Public hospital authority gets governmental income and payroll-tax treatment

Plain-English summary

A county created a separate public authority to receive and operate its hospital, provide care to indigent residents, and preserve the hospital's viability. The IRS ruled that the authority performed an essential governmental function and that its income was excluded under section 115 because no private interests participated and its assets would return to a public entity on dissolution. It also treated the authority as a county-owned instrumentality, exempting employee remuneration from FUTA and, for employees outside a Social Security Act section 218 agreement, from Social Security tax when the applicable retirement-plan requirements were met. Medicare tax generally continued to apply unless the continuing-employment exception applied. Finally, because the authority would acquire substantially all hospital assets and immediately employ the transferred workers, it could use the county's earlier wages in applying the annual Social Security wage base as a successor employer.

Ruling snapshot

• Question: How would federal income and employment-tax rules apply when a county transferred its public hospital to a newly created authority?
• Outcome: Approved, subject to the stated retirement-plan and employee-transfer conditions.
• Key authorities: IRC §§ 115, 3121, and 3306; Treas. Reg. §§ 31.3121(a)(1)-1 and 31.3121(b)(7)-2; Rev. Rul. 57-128.

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201635004                                              Third Party Communication: None
Release Date: 8/26/2016                                        Date of Communication: Not Applicable
Index Number: 115.00-00, 115.03-00,
              115.06-00, 3121.02-05,                           Person To Contact:
              3121.01-00, 3306.03-00                           -----------------------------------------------------
                                                               -----------------------------------------------------
--------------------------                                     ----------------------------
------------------------------------------------------------   Telephone Number:
---------------------------------------                        --------------------
-----------------------------------------                      Refer Reply To:
-------------------------------------                          CC:TEGE:EOEG:EO1
------------------------------------                           PLR-138562-15
                                                               Date:
                                                               May 25, 2016

Legend

Authority                           = --------------------------------------------
State                               = -------------
Hospital                            = ---------------------------
County                              = -----------------
Act                                 = ------------------------------------------------
Ordinance                           = ---------------------------------------------------------------------
County Defined Benefit              = ----------------------------------------------------------------------------
Plan                                  --
County Defined                      = ----------------------------------------------------------------------------
Contribution Plan                     --------------

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

This letter responds to a letter from your authorized representative dated November 23,
2015, as well as subsequent correspondence, submitted on behalf of Authority,
requesting rulings that:

(1) Authority’s income is excludable from gross income under section 115(1) of the
Internal Revenue Code (Code);

PLR-138562-15                                 2

(2) (a) Authority is an instrumentality within the meaning of sections 3121(b)(7) and
3306(c)(7); and accordingly, (b) remuneration paid to Authority’s employees is not
subject to the taxes imposed under the Federal Unemployment Tax Act (FUTA),
(c) remuneration paid to an employee of the Authority is subject to social security taxes
imposed under sections 3101(a) and 3111(a) of the Code if the employee is covered
under an agreement under section 218 of the Social Security Act (“section 218
agreement”); (d) remuneration paid to an employee of the Authority is not subject to
social security taxes if the employee is a participant in the County Defined Contribution
Plan provided the employee is not covered under a section 218 agreement, (e)
remuneration paid to an employee of the Authority is not subject to social security taxes
if the employee is a participant in the County Defined Benefit Plan provided the
employee is not covered under a section 218 agreement; and

(3) Authority is a successor employer to the County for purposes of determining whether
the maximum wage base exception provided by section 3121(a)(1) applies.

FACTS

State passed the Act in order to facilitate Hospital continuing in its mission as a public
hospital with improved organizational and operational structure that allows for greater
flexibility, responsiveness, and innovation. The Act authorizes the County Board of
Supervisors (County Board) to pass Ordinance creating Authority and to transition
Hospital and its operations to Authority. The Act provides that Authority will be a public
agency that is a local unit of government separate and apart from the county and any
other public entity for all purposes.

The purpose of Authority is to provide medical care for County’s indigent population, to
achieve continued viability of the Hospital, and to provide an ongoing material benefit to
County and its residents.

To accomplish its purpose, Authority is authorized by statute to enter into joint ventures
with any public or private entity. However, Authority represents that it is not a party to
any joint venture with any private non-governmental entity.

Ordinance establishing Authority provides that substantially all of the assets of Hospital
and related health care resources shall be transferred to Authority. Authority represents
that County will transfer to Authority all the real property, buildings, fixtures, equipment,
supplies, and other assets necessary to operate Hospital, and that immediately
thereafter employees will be transferred directly and immediately from the employ of
County to the employ of Authority.

