires that the trust from which the excess benefits
are paid must not form a part of the governmental plan which contains the excess
benefit arrangement, unless such trust is maintained solely for the purpose of providing
such benefits. In this case, Excess Plan X will be funded on a pay-as-you-go basis.
System X’s Board of Trustees established a trust fund for the segregation of assets
related to Excess Plan X which is maintained separately from Plan X. This trust fund
was established solely for the purpose of holding employer contributions intended to pay
excess benefits to affected Plan X participants. Contributions to the trust fund will
consist only of the amounts required to pay the excess benefits and administrative
expenses for the plan year. Any contributions not used to pay the excess benefits for a
current plan year, together with any income accruing to the trust fund, will be used to pay
the administrative expenses of Excess Plan X for the plan year. Any contributions not so
used that remain after the payment of administration expenses will be used to fund
excess benefits of participants in future years. Therefore, we have determined that the
requirements of section 415(m)(3)(C) are met.

Since Excess Plan X satisfies all of the requirements of section 415(m)(3) of the Code,
we conclude with respect to your first ruling request that Excess Plan X is a qualified

governmental excess benefit arrangement within the meaning of section 415(m) of the
Code.

Page 5

201036022

With respect to the second requested ruling, section 415(m)(2) of the Code provides that
for purposes of this chapter, (A) the taxable year or years for which amounts in respect
of 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 Excess Plan X 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 Excess Plan X to the
participants is determined as if such qualified governmental excess benefit arrangement
was 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.

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 forfeiture.

Section 1.83-3(e) of the Income Tax Regulations (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.

Page 201036027

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 (6 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.

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

With respect to your third requested ruling, Code section 415(m)(1) provides that income
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 will constitute income
derived from the exercise of an essential governmental function upon which such
governmental plan (or trust) will be exempt from tax under section 115. Ruling 1 has
already determined that Excess Plan X 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 Excess Plan X 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.

No opinion is expressed as to the tax treatment of the transactions described herein
under the provisions of any other section of either the Code or regulations which may be
applicable thereto.

This letter assumes that Plan X is and was a governmental plan as described in section
414(d) of the Code, is and was qualified under section 401, and its related trust is and
was exempt from tax under section 501(a) at all times relevant thereto.

This ruling is contingent upon the adoption of the amendment to Excess Plan X, as
Stated in the correspondence dated December 8, 20

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

Page 7 201036027

Pursuant to a power of attorney on file with this office, a copy of this ruling letter is being
sent to your authorized representatives. If you wish to inquire about this ruling, please
contact . Please address all
correspondence to SE:T:EP:RA:G1.

Sincerely yours,

Ingrid Grinde, Manager
Employee Plans Technical Guidance and
Quality Assurance Group 1

Enclosures:
Deleted copy of letter ruling
Notice of Intention to Disclose