Governmental excess-benefit plan qualifies under section 415(m)

Plain-English summary

A state retirement system proposed a mandatory excess-benefit arrangement for governmental defined-benefit plan participants whose pensions were limited by § 415. The arrangement would pay only the benefits that the qualified plan could not pay, would offer no direct or indirect deferral election, and would use a separate pay-as-you-go trust funded solely by the state. The trust assets remained subject to the state's general creditors, and participants had only a contractual payment right. The IRS ruled that the arrangement qualified under § 415(m), that benefits would enter participants' income when paid or otherwise made available, and that income accruing to the arrangement was exempt under § 115 as income from an essential governmental function. The ruling assumed the underlying plan remained qualified and was contingent on specified plan amendments.

Ruling snapshot

• Question: Did the state excess-benefit arrangement qualify under § 415(m), and when would its benefits and trust income be taxed?
• Outcome: Approved, contingent on specified amendments and the underlying plan's governmental and qualified status
• Key authorities: IRC §§ 115, 401, 402, 414(d), and 415(m); Treas. Reg. §§ 1.83-3(e) and 1.451-2(a)

Full text (IRS public release)

201447061

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

JUL 17 2014

Uniform Issue List: 415.00-00

SE:T:EP:RA:T2

Attention: ***

Legend:

System X = ***
State S = ***
Plan X = ***
Excess Plan X = ***
Board B = ***

Dear ***:

This is in response to correspondence dated September 24, 2009, as
supplemented by correspondence dated September 10, 2010, January 3, 2011,
February 27, 2013, and June 24, 2014, 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.

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State S has established Plan X on behalf of its eligible employees, who are
certain judges, justices, solicitors and circuit public defenders of State S. 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
intended to meet the qualification requirements of section 401(a) of the Code.

System X, an instrumentality of State S, is the administrator of Plan X. Board B,
a board comprised of officials of State S, is the Trustee of Plan X.

Contributions to Plan X are mandatory for participating employees and are equal
to a fixed percentage of each participant's compensation. Plan X allows
participants to make pre-tax elective contributions to Plan X to buy years of
service credit in Plan X for eligible prior service in other specified public
employment. These purchases of years of service credit may also be made by
after-tax contributions, rollovers, or trustee-to-trustee transfers.

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 September 23, 2009, Board B adopted and is planning to
implement 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. 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 government plans. Participation in Excess Plan
X is mandatory and automatic for all participants in Plan X whose retirement
benefits from Plan X are limited by section 415 of the Code.

Section 4.01 of Excess Plan X provides that a participant will receive a benefit
equal to the amount of retirement income that would have been payable to, or
with respect to, a Participant that could not be paid by Plan X because of the
application of the limitations on his retirement income under section 415(b) of the
Code. 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. Section 4.01 of
Excess Plan X will be amended to provide that no portion of benefits in excess of
the Code section 415(b) limit paid to a participant can be attributable to service
credit purchases made with picked-up employer contributions.

Excess Plan X will be administered by System X. Board B has established a
separate trust fund for segregation of the assets related to Excess Plan X.

The trust fund was established solely for the purpose of holding employer
contributions intended to pay excess benefits to affected Excess Plan X
participants. The trustees of this separate trust fund will be members of Board B.
Your authorized representatives have represented in the correspondence dated
February 27, 2013 that the trust fund is designed to constitute a grantor trust

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under state law and for federal income tax purposes. Under the represented
facts, Excess Plan X participants will receive no property right or interest in the
trust assets, and the trust assets are subject to the claims of State S’s general
creditors in the event of insolvency.

Excess Plan X will be funded on a pay as you go basis. Board B 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 in an amount determined
by Board B 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. Any contributions not used to pay the excess benefits for a current
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 administrative expenses will be
used to fund administrative expenses or excess benefits of participants in future
years.