Ordinance provides that Authority shall not be an agency, division, or department of
County or any other public entity, but shall be an instrumentality of County for purposes
of participating in the County’s Retirement Plan and other governmental plan.

PLR-138562-15                                 3

Ordinance provides for a transitional governing board consisting of the Chief Executive
Officer (CEO) of Hospital, a person engaged in the administration of Hospital appointed
by the CEO, the County Administrative Officer, and one County executive appointed by
the County Administrative Officer. The County Administrative Officer is the chair of the
transitional governing board. The transitional governing board is to function for the
exclusive purpose of facilitating the transfer of Hospital and its operations to Authority in
advance of the appointment of the Governing Board of Authority. Any action taken by
the transitional governing board may be taken only after a unanimous vote in favor of
the action. The transitional governing board shall cease upon its dissolution by the
County Board, or shall automatically be dissolved upon the assumption of office of
sufficient members of the Governing Board to constitute a quorum allowing Authority to
conduct business.

Under County law, the Authority Governing Board shall consist of the County
Administrative Officer (ex officio), a member of the Hospital medical staff, and five
members of the community at large appointed by the County Board, none of whom shall
be a physician. Announcement of community member vacancies and Hospital medical
staff vacancies on the Governing Board shall be posted on County and Authority web
sites, at Hospital, and via press release. The applications for positions on the Authority
Governing Board will be reviewed by a committee consisting of the County Counsel, the
CEO of Hospital, and the County Administrative Officer. The completed applications of
all qualified applicants are submitted to the County Board at least 30 days prior to the
scheduled meeting of the County Board to consider appointment of an individual to fill
any vacancy on the Governing Board.

The County Board will select the five community members and the medical staff
member of the Governing Board from the pool of qualified applicants as reviewed by the
reviewing committee discussed in the preceding paragraph. Under Ordinance,
applications from all qualified applicants for the Governing Board shall be provided to
the County Board, and the County Board selects the new appointees. With respect to
selection of the member of the Hospital medical staff on the Governing Board, the
County Board conducts interviews before making the selection.

Ordinance provides that Authority shall have the ability to retain surplus revenues for
uses consistent with its purposes. If Authority participates in the County treasury pool,
Authority is required to deposit all revenues received in the treasury pool, and the
treasurer shall immediately credit and apply on its books any and all revenues so
deposited to the repayment of any temporary transfers made to Authority by County.

Ordinance provides that the County Board shall either approve or reject Authority’s
annual budget in its entirety; the County Board shall not approve or reject individual line
items in the budget. Authority shall conduct and fund an independent annual audit by
an audit firm approved by the County Board and shall provide copies of all final audits of

PLR-138562-15                                4

Authority or the Hospital to the County Board. Authority shall provide the County Board
upon request with a plan to address audit findings requiring corrective action, and a
report of corrective action taken. The County Board shall approve the initial and any
successive CEO of Authority prior to his or her appointment by Authority. The County
Board may participate in the evaluation of the CEO and shall have the authority to
remove the CEO.

Authority shall obtain the approval of the County Board prior to entering into or incurring
any debt other than (1) debt which has a repayment term of less than one year and (2)
debt secured only by private property. Authority may request that the County Board
levy a tax on behalf of Authority. If the County Board approves the proposal to levy the
tax, it shall call the election to seek voter approval and place the appropriate measure
on the ballot for that election. The County Board may, at the request and on behalf of
Authority, contract for services or purchase items as it deems necessary, appropriate, or
convenient for the conduct of Authority’s activities consistent with its purposes. The
County shall provide or arrange for legal services to Authority, and shall bill Authority
accordingly. The County Board shall have the right to approve certain actions by
Authority, which include, among other things: (a) transfer of substantially all of the
assets, operations, or control of Hospital from Authority; (b) relocation or replacement of
the acute care hospital; (c) replacement or acquisition of any new acute care hospital;
and (d) establishment or acquisition of new health care programs or facilities that have
an annual operating budget that exceeds a certain percentage of Authority’s total
annual operating budget; (e) elimination of certain services; (f) establishment or
operation of certain types of health plans; and (g) operation or ownership of any facility
or clinic located outside of County.

