Volunteer-firefighter benefit trust earns section 115 income exclusion

Plain-English summary

A city used a trust to provide length-of-service incentive benefits to volunteer firefighters and their beneficiaries. The trust was city-controlled, its assets were dedicated to benefits and necessary expenses, and any surplus after termination had to return to the city. The IRS ruled that the trust performed an essential governmental function and that its income accrued to a political subdivision, so the income was excluded under section 115(1). The IRS separately noted that the plan exceeded section 457's annual accrual limit and could create participant income, employment-tax, withholding, and reporting consequences that were outside the requested ruling.

Ruling snapshot

• Question: Was the city firefighter-benefit trust's income excluded from gross income under section 115(1)?
• Outcome: Approved
• Key authorities: IRC § 115(1); Rev. Rul. 77-261; Rev. Rul. 90-74

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201538011 Third Party Communication: None
Release Date: 9/18/2015 Date of Communication: Not Applicable
Index Number: 115.00-00, 115.03-00
Person To Contact:
-------------------------- -----------------------, ID No. ----------------
---------- Telephone Number:
------------------------------------------------------------ --------------------
---------------------------- Refer Reply To:
------------------------------ CC:TEGE:EOEG:EO1
--------------------------------- PLR-145218-14
Date:
June 16, 2015

Trust = -----------------
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City = ----------------
State = -----------------
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x = ------

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

This letter responds to a letter from your authorized representative dated November 14,
2014, and subsequent correspondence submitted on behalf of the Trust, requesting a
ruling that the Trust’s income is excludable from gross income under Internal Revenue
Code (IRC) section 115. The Trust represents the facts as follows.

FACTS

The City is a political subdivision of the State. Through the Trust the City provides a
length of service incentive plan that benefits its volunteer firefighters. Each firefighter
who participates in the plan accrues a benefit equal to x, multiplied by his or her years
of credited service. There are no general limitations on the amount of creditable
service.

The Trust assets will be used for the exclusive purpose of providing the incentive benefit
payments to active and former volunteer firefighters and their beneficiaries who are
eligible to receive such payments under the terms of the Trust, and for paying
reasonable and necessary expenses. Under the terms of the Trust, an eligible

PLR-145218-14 2

firefighter may elect to receive his or her benefits for life, or the firefighter can elect to
receive a reduced benefit for his or her life plus certain additional benefits for his or her
beneficiary upon the firefighter’s death.

Seven Trustees, consisting of three selected by a committee representing the fire
stations in the City, one councilmember selected by the City’s city council, the City’s
manager (or designee), the City’s financial services director (or designee), and one
citizen of the City who is appointed by the City’s mayor, manage and administer the
assets of the Trust. The Trustees will employ an investment manager or managers to
manage some or all of the assets of the Trust. The Trustees are responsible for
holding, investing and reinvesting the Trust’s assets, and for making payments from the
Trust.

Neither active or former volunteer firefighters nor their respective beneficiaries have any
preferred claim in, or any beneficial ownership interest in, any asset of the Trust.

The Trust may be terminated by the City. However, upon termination of the Trust, any
remaining assets will be used to provide the incentive benefits under the terms of the
Trust. Any assets remaining in the Trust after satisfying all benefit obligations must be
returned to the City.

LAW AND ANALYSIS

IRC section 115(1) provides that gross income does not include income derived from
any public utility or the exercise of any essential governmental function and accruing to
a state or any political subdivision thereof.

Rev. Rul. 77-261, 1977-2 C.B. 45, holds that income generated by an investment fund
that is established by a state to hold revenues in excess of the amounts needed to meet
current expenses is excludable from gross income under IRC section 115(1), because
such investment constitutes an essential governmental function. The ruling explains
that the statutory exclusion is 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
an entity engaged in the operation of a public utility or the performance of some
governmental function that accrues to either a state or political subdivision of a state.
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 that are within the
ambit of a sovereign to conduct.

