PLR 1047011: A city retiree health subsidy trust qualified for section 115 treatment and had no filing requirement

Plain-English summary

The IRS ruled on a city trust that funded an implicit rate subsidy so retired city employees could pay the same health insurance premiums as current employees. The trust was funded and controlled by the city, used only for the retiree subsidy and related expenses, and returned any remaining assets to the city on termination. The IRS concluded that providing this benefit to former public employees was an essential governmental function and that the trust’s income accrued to the city, so the income was excluded under IRC § 115(1). Assuming the trust was a separate entity and had no taxable income, the IRS also concluded that it did not have to file an annual income tax return under section 6012(a)(4).

Ruling snapshot

• Question: Is the city’s retiree health subsidy trust’s income excluded under section 115, and must the trust file an annual income tax return?
• Outcome: approved
• Key authorities: IRC §§ 115(1), 6012(a)(4), and 6110(k)(3); Treas. Reg. §§ 301.7701-1(b) and 301.7701-4(a).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201047011
Release Date: 11/26/2010
Index Number: 115.00-00

----------------------------------------------- Person To Contact:
------------------------------------------- --------------------, ID No. -------------
-------------------------------- Telephone Number:
------------------------------------------- ---------------------
Refer Reply To:
CC:TEGE:EOEG:EO1
- PLR-114296-10
- Date: August 19. 2010

     City:                        -------------------------------------------------

     Trust:                     ---------------------------------------------------------------------------------
                                ------------------

     State:                     ------------

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

This letter responds to a letter from your authorized representative dated February 12,
2010, as well as subsequent correspondence, submitted on behalf of the City,
requesting rulings that the Trust’s income is excludable from gross income under § 115
of the Internal Revenue Code (Issue 1) and that the Trust is not required to file an
annual income tax return (Issue 2).

On December 8, 2009, the Internal Revenue Service issued a favorable private letter
ruling to the City under § 115 of the Code (PLR 201013026) regarding a trust
established by the City to fund post-employment health insurance for eligible retirees.
Under the health benefit plan funded by this trust, a retiree may elect to continue his
coverage under the City’s group health insurance plan or to purchase coverage from
another insurance carrier. The trust which was the subject of the December ruling
reimburses a retiree for his health care expenses according to a formula based on years
of service. The specific facts and representations submitted by the City with respect to
the December ruling are incorporated by reference. With respect to the current ruling,
the City represents the following facts.

                                          2

PLR-114296-10

                                       FACTS

The Trust was established by the City to fund an implicit rate subsidy. The purpose of
the Trust is to allow retired City employees who elect to continue their health care
coverage under the City’s group health insurance policy to pay the same premiums as
are charged for current employee coverage.

The board of trustees (the board) is responsible for the administration and management
of the Trust, including investment of trust assets. The board is composed of the
treasurer, the finance director, and a council member of the City, as well as two
residents of the City appointed by, and serving at the pleasure of, the city council. The
trust instrument may be amended at any time by an ordinance adopted by the city
council, upon recommendation of the board. The City represents that the Trust
provision allowing for retroactive amendments will be deleted.

Under the terms of the trust instrument, only the City may make contributions to the
Trust; the board holds all fiduciary powers necessary to carry out the purposes of the
Trust, including investment, management, and control of trust assets; trust assets are
used to make periodic payments to the City for reimbursement of its retiree implicit rate
subsidy, the amount of which is actuarially determined according to the Governmental
Accounting Standards Board (GASB); and the income and earnings of the Trust are
used to pay trust expenses and fees and offset future contributions by the City.

Before trust termination, and except for trust administrative expenses, trust assets may
not be used or diverted for any purpose other than to fund the retiree health insurance
subsidy for the exclusive benefit of the City and its retirees. The board may terminate
the Trust at any time by executing a written instrument. Upon termination, and after
satisfaction of all trust liabilities, any remaining assets shall be returned to the City. In
no event may trust assets be distributed to an entity that is not a state, a political
subdivision of a state, or an entity, the income of which is excluded from gross income
under § 115.

                               LAW AND ANALYSIS
                                    ISSUE 1

Section 115(1) 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

                                          3

PLR-114296-10

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 properly to 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 income of an organization formed, funded, and
operated by political subdivisions to pool various risks (casualty, public liability, workers’
compensation, and employees’ health) was excludable from gross income under § 115.
In Rev. Rul. 90-74, private interests neither materially participated in the organization
nor benefited more than incidentally from the organization.

The Trust was established and is maintained by the City to provide a special rate
subsidy that allows retired employees to obtain health insurance under the City’s group
policy at the same premium rates as are charged to cover active employees. Providing
such a benefit to former public employees constitutes the performance of an essential
governmental function within the meaning of § 115(1). See Rev. Rul. 90-74 and Rev.
Rul. 77-261.

The provision of health insurance to its retired employees satisfies the obligation of the
City under its retiree health benefit plan to provide that benefit; thus, the income of the
Trust accrues to the benefit of the City, which is a political subdivision of the State. No
private interests participate in, or benefit from, the operation of the Trust, other than as
providers of goods and services. Any amounts remaining in the Trust after the
satisfaction of all Trust liabilities, including reasonable fees and expenses, shall be
returned to the City. The benefit to retired City employees is incidental to the public
benefit. See Rev. Rul. 90-74.

                                 LAW & ANALYSIS
                                    ISSUE 2

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

                                          4

PLR-114296-10

Section 301.7701-4(a) of the regulations provides, in general, that an arrangement will
be treated as a trust under the Code 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.

The City contributes money to the Trust to fund its retiree implicit rate subsidy. The
board is charged with protecting and conserving trust assets for beneficiaries who
cannot share in the discharge of this responsibility and, therefore, are not associates in
a joint enterprise for the conduct of a business for profit. If the Trust is recognized as a
separate entity under § 301.7701-1, then it will be treated as an ordinary trust under
§ 301.7701-4(a).

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

                                  CONCLUSION

Based solely on the facts and representations submitted by the City, and as of the date
the proposed amendment to the Trust agreement is adopted:

1. We conclude that the income of the 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). Consequently, we rule that the
   Trust’s income is excludable from gross income under § 115(1).

2. Assuming that it is a separate entity under § 301.7701-1, we conclude that the
   Trust is classified as an ordinary trust under § 301.7701-4(a). Section 6012(a)(4)
   does not require a trust without taxable income to make a return of income when
   gross income is less than $600. Because the Trust’s income is excludable from
   gross income under § 115(1), we rule that the Trust is not required by
   § 6012(a)(4) to file an annual income tax return.

Except for the specific rulings above, no opinion is expressed or implied regarding the
federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, no representation is made that contributions or premiums paid on
behalf of, or benefits received by, employees, former employees, retirees, spouses,
dependents, or others will be tax-free. This ruling concerns only the federal tax
treatment of the Trust's income and may not be cited or relied upon as to any matter
relating to the taxation of accident or health contributions or benefits.

                                         5

PLR-114296-10

Under a power of attorney on file with this office, we are sending a copy of this letter to
your authorized representative.

This ruling is directed only to the taxpayer who requested it. According to
§ 6110(k)(3), this ruling may not be used or cited as precedent.

                                      Sincerely,




                                      SYLVIA HUNT
                                      Assistant Chief
                                      Exempt Organizations Branch 2
                                      Office of Division Counsel /
                                             Associate Chief Counsel
                                      (Tax Exempt & Government Entities)

enclosures: copy for § 6110 purposes