County Board shall adopt the initial governing Bylaws for Authority, which it may amend
from time to time. The Bylaws shall become operative upon approval by a majority vote
of the County Board. Any changes or amendments to the Bylaws shall be by majority
vote of the County Board.

Employees of Authority are deemed to be employees of County under County Defined
Benefit Plan and are eligible to participate in the plan. Employees transferring to
Authority will maintain equivalent positions and benefits seniority. Although the financial
obligations of Authority are generally not obligations of County or State, County is
obligated to make employer contributions to County Defined Benefit Plan for legacy
employees in the event Authority fails to do so and, in the event of Authority’s
dissolution or bankruptcy, County is also obligated to make employer contributions to
County Defined Benefit Plan for Authority employees hired after the transfer of Hospital
from County to Authority. Authority represents that the benefits provided under the
County Defined Benefit Plan are at least equal to the Primary Insurance Amount under
social security.

PLR-138562-15                                  5

County Defined Contribution Plan is a mandatory plan under which 7.5 percent of a
participant employee’s compensation is deferred and required to be contributed to the
plan. An eligible employee for purposes of the County Defined Contribution Plan
includes all common law part-time, temporary, and seasonal employees of the County
who are not eligible to participate in the County Defined Benefit Plan, the County
pension plan for physician employees or any other County retirement plan which
satisfies the requirements of section 218 of the Social Security Act. The County
Defined Contribution Plan is intended to be a plan described in section 457(b) of the
Code and to meet the definition of a “retirement system” under section 3121(b)(7)(F) of
the Code. The plan provides that all amounts of deferred compensation shall at all
times be and remain as assets of the participant. The plan also provides that any and
all interest or other income payable on any of the participant’s investments of deferred
compensation also shall be an asset of the participant. The plan covers employees of
eligible employers pursuant to section 457(e) who adopt the plan and meet certain
additional conditions. The Authority intends to adopt the plan and become an eligible
employer in an agreement between Authority and County.

County Board has the power to dissolve Authority. In the event of dissolution, County
Board shall provide for the disposition of Authority’s assets, obligations, and liabilities to
County or another State or public entity for a public purpose.

LAW AND ANALYSIS

1. Income Excluded from Gross Income under 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 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) of the Code,
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 (casualty, public

PLR-138562-15                                  6

liability, workers’ compensation, and employees’ health) is excludable from gross
income under section115(1) of the Code because the organization is performing an
essential governmental function. The revenue ruling states that the income of such an
organization is excluded 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.

By providing hospital and medical care to County’s residents, including the indigent
population in particular, Authority promotes public health. Promoting public health is an
essential government function within the meaning of section 115(1) of the Code. See
Rev. Rul. 77-261.

No part of the net earnings of Authority inures to the benefit of, or is distributable to, any
private entity or individual. No private interests are involved or participate in the
Authority. Upon dissolution, assets of the Authority must be distributed to County or
another State or other public entity. Thus, the Authority’s income accrues to a state or a
political subdivision of a state within the meaning of section 115(1) of the Code. See
Rev. Rul. 90-74.

Based solely on the facts and representations submitted, Authority’s income is
excludible from gross income under section115(1) of the Code.

2. Instrumentality Issue

Federal Insurance Contributions Act (FICA) taxes are imposed on wages as defined in
section 3121 of the Code. The term “wages” is defined in section 3121(a) as all
remuneration for employment, unless specifically excepted. “Employment” is defined in
section 3121(b) as including any service of whatever nature, performed by an employee
for the person employing him or her, with certain exceptions. FICA taxes include the
Old-Age, Survivors, and Disability Insurance Tax (social security taxes) and hospital
insurance taxes (Medicare taxes). Social security taxes are imposed by sections
3101(a) (employee’s portion) and 3111(a) (employer’s portion). Medicare taxes are
imposed by sections 3101(b) (employee’s portion) and 3111(b) (employer’s portion).
The Additional Medicare Tax is imposed under section 3101(b)(2) and consists of the
employee’s portion only.

Section 3121(b)(7) provides an exception from the definition of employment for service
performed in the employ of a State or any political subdivision thereof, or any
instrumentality of one or more of the foregoing which is wholly owned thereby, except
that the paragraph shall not apply in the case of certain services. The section
3121(b)(7) exception does not apply if the service is covered under an agreement
entered into pursuant to section 218 of the Social Security Act (“section 218
agreement”). Generally, the exception provided by section 3121(b)(7) applies if the

PLR-138562-15                                 7

employee of the State, political subdivision, or instrumentality is a member of a
retirement system of such State, political subdivision or instrumentality and if the
employee is not covered under a section 218 agreement.