Rev. Rul. 90-74, 1990-2 C.B. 34, holds that the income of an organization formed,
funded, and operated by political subdivisions to pool various risks (e.g., casualty, public

PLR-145218-14 3

liability, workers’ compensation, and employees’ health) is excludable from gross
income under IRC section 115(1), because the organization is performing an essential
governmental function. The revenue ruling states that the income of such an
organization is excludable from gross income so long as private interests do not
participate in the organization or benefit more than incidentally from the organization.
The benefit to the employees of the insurance coverage obtained by the member
political subdivisions was deemed incidental to the public benefit.

Through the Trust, the City provides length of service incentive benefits to active and
former volunteer firefighters and their beneficiaries. Providing these incentive benefits
constitutes the performance of an essential government function within the meaning of
IRC section 115(1). See Rev. Rul. 90-74 and Rev. Rul. 77-261.

The Trust’s income accrues to the City. No private interests will participate in, or benefit
from, the operation of the Trust other than the benefit to the firefighters or as providers
of goods or services. The benefit to active or former volunteer firefighters and their
beneficiaries is incidental to the public benefit. See Rev. Rul. 90-74.

Except for the benefit to the firefighters and for paying reasonable and necessary
expenses, in no event, including dissolution, will the Trust’s assets be distributed or
revert to any entity or person that is not a state, a political subdivision of a state, or
another entity the income of which is excludable from its gross income by application of
IRC section 115.

Based solely on the facts and representations submitted by the Trust, we conclude that,
because the income of the Trust derives from the exercise of an essential governmental
function and will accrue to a state or a political subdivision thereof, the Trust’s income is
excludable from gross income under IRC section 115(1).

Except as expressly provided herein, no opinion is expressed or implied as to the
federal tax consequences of the facts described above under any other provision of the
IRC. Specifically, no opinion is expressed as to the taxation of plan participants and
beneficiaries under IRC sections 457(f), 402(b), 83, and the economic benefit
doctrine. Furthermore, no opinion is expressed as to the application of Federal
Insurance Contributions Act (FICA) taxes, including social security tax and Medicare
tax, and Federal Income Tax Withholding to the City, the Trust, or participants and
beneficiaries.

It should be noted that the incentive plan component of the Trust for the City’s volunteer
firefighters fails the annual $3,000 accrual limit of IRC section 457(e)(11)(B)(ii), and
therefore does not qualify for the exception from treatment as a deferred compensation
plan subject to IRC section 457(f). To the extent the incentive plan is a deferred

PLR-145218-14 4

compensation plan subject to IRC section 457(f), involves the use of a nonexempt
employees’ trust under IRC section 402(b), results in a transfer of property under IRC
section 83 as a transfer of an interest in a trust, or results in application of the economic
benefit doctrine, the value of a participant’s benefits under the plan is includible in the
participant’s gross income at the time the rights to those benefits are attained and no
longer subject to a substantial risk of forfeiture (regardless of whether vested benefits
have yet been paid).

Furthermore, the fact that a participant may be called a “volunteer” does not determine
his or her status as an employee or an independent contractor for federal tax
purposes. To the extent that a participant is a current or former employee of the City
and is not covered under a state retirement system within the meaning of IRC section
3121(b)(7)(F) (or, alternatively, is covered under both a state retirement system and an
agreement under section 218 of the Social Security Act), social security tax would
generally apply. Also, to the extent that a participant is a current or former employee of
the City, Medicare taxes would generally apply. In addition, if the participant is an
employee or former employee of the City, income tax withholding obligations may apply
to the extent that the arrangement involves the use of a nonexempt employees’ trust
under IRC section 402(b), results in a transfer of property under IRC section 83 as a
transfer of an interest in a trust, or results in application of the economic benefit
doctrine. To the extent that a participant is a current or former employee of the City, the
amount included in income would generally be subject to Form W-2 reporting
obligations under IRC section 6051. In addition, any social security wages, Medicare
wages, and income tax withholding would be required to be reported on Form W-2.

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

This ruling is directed only to the taxpayer requesting it. IRC section 6110(k)(3)
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.

PLR-145218-14 5

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

                                   Sincerely,



                                   Kenneth M. Griffin
                                   Branch Chief
                                   (Tax Exempt & Government Entities)

cc: