PLR 1047017: A city employee health-benefit trust qualified for the section 115 income exclusion

Plain-English summary

The IRS ruled on a trust established by a city to fund hospital, surgical, and health insurance coverage for retired city employees and their families. Only the city could contribute, private interests could not participate or benefit except through reasonable compensation for goods or services, and any remaining assets had to return to the city or go to another qualifying entity. The IRS concluded that providing health benefits to current and former employees of a political subdivision is an essential government function and that the trust’s income accrued to the city. The trust’s income was therefore excluded from gross income under IRC § 115(1), although the ruling did not address the tax treatment of contributions or benefits.

Ruling snapshot

• Question: Is income earned by a city-funded trust that provides health benefits to retired city employees excluded under IRC § 115(1)?
• Outcome: approved
• Key authorities: IRC §§ 115(1), 6012(a)(2), and 6110(k)(3); Rev. Rul. 77-261; Rev. Rul. 90-74.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201047017 [Third Party Communication:
Release Date: 11/26/2010 Date of Communication: Month DD, YYYY]
Index Number: 115.00-00
Person To Contact:
------------------------ ------------------, ID No. -------------
--------------------------- Telephone Number:
----------------- ---------------------
------------------------------------ Refer Reply To:
------------------------------ CC:TEGE:EOEG:EO2
PLR-120155-10
Date:
July 29, 2010

Legend

City = ----------

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

City Code = ------------------------------------------------------

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

City Council = ----------------------------

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

  This is in reply to a letter dated May 10, 2010, and subsequent correspondence,

requesting a ruling that the income of Trust is excluded from gross income under §
115(1) of the Internal Revenue Code.

                                                 FACTS

   City, a political subdivision of State, adopted a Trust Agreement pursuant to the

City Code. City established the Trust as a vehicle to fund group hospital, surgical, and
health insurance coverage for retired City employees, their spouses, and their
dependents. Trust is administered by a board of five trustees consisting of the City
Controller/Treasurer, City Human Resources Director, City Manager, and two elected
members of the City Council appointed by the President of the City Council.

   Under the provisions of the Trust, only the City may make contributions to the

Trust. No portion of the principal or income of Trust shall be used for or diverted to any

PLR-120155-10 2

purpose other than the payment of Plan benefits and the reasonable expenses incurred
in the supervision and administration of Trust. Private interests will neither participate in
nor benefit from the operation of Trust other than as providers of goods or services for
reasonable compensation.

    The Trust Agreement may be amended at any time by City. Further, Trust is

irrevocable unless and until there are no longer any participants eligible for benefits
from Trust. Upon termination of Trust and satisfaction of all liabilities of Trust, any
remaining assets shall be returned to City or transferred to another entity that meets the
requirements of § 115 of the Code. In no event will 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 of the Code.

                                 LAW & 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.

  Trust provides health coverage to retired employees of City, a political

subdivision of State. Providing health benefits to current and former employees of a

PLR-120155-10 3

political subdivision constitutes the performance of an essential government function.
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.

    The income of Trust accrues to City. The benefit to the participating employees

is incidental to the public benefit. See Rev. Rul. 90-74.

   Based on the information and representations submitted by the City, we hold that

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.

   No opinion is expressed concerning the federal tax consequences under any

provision of the Code other than those specifically cited above. In particular, 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 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.

  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,




                                   Sylvia Hunt
                                   Assistant Chief, Exempt Organizations Branch 2
                                   Division Counsel/Associate Chief Counsel
                                   (Tax Exempt & Government Entities)

Enclosures: Copy of this letter
Copy for § 6110 purposes