Public-school trust keeps its governmental-income exclusion after asset sale

Plain-English summary

A trust serving public-school entities planned to sell an insurance subsidiary and most assets of a claims and benefits company to an unrelated buyer at fair market value. It would use most sale proceeds for training, information, consulting, public outreach, and a student accident insurance program, while continuing certain insurance activities. The IRS ruled that the expanded activities and asset sale served essential governmental functions without providing more than incidental private benefit. Income from the sale and later activities therefore remained excluded from gross income under IRC § 115(1), and the proceeds could fund those activities without losing that treatment.

Ruling snapshot

• Question: Will the trust's asset sale, expanded education activities, and use of sale proceeds remain within IRC § 115(1)?
• Outcome: Approved on all four requested rulings
• 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: 201634012 Third Party Communication: None
Release Date: 8/19/2016 Date of Communication: Not Applicable
Index Number: 115.00-00
Person To Contact:
------------------------------------- --------------------------ID No.
------------------------------------------------------------ -----------------
--------------------- Telephone Number:
----------------------------------- ---------------------
------------------------------------------ Refer Reply To:
CC:TEGE:EOEG:EO2
PLR-137724-15
Date:
May 17, 2016

Legend

Trust = -----------------------------------------------------------------------------
Association = ----------------------------------------------------------------------------------------------
Subsidiary = ----------------------------------------------------------------------------------------------
Company = -----------------------------
State = ------------------
Year 1 = -------
Trust = ----------------------------------------------------------------------------------------------
Agreement ----------------------------------------------------------------------------------------------
-----
Year 2 = -------
Year 3 = -------
Date 1 = ------------------

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

This letter is in response to the ruling request your authorized representative submitted
on November 17, 2015. That request, and subsequent correspondence, seeks several
rulings, including that income the Trust receives upon completion of the transaction
described below will be excludable from gross income under section 115(1) of the
Internal Revenue Code (Code).

Facts

The Association is incorporated in State and is treated as an organization described in
section 501(c)(4) of the Code. Its membership is limited to certain types of public
school entities, as enumerated in its bylaws, in State. Each of its current members
qualifies as a state of the United States, a political subdivision of a state of the United
PLR-137724-15 2

States, or an entity, the income of which is excluded from gross income under section
115(1) of the Code. The Association’s mission is to promote public education and
improve public school board governance in State.

The Association formed the Trust in Year 1. Trust was formed to provide risk
management and insurance related services to the Association’s members. Since its
formation, Trust has provided the participants in its insurance program with risk
management services, negotiated the design of policies with other insurance providers,
and endorsed such policies.

In order to be a participant in Trust, an entity must be a member of the Association,
qualify as one of the enumerated types of public school entities in State, and participate
in one of the Trust’s programs. To participate in one of the Trust’s programs, an entity
must qualify as a state of the United States, a political subdivision of a state, or an
entity, the income of which is excluded from gross income under section 115 of the
Code.

A member of the Association has the option, but is not required, to participate in the
Trust’s programs. The Trust is governed by a board of trustees consisting of between
seven and eleven Trustees. The Trustees are elected by members of the Association
who are also participants. The Trust Agreement provides that on termination no
distribution will be made unless the entity receiving the distribution qualifies as a state, a
political subdivision of a state, or an entity, the income of which is excluded from gross
income under section 115(1) of the Code.

The IRS issued a private letter ruling to the Trust in Year 2, concluding that its income is
excludable from gross income under section 115 of the Code. The IRS issued a second
private letter ruling to the Trust in Year 3, confirming that its income would continue to
be excluded from gross income under section 115 of the Code, after the Trust placed
the majority of its insurance programs in Subsidiary, a State licensed for-profit insurance
company, and thereby altered the way it serves its participants. Subsidiary also
received a private letter ruling from the IRS in Year 3, concluding that its income is
excludable from gross income under section 115 of the Code.