Rev. Rul. 57-128, 1957-1 C.B. 311, sets forth six factors that are used to determine
whether an organization is an instrumentality of a state or political subdivision which is
wholly owned thereby:

(1) Whether the organization is used for a governmental purpose and performs a
governmental function;

(2) Whether the performance of the organization’s function is on behalf of one or more
states or political subdivisions;

(3) Whether there are any private interests involved, or whether the states or political
subdivisions involved have the powers and interests of an owner;

(4) Whether control or supervision of the organization is vested in public authority or
authorities;

(5) If express or implied statutory or other authority is necessary to the creation and/or
use of such an instrumentality, and whether such authority exists; and

(6) The organization’s degree of financial autonomy and the source of its operating
expenses.

Generally, the exception provided by section 3121(b)(7) does not apply for Medicare tax
purposes. The rules governing Medicare taxation of services performed by employees
of states and political subdivisions and instrumentalities are in section 3121(u)(2).
Generally, remuneration paid for services of an employee of a state, local government,
or one of their instrumentalities is subject to Medicare taxes unless the continuing
employment exception provided by section 3121(u)(2)(C) applies. Generally, the
continuing employment exception from Medicare taxation in section 3121(u)(2)(C) may
apply if the employee has been continuously employed by the same governmental
entity and was performing services prior to April 1, 1986.

Section 3301 imposes on every employer (as defined in section 3306(a)) for each
calendar year the tax under the FUTA equal to a certain percentage of wages. Section
3306(b) provides that wages for FUTA purposes means all remuneration for
employment with certain specific exceptions. Employment is defined in section 3306(c)
for FUTA purposes as including services performed by an employee for an employer
with certain specific exceptions. Section 3306(c)(7) provides an exception from
employment for FUTA tax purposes for services performed in the employ of a State, or
any political subdivision thereof, or in the employ of an Indian tribe, or any

PLR-138562-15                                 8

instrumentality of one or more of the foregoing which is wholly owned by one or more
States or political subdivisions or Indian tribes.

In determining whether Authority is an instrumentality of County wholly owned by
County for purposes of FICA and FUTA, we consider the factors set forth in Rev. Rul.
57-128. With respect to the first factor, Authority is used for a governmental purpose
and performs a governmental function. The provision of medical care to County’s
indigent population and the provision of public medical care qualify as a governmental
purpose. Also, providing medical care to the public is considered a governmental
function.

With respect to the second factor, the performance of its function is on behalf of County.
Authority is providing and promoting health care for the indigent residents of County and
for the benefit of the residents of County.

With regard to the third factor, there are no private interests involved and County has
powers and interests of an owner. Authority is run by the Governing Board, which is
appointed by the County Board, with the County Administrative Officer serving ex-
officio. A member of the Governing Board may be removed by the County Board during
his or her term with or without cause. The County Board approves the annual budget of
Authority. The County Board approves the CEO of Authority and has the authority to
remove the CEO. The County Board, in its discretion, may find and declare by adoption
of a resolution that Authority shall cease to exist and cause Authority to be dissolved. In
event of dissolution, the County Board shall provide for the disposition of Authority’s
assets, obligations, and liabilities. Authority is required to conduct and fund an
independent annual audit by an audit firm approved by the County Board. County
retains control over any transfer of operations and/or any subleasing of Hospital.

With regard to the fourth factor, some control and supervision of Authority is vested in
County. The County Board appoints and can remove board members, adopts and
amends the Bylaws of Authority, and can dissolve Authority. The County Board
approves the CEO of Authority and has the authority to remove the CEO. The County
Board approves the annual budget. Authority must obtain the approval of the County
Board before incurring any debt other than debt of less than one year, or debt secured
by personal property.

With regard to the fifth factor, State law passed legislation (Act) that authorized the
creation of Authority by County law (Ordinance).

The sixth factor is the degree of financial autonomy and the source of operating
expenses. The operating expenses of the Authority are paid by a combination of public
funding and Authority’s own income. Authority may ask the County to levy a tax on its
behalf. Authority may borrow money from County. The County Board may make
purchases and contract for services on behalf of Authority. County will pay

PLR-138562-15                                  9

contributions for the pensions of legacy employees and upon dissolution or bankruptcy,
County will pay the employer contributions of newly-hired employees. Upon dissolution,
the County Board shall provide for the disposition of any remaining Authority assets,
including transfer of such assets to County or another State or public entity for a public
purpose. County retains the ultimate responsibility for indigent medical care, even
though the care will be performed by Authority.

