A state retirement system's benefits trust owes no federal income tax on its earnings

Plain-English summary

Internal Revenue Code § 115(1) excludes from federal gross income any earnings that come from performing an "essential governmental function" and that accrue to a state or its political subdivisions. Here a state retirement system runs several plans providing health and welfare benefits to current and retired state and local government employees, and it pools the assets funding those plans into a single trust for investment and administration. The trust's board is the state retirement system's board, whose members are appointed by the governor or the legislature. The trust's money can be used only to pay plan benefits and reasonable administrative expenses, and its assets can never revert to any entity that is not a state, a political subdivision, or another § 115-exempt entity, even on dissolution. The IRS ruled that the trust's income is excludable under § 115(1): funding government employee benefits is an essential governmental function, no private interests participate or benefit beyond incidentally (the covered employees' benefit is incidental to the public purpose), and the assets stay within the governmental sphere. Relying on Rev. Rul. 77-261 and Rev. Rul. 90-74, the IRS concluded the trust owes no federal income tax on its earnings.

Ruling snapshot

• Question: Is the income of a trust that funds a state retirement system's employee health and welfare benefit plans excludable from gross income under § 115(1)?
• Outcome: Approved (the trust's income is excludable under § 115(1))
• 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: 201844001                                         Third Party Communication: None
Release Date: 11/2/2018                                   Date of Communication: Not Applicable
Index Number: 115.00-00, 115.07-00
                                                          Person To Contact:
--------------------------                                ---------------------, ID No. ------------------
--------------------------------                          Telephone Number:
------------------------------------------------------    ----------------------
-------------------------------                           Refer Reply To:
---------------------------------                         CC:TEGE:EOEG:EO3
                                                          PLR-102794-18
                                                          Date:
                                                          July 27, 2018




Legend
Trust = -------------------------------------------------------
State = -----------
Plans = ---------------------------------------------------------------------------------------
        ---------------------------------------------------------------------------------------
        ---------------------------------------------------------------------------------------

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

This letter responds to a letter from your authorized representative, dated January 26,
2018, requesting a ruling that the Trust's income is excludable from gross income under
section 115(1) of the Internal Revenue Code (Code). The Trust represents the facts as
follows.

                                                     FACTS

The State retirement system, which is governed by State law, maintains various Plans
that provide health and welfare benefits to current and retired employees (including their
beneficiaries) of State and political subdivisions of State. Each plan is authorized and
governed by State law. Each plan maintains a trust that has elected to participate in the
Trust. The Trustee of the Trust is the board of the State retirement system. The board
is comprised of members appointed either by the governor of State or a committee of
the State legislature. The Trust is intended as a funding vehicle for the Plans, and it
accepts contributions for holding, investment, and administration.

The Trustee distributes money from the Trust only to provide benefits to employees and
retirees entitled to benefits under the Plans. No part of the Trust may be used for any
purpose other than providing benefits to covered employees and retirees, or to pay
reasonable expenses associated with administering the Trust and the Plans.
PLR-102794-18                                   2


The board of the State retirement system may amend the Trust agreement at any time
and in any manner, provided the amendment is consistent with State law and section
115 of the Code. In no event, including upon dissolution, will the Trust assets be
transferred to or revert to an entity that is not a state, a political subdivision of a state, or
an entity whose income is excludable from gross income under section 115(1).

                                    LAW AND 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 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 section 115(1) because such
investment constitutes an essential governmental function. The ruling states 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
explains 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 (casualty, public
liability, workers' compensation, and employees' health) is excludable from gross
income under 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.

The Trust's provision of benefits under the Plans constitutes the performance of an
essential governmental function within the meaning of section 115 of the Code. See
Rev. Rul. 90-74 and Rev. Rul. 77-261.

No private interests will participate in, or benefit from, the operation of the Trust other
than as providers of goods or services. The benefit to employees and retirees is
incidental to the public benefit. See Rev. Rul. 90-74.
PLR-102794-18                                  3

In no event, including dissolution, will the Trust's assets be distributed or revert to any
entity 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 section 115(1).

                                           RULING

Based on the information and representations submitted on behalf of the Trustee, 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 section
       115(1) of the Code.

The ruling contained in this letter is based upon information and representations
submitted by or on behalf of the Trust and accompanied by a penalty of perjury
statement executed by an individual with authority to bind the Trust, and upon the
understanding that there will be no material changes in the facts. While this office has
not verified any of the material submitted in support of the request for a ruling, it is
subject to verification on examination. The Associate office will revoke or modify a letter
ruling and apply the revocation retroactively if there has been a misstatement or
omission of controlling facts; the facts at the time of the transaction are materially
different from the controlling facts on which the ruling was based; or, in the case of a
transaction involving a continuing action or series of actions, the controlling facts
change during the course of the transaction. See Rev. Proc. 2018-1, section 11.05.
This letter does not address the applicability of any section of the Code or Regulations
to the facts submitted other than with respect to the sections specifically described, and,
except as expressly provided in this letter, no opinion is expressed or implied
concerning the tax consequences of any aspects of any transaction or item of income
discussed or referenced in this letter.

Because it could help resolve questions concerning federal income tax status, this letter
should be kept in the Trust's permanent records.

A copy of this letter must be attached to any tax return to which it is relevant.
Alternatively, if the Trust files a return electronically, this requirement may be satisfied
by attaching a statement to the return that provides the date and control number of this
letter.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to the Trust's authorized representative.
PLR-102794-18                                 4

This ruling letter is directed only to the Trust. Section 6110(k)(3) provides that it may
not be used or cited as precedent.

                                          Sincerely,




                                          Kenneth M. Griffin
                                          Branch Chief
                                          Office of the Chief Counsel
                                          (Tax Exempt & Government Entities)