Trust owns all of the outstanding stock of Subsidiary and is the sole member of
Company, a State limited liability company that is treated as a disregarded entity for
purposes of federal income taxes. Subsidiary provides insurance and reinsurance to
Trust’s participants. Company provides services related to insurance claims, risk
management, employee benefits, and benefits counseling to the public school members
of Association. Trust has determined that owning Subsidiary and Company is no longer
economically feasible and that a buyer with greater capital and risk tolerance will be
positioned to offer better insurance products to its participants.
PLR-137724-15 3

Under the proposed transaction, the Trust will sell all of the outstanding stock of
Subsidiary, and substantially all of the assets of Company, to an unrelated third party for
fair market value. Certain insurance activities that were discussed in the Year 2 and
Year 3 private letter rulings have been conducted directly by the Trust and have not
been placed in Subsidiary or Company. Thus, these insurance activities will not be part
of the proposed transaction. And upon completion of the transaction, the Trust will
continue to conduct these insurance activities, as discussed in the Year 2 and Year 3
private letter rulings.

Upon completion of the transaction, the Trust will engage primarily in programs that
strive to advance public education in State through financial and educational support for
its participants (referred to herein as “expanded activities”). According to the Trust, the
expanded activities will promote the adoption of policies and practices that will improve
the quality of public education in State. The Trust represents that the expanded
activities will accomplish the Trust’s mission by providing training sessions and
conferences, disseminating information pertinent to the successful operation of public
education, studying and interpreting legislation that will impact public education,
contracting with third-party vendors to provide necessary consulting and additional
resources to the Trust’s participants, and informing the public of the conditions and
needs of public schools. The Trust Agreement was amended on Date 1 to list the
expanded activities in its purpose provision. With respect to contracts with third-party
vendors, the Trust represents that it will conduct this expanded activity in a manner
which will ensure that the agreements do not provide more than an incidental benefit to
private interests.

The Trust administers a student accident insurance program. Upon completion of the
transaction, the Trust will continue to administer the student accident insurance
program, which provides benefits for medical expenses related to injuries to student
athletes participating in school-supervised or sponsored activities, as part of the
expanded activities. The coverage also includes accidental death and dismemberment
benefits. The Trust markets this policy to the participants, bills the participants, and
collects their premiums. The Trust represents that it has and will continue to take the
appropriate precautions to ensure that its operation of this program does not provide
more than an incidental benefit to private interests. The student accident insurance
program was not discussed in the Year 2 or Year 3 private letter rulings.

The Trust plans to use a majority of the proceeds from the sale of its insurance assets
to fund the Trust’s expanded activities, including its administration of the student
accident insurance program as discussed above. The remaining proceeds will be
utilized to conduct the Trust’s insurance activities as discussed in its Year 2 and Year 3
private letter rulings.

Rulings Requested:
PLR-137724-15 4

The Trust requests the following rulings:

1. The expanded activities that the Trust will perform qualify as the exercise of an
   essential governmental function under section 115;

2. The income from the transaction is excluded from the Trust’s income under section
   115;

3. After the Trust engages in the expanded activities, its income will be excluded from
   gross income under section 115; and

4. The use of the proceeds from the transaction to fund the expanded activities will be
   the exercise of an essential governmental function and such income will accrue to a
   state, or political subdivision thereof, within the meaning of section 115.

Law

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 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
established by a state to hold revenues in excess of the amounts needed to meet
current expenses is excludable from gross income under section 115(1) of the Code.

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
liability, workers’ compensation, and employees’ health) is excludable from gross
income under section 115(1). The revenue ruling states that the income of such an
organization is excluded from gross income as long as private interests do not
participate in the organization or benefit more than incidentally from the organization.

Analysis

Ruling 1: the expanded activities that the Trust will perform qualify as the exercise of an
essential governmental function under section 115.

After the transaction, the Trust plans to provide training sessions and conferences;
disseminate information pertinent to the successful operation of public education; study
and interpret legislation that will impact public education; contract with third-party
vendors to provide necessary consulting and additional resources to the Trust’s
participants; and inform the public of the conditions and needs of public schools. The
Trust’s engagements with third-party vendors will not provide more than an incidental
benefit to private interests. The Trust also plans to continue to administer the student
PLR-137724-15 5

accident insurance program in a manner that does not provide more than an incidental
benefit to private parties.

The activities described above relate directly to the provision of public education and its
accompanying responsibilities and obligations, and utilize economies of scale on behalf
of State, political subdivisions of State, and entities in State whose incomes are
excluded under section 115, to assist them in their provision of public education and in
meeting their accompanying responsibilities and obligations. The activities do not
provide more than an incidental benefit to private parties. Accordingly, they are
essential governmental functions under section 115(1) of the Code.

