PLR 1119008: Trust income for public retiree health benefits is excluded under section 115

Plain-English summary

A state-created trust pooled and invested assets set aside by local public agencies for retiree health benefits. The trust was limited to governmental participants, and its assets could be used only for retiree health benefits and related administration. The IRS ruled that the trust performed an essential governmental function and that its income accrued to a state or political subdivision, so the income was excludable from gross income under IRC § 115(1). The ruling addressed only the federal tax treatment of the trust's income and did not decide the tax treatment of contributions or benefits.

Ruling snapshot

• Question: Is the trust's investment income excludable from gross income under IRC § 115(1)?
• Outcome: Approved.
• Key authorities: IRC § 115(1); IRC §§ 6012(a)(2) and 7701; Rev. Rul. 77-261 and Rev. Rul. 90-74.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201119008 [Third Party Communication:
Release Date: 5/13/2011 Date of Communication: Month DD, YYYY]
Index Number: 115.00-00, 115.07-00,
6012.00-00, 6012.05-01, Person To Contact:
7701.03-00 ----------------------------, ID No. --------------
-----------------
------------------------------------------------------------ Telephone Number:
------- ---------------------
------------------------------ Refer Reply To:
------------------------------------------------- CC:TEGE:EOEG:E02
---------------------------------------------------- PLR-132641-10
Date:
January 5, 2011

Trust = -----------------------------------------------------------------
State = -------------
Commission = ----------------------------------------------------------------------------
Fund = ---------------------------------
Bill A = ------------------
Association = -------------------------------------------------------------------------------
Date 1 = -----------------------
$A = ----------------
$B = ---------------
D = ----

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

This is in response to your August 6, 2010 letter requesting the following ruling:

Trust’s income is excludable from gross income under I.R.C. § 115(1) because the
Trust’s income is derived from the exercise of an essential governmental function and
accrues to a state or political subdivision thereof.

Facts and Representations:

Trust is represented as an agency of State that was created to allow local State
governmental agencies to pool investment assets to pay for retiree health benefits.
Trust was created after State’s Governor formed Commission to deal with potential
crisis that the present value of the liabilities for health benefits for retired public
employees was $A and only $B had been set aside to pay retiree health benefits.

PLR-132641-10 2

Commission’s first recommendation was prefunding such benefits and as a policy this
was as important as prefunding pensions.

It is represented that local agencies are establishing trusts to hold and invest assets for
retiree health benefits. As these trusts accumulate assets, they are searching for
economically efficient ways to invest these assets. In State, public agencies having
most experience in investing assets for the benefit of public agencies and their
employees are the large Funds. Using the Fund’s expertise to invest Trust’s assets
makes sense, but only if Benefit assets are keep completely separate from Fund’s
assets.

State Bill A was enacted by State legislature and permitted the governing board of
Association to establish Trust, a separate legal entity for the sole purpose of investing
assets held by local agency trusts to provide retiree health benefits. State Bill A was
carefully drafted to ensure that:

   Trust was a separate local government agency, in particular separate from
   Association;

   Trust’s assets are held and owned separately from those of Association;

   Only assets held by Trust are contributed to it by local agency trusts or local
   agencies for the exclusive purpose of providing retiree health benefits;

   No assets received by Trust can revert to the public agency and must be used to
   provide retiree health benefits;

   Trust will be responsible for investing contributed assets in accordance to
   fiduciary principles established in State Constitution and is not responsible for
   providing retiree health benefits.

The governing board of Association established Trust on Date 1. The Declaration of
Trust says Trust’s purpose is to establish a trust for public agencies to combine for
investment assets set aside by local State government agencies for retiree health
benefits, to take advantage of economies of scale and to use existing investment
expertise to reduce the cost of providing retiree health benefits and to increase the
security of such benefits. Trust assets are held exclusively to provide retiree health
benefits to employees of public agencies and to defray the reasonable administrative
costs of administering the Trust. If a local agency trust terminates participation in Trust,
assets allocated to its account can only be transferred to another fund that holds the
assets for the exclusive purpose of providing retiree health benefits. The exclusive
purpose rule may not be amended to change or eliminate this requirement. Trust
assets may not be alienated, attached or garnished.

PLR-132641-10 3

State law provides which public agencies can participate in Trust. Trust’s only source of
assets are contributions and transfers of assets from a trust established by a local
agency solely to provide for retiree health benefits or from a public agency on behalf of
a local trust. The local agency, local agency trust and appropriate fiduciary are required
to certify that the agency participating in Trust is a local government agency in adoption
agreement. Only trusts established by entities whose income is excludable from gross
income under Code section 115 may participate in Trust.

Each participating local agency trust and sponsoring local agency must sign an
Adoption Agreement with Trust which sets out terms of participation and requires
representations that all conditions are met including a representation of satisfying the
requirements under section 115. Adoption Agreement states that there is no guaranty
as to the federal tax treatment of payments or reimbursements made by the local
agency trust, that Trust will seek a ruling relating only to Trust’s income.

With respect to Trust investments being governed by State Constitutional Fiduciary
Rules, a strict prudent person rule applies to Trust investments. It is represented that
Trust assets, and Retirement Assets, may be parallel invested, not commingled, unless
federal tax law allows comingling. Contributions of each participating local agency are
accounted for separately.

Trust is governed by a D member board of trustees who are the same persons as
Association’s governing board. This is to take advantage of their existing expertise.
State Government Code specifies the composition of the governing board. State’s open
meeting laws apply to Trust, like any other State public agency, and Trust makes
regular reports of its operations to participating local agency trusts.

Only local agencies provide retiree health benefits, and the Trust only invests and
disburses assets to local agency trusts and only for purpose of providing retiree health
benefits. Local agencies must make written representations regarding the use of assets
before disbursement. To the extent trust assets are used to pay fees, this comes either
from contributions by local agencies or reduced net return to the local agency trust.

                               LAW & ANALYSIS

Section 115

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

PLR-132641-10 4

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
pointed 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) was
excludable from gross income under § 115 of the Code. In Rev. Rul. 90-74, private
interests neither materially participated in the organization nor benefited more than
incidentally from the organization.

Trust was created pursuant to State Law that was enacted after Commission made
recommendations on funding of retiree health benefits for retired employees by local
public agencies. Local public agencies that have set up trusts to prefund payment of
retiree health benefits and in turn these trusts sign Adoption Agreements to participate
in Trust to invest the local agencies trusts’ assets, to benefit from economic efficiencies,
as well as Trust’s investment expertise to reduce the cost of funding retiree health
benefits and increase the security of the retiree health benefits. Only local public agency
trusts which satisfy the requirements of section 115 and which provide that proceeds
from trust can be only used by the local trusts to pay health benefits to retired
employees. Payment of such benefits constitutes the performance of essential
government functions. 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.

Trust income accrues to the local agency trusts. No private interests participate in or
benefit from the operation of Trust. Any distribution of funds in Trust can only be used
to pay retiree health benefits, whether a local trust withdraws from Trust or if Trust
dissolves. 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 Trust, 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).

PLR-132641-10 5

Accordingly, Trust’s income is excludable from gross income under § 115(1) of the
Code.

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.

No opinion is expressed concerning the Federal tax consequences under any provision
of the Code other than 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.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                   Sincerely,



                                   Sylvia F. Hunt
                                   Assistant Branch Chief, Exempt Organizations
                                   Branch 2 (Exempt Organizations/Employment
                                   Tax/Government Entities)
                                   (Tax Exempt & Government Entities)