Therefore, after consideration of the factors set forth in Rev. Rul. 57-128, we conclude
that Authority is an instrumentality wholly owned by County for purposes of section
3121(b)(7) and 3306(c)(7).

Whether FUTA tax applies to the remuneration paid to employees of Authority

Because Authority is an instrumentality wholly owned by County, services in the employ
of authority are excepted from employment by section 3306(c)(7). Therefore,
remuneration paid for services in the employ of Hospital is not subject to FUTA tax.

Whether social security tax applies to the remuneration paid to employees of Authority

If an employee of a state, political subdivision, or instrumentality thereof is covered
under an agreement under section 218 of the Social Security Act, the employee’s
remuneration is subject to social security taxes. See section 3121(b)(7)(E). When an
employee is not covered under a section 218 agreement, the employee’s remuneration
is generally subject to social security taxes unless the employee is a member of a
retirement system. Section 31.3121(b)(7)-2 of the regulations provides rules for
determining whether an employee is a “member of a retirement system.” These rules
generally treat an employee as a member of a retirement system if he or she
participates in a system that provides retirement benefits, and has an accrued benefit or
receives an allocation under the system that is comparable to the benefits he or she
would have or receive under Social Security. In the case of part-time, seasonal and
temporary employees, this minimum retirement benefit is required to be nonforfeitable.

Section 31.3121(b)(7)-2(e)(2) of the regulations provides that a plan must provide a
minimum level of benefits to an employee for the employee to qualify as a member of a
retirement system. Under section 31.3121(b)(7)-2(e)(2)(ii), a defined benefit retirement
system maintained by a State, political subdivision or instrumentality thereof meets the
requirements of section 31.3121(b)(7)-2(e)(2) with respect to an employee on a given
day if and only if, on that day, the employee has an accrued benefit under the system
that entitles the employee to an annual benefit commencing on or before his or her
Social Security retirement age that is at least equal to the annual Primary Insurance
Amount the employee would have under Social Security. For this purpose, the Primary
Insurance Amount an individual would have under Social Security is determined as it
would be under the Social Security Act if the employee had been covered under Social
Security for all periods of service with the State, political subdivision or instrumentality,

PLR-138562-15                                10

had never performed service for any other employer, and had been fully insured within
the meaning of section 214(a) of the Social Security Act, except that all periods of
service with the State, political subdivision or instrumentality must be taken into account
(i.e., without reduction for low-earning years). Rev. Proc., 91-40, 1991-2 C.B. 694,
provides safe harbor formulas for defined benefit retirement systems for purposes of
meeting the minimum benefit requirement of the regulations.

A defined contribution retirement system maintained by a State, political subdivision or
instrumentality thereof meets the requirements of section 31.3121(b)(7)-2(e)(2) with
respect to an employee if and only if allocations to the employee's account (not
including earnings) for a period are at least 7.5 percent of the employee's compensation
for service for the State, political subdivision or instrumentality during the period.
Matching contributions by the employer may be taken into account for this purpose.

Authority states that the County Defined Benefit Plan provides benefits that are in
excess of the primary insurance amount under social security. If the County Defined
Benefit Plan provides benefits to an employee that are in excess of the primary
insurance amount under social security under the specific test set forth in section
31.3121(b)(7)-2(e)(2)(ii) of the regulations or that meets one of the safe harbors
described in Rev. Proc. 91-40, 1991-2 C.B. 694, the services of the employee in the
employ of Authority are excepted from employment for social security tax purposes,
provided the employee is not covered under a section 218 agreement.

A participant in the County Defined Contribution Plan meets the requirements to be a
member of a retirement system under section 3121(b)(7)(F), because the plan provides
for a 7.5 percent contribution from deferred compensation that is nonforfeitable and that
is required to be made with respect to part-time, seasonal and temporary employees.
Thus, the services of employees who are not covered under a section 218 agreement
and who are covered under the County Defined Contribution Plan whose compensation
is deferred as set forth in the plan will be excepted from employment by section
3121(b)(7)(F) and their remuneration will not be subject to social security taxes.