Benefits under Excess Plan X will be paid only if and to the extent the participant
is receiving benefits from Plan X. Participation in Excess Plan X will cease for
any 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 member, 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) of the Code. 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, under the
represented facts, 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:

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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 sections 115 and 415(m)(1) of the Code as income derived from the
   exercise of an essential governmental function.

Section 415(b) of the Code and section 1.415(b)-1 of the Income Tax
Regulations (“Regulations”) set forth the limitations on annual benefits for
participants in defined benefit plans.

Section 415(m)(1) of the Code provides that, in determining whether a
governmental plan (as defined in section 414(d) of the Code) meets the benefit
limitations of section 415 of the Code, benefits provided under a qualified
governmental excess benefit arrangement shall not be taken into account.
Section 415(m)(1) also states 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) shall constitute income
derived from the exercise of an essential governmental function upon which such
governmental plan (or trust) shall be exempt from tax under section 115 of the
Code.

Section 415(m)(2) of the Code describes the tax treatment of benefits payable
under a qualified governmental excess benefit arrangement. Under section
415(m)(2) of the Code, the taxable year or years for which amounts in respect of
a qualified excess benefit arrangement are includable in gross income by a
participant, and the treatment of such amounts when so includible by the
participant, are determined as if such qualified governmental excess benefit
arrangement were treated as a plan for the deferral of compensation that is
maintained by a corporation not exempt from tax and which does not meet the
requirements for qualification under section 401 of the Code.

Section 415(m)(3) of the Code defines a qualified governmental excess benefit
arrangement as a portion of a governmental plan that 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 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

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(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 Board
B 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 who are
participants 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 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 415(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. Board B 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 administrative expenses will be used to fund excess benefits
of participants or pay administrative expenses in future years. Therefore, we
have determined that the requirements of section 415(m)(3)(C) of the Code are
met.

6 201447061

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.

Your second ruling request asks whether 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. In response to your
first ruling request, we determined that Excess Plan X meets the legal
requirements of section 415(m) of the Code and, therefore, constitutes a
qualified governmental excess benefit arrangement. Accordingly, under section
415(m)(2) of the Code, the tax treatment of the amounts distributed under
Excess Plan X to the participants is determined as if such qualified governmental
excess benefit arrangement were a plan for the deferral of compensation which
is maintained by a corporation not exempt from tax and which does not meet the
requirements for qualification under section 401 of the Code.

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 Regulations provides that for purposes of Code 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 of the Code.

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

7 201447061

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.

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 (6th
Cir. 1952), Rev. Rul. 60-31, Situation 4. Rev. Rul. 72-25, 1972-1 C.B. 127, and
Rev. Rul. 68-99, 1968-1 C. B. 193, holds that 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.

Based on the foregoing, 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, section 415(m)(1) of the Code
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 of the Code. We have determined, in
connection with your first ruling request, that Excess Plan X meets the legal
requirements of section 415(m) of the Code for qualified governmental excess
benefit arrangements. Therefore, under section 415(m)(1) of the Code, with
respect to your third requested ruling, we conclude that income accruing to
Excess Plan X is exempt from federal income tax under sections 115 and
415(m)(1) of the Code as income derived from the exercise of an essential
governmental function.

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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.

No opinion is expressed as to whether the trust fund established for the purpose
of holding employer contributions intended to pay excess benefits to affected
Excess Plan X participants constitutes a grantor trust under Rev. Proc. 92-64,
1992-33 I.R.B. 11. No opinion is expressed as to the tax treatment of the
transactions described herein with respect to the trust holding the contributions
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 relevant
times thereto.

This ruling is contingent upon the adoption of the amendments to Article III and
Section 4.01 of Excess Plan X, as stated in the correspondence dated
September 10, 2010 and June 24, 2014.

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.

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 *** at () -****. Please
address all correspondence to SE:T:EP:RA:T3.

Sincerely yours,

Laura B. Warshawsky, Manager
Employee Plans Technical Group 3

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

cc. ***