Ruling 2: the income from the transaction is excluded from the Trust’s income under
section 115.

Trust has determined that owning Subsidiary and Company is no longer economically
feasible or beneficial to its participants due to regulatory and market pressures. Trust
has also determined that a buyer with greater capital and risk tolerance will be
positioned to offer better insurance products to its participants.

Under the proposed transaction, the Trust will sell all of the outstanding stock of
Subsidiary, an entity whose income is excluded under section 115(1) of the Code. The
Trust will also sell substantially all of the assets of Company, an entity for which the
Trust is the sole member and that is disregarded for purposes of federal income tax.
The buyer of these assets is an unrelated third party and the assets will be sold for fair
market value. Based upon your representations, we conclude that the proposed
transaction will ensure the financial integrity of State entities, political subdivisions of
State, or entities in State whose incomes are excluded under section 115(1). The
proposed transaction will not provide more than an incidental benefit to private parties.
Accordingly, the income derived from the proposed transaction will be derived from the
exercise of an essential governmental function under section 115(1) of the Code.

The Trust Agreement provides that on termination no distribution will be made unless
the entity receiving the distribution qualifies as a state, a political subdivision of a state,
or an entity, the income of which is excluded from gross income under section 115(1) of
the Code. Accordingly, income derived from the proposed transaction will accrue to a
state or a political subdivision of a state under section 115(1) of the Code.

Ruling 3: after the Trust engages in the expanded activities, including the Student
Accident Insurance Program, its income will be excluded from gross income under
section 115.

Under Ruling 1, we have concluded that the expanded activities qualify as essential
governmental functions under section 115(1) of the Code. The Trust Agreement
provides that on termination, no distribution will be made unless the entity receiving the
PLR-137724-15 6

distribution qualifies as a state, a political subdivision of a state, or an entity whose
income is excluded from gross income under section 115(1) of the Code. Accordingly,
income to the Trust will accrue to a state or a political subdivision of a state under
section 115(1) of the Code after the Trust engages in the expanded activities.

Ruling 4: the use of the proceeds from the transaction to fund the expanded activities
will be the exercise of an essential governmental function and such income will accrue
to a state, or political subdivision thereof, within the meaning of section 115.

Under Ruling 1, we have concluded that the expanded activities qualify as essential
governmental functions under section 115(1) of the Code. Under Ruling 2, we have
concluded that the income derived from the proposed transaction will be derived from
the exercise of an essential governmental function under section 115(1) of the Code.
Accordingly, the use of the proceeds from the transaction to fund the expanded
activities will be the exercise of an essential governmental function.

Under Rulings 2 and 3, we have concluded that income derived from the proposed
transaction will accrue to a state or a political subdivision of a state under section 115(1)
of the Code.

Conclusion

Based on the foregoing, we rule that:

Ruling 1: the expanded activities that the Trust will perform qualify as the exercise of an
essential governmental function under section 115(1) of the Code.

Ruling 2: the income from the transaction is excluded from the Trust’s income under
section 115(1) of the Code.

Ruling 3: after the Trust engages in the expanded activities, its income will be excluded
from gross income under section 115(1) of the Code.

Ruling 4: the use of the proceeds from the transaction to fund the expanded activities
will be the exercise of an essential governmental function and such income will accrue
to a state, or political subdivision thereof, within the meaning of section 115(1) of the
Code.

This ruling is based on the facts as they were presented in the ruling request and on the
understanding that there will be no material changes to those facts. This ruling does not
address the applicability of any section of the Code or regulations to the facts submitted
other than with respect to the sections expressly described herein.
PLR-137724-15 7

The ruling contained in this letter is 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 ruling request, that material is subject to verification during an
examination.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

This ruling will be made available for public inspection under section 6110 of the Code
after certain deletions of identifying information are made. For details, see enclosed
Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we
intend to make available for public inspection is attached to Notice 437. If you disagree
with our proposed deletions, you should follow the instructions in Notice 437.

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. Because it could help resolve
questions concerning your federal income tax status, this ruling should be kept in your
permanent records.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

If you have any questions about this ruling, please contact the person whose name and
phone number are shown in the heading of this letter.

                                   Sincerely,



                                   Andrew F. Megosh, Jr.
                                   Senior Tax Law Specialist
                                   (Tax Exempt & Government Entities)

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