Whether Medicare tax applies to the remuneration paid to employees of Authority

Section 3121(u)(2) provides generally that remuneration paid to employees of states,
political subdivisions, or instrumentalities thereof is subject to Medicare tax unless the
continuing employment exception provided by section 3121(u)(2)(C) applies. Therefore,
remuneration paid to Authority employees is subject to Medicare tax unless the
continuing employment exception applies.

3. Successor Employer Issue

With respect to those employees who are subject to social security tax because they
are covered under a section 218 agreement, Authority has requested a ruling that it will

PLR-138562-15                               11

qualify as a successor employer to the County for purposes of determining whether the
exception from wages for social security tax purposes provided by section 3121(a)(1)
applies.

Section 3121(a)(1) provides an exception from the social security tax portion of the
FICA for remuneration paid by an employer to an employee with respect to employment
during the calendar year after the employer has paid wages to the employee equal to
the contribution and benefit base for the year. There is generally no exception from
wages for an employer because another employer has already paid wages to the
employee equal to the contribution and benefits base during the calendar year.
Remuneration paid by the second employer is generally subject to social security taxes
on remuneration that is not otherwise excepted up to the amount of a new contribution
and benefit base applicable to that employer with respect to the employee. Although
the employee can obtain a refund of the employee portion of social security taxes on his
or her income tax return to the extent the employee portion of social security taxes has
been paid on wages in excess of the contribution benefit base as a result of the
employee having two or more employers, the employer is not entitled to a refund of the
employer portion of social security tax on such wages.

The predecessor-successor rule in section 3121(a)(1) provides an exception to the
general rule that a new contribution and benefit base applies in the case of a second
employer. Section 3121(a)(1) provides that, if an employer (referred to as a successor
employer) during any calendar year “acquires substantially all the property used in a
trade or business of another employer (hereinafter referred to as a predecessor), or
used in a separate unit of a trade or business of a predecessor, and immediately after
the acquisition employs in his trade or business an individual who immediately prior to
the acquisition was employed in the trade or business of such predecessor, then, for the
purpose of determining whether the successor employer has paid remuneration … with
respect to employment equal to the contribution and benefit base …, to such individual
during such calendar year, any remuneration … paid with respect to employment paid
… to such individual by such predecessor during such calendar year and prior to the
acquisition shall be considered as having been paid by such successor employer.”

Section 31.3121(a)(1)-1(b)(2) of the regulations provides that three tests must be met
for the wages paid, by a predecessor to an employee to be, for purposes of the annual
wage limitation, treated as having been paid to such employee by a successor:
        (i) The successor during a calendar year acquired substantially all the property
used in a trade or business, or used in a separate unit of a trade or business, of the
predecessor;
        (ii) Such employee was employed in the trade or business of the predecessor
immediately prior to the acquisition and is employed by the successor in the successor’s
trade or business immediately after the acquisition; and
        (iii) Such wages were paid during the calendar year in which the acquisition
occurred and prior to such acquisition.

PLR-138562-15                                  12

Section 31.3121(a)(1)-1(b)(3) of the regulations provides that the method of acquisition
by an employer of the property of another employer is immaterial. The acquisition may
occur as a consequence of the incorporation of a business by a sole proprietor or a
partnership, the continuance without interruption of the business of a previously existing
partnership by a new partnership or by a sole proprietor, or a purchase or any other
transaction whereby substantially all the property used in a trade or business, or used in
a separate unit of a trade or business, of one employer is acquired by another
employer.

Section 31.3121(a)(1)-1(b)(4) of the regulations provides that substantially all the
property used in a separate unit of a trade or business may consist of substantially all
the property used in the performance of an essential operation of the trade or business,
or it may consist of substantially all the property used in a relatively self-sustaining entity
which forms a part of the trade or business.

Section 31.3121(a)(1)-1(b)(4) of the regulations provides two examples of the
requirement that the successor acquired substantially all the property used in a
separate unit of a trade or business. In Example 1, the M Corporation, which is
engaged in the manufacture of automobiles, including the manufacture of automobile
engines, discontinues the manufacture of the engines and transfers all the property
used in such manufacturing operation to the N Company. Under the regulations, the N
Company is considered to have acquired a separate unit of the trade or business of the
M Corporation, namely, its engine manufacturing unit. In Example 2, the R Corporation
which is engaged in the operation of a chain of grocery stores transfers one of such
stores to the S Company. The regulations provide that the S Company is considered to
have acquired a separate unit of the trade or business of the R Corporation.

Section 31.3121(a)(1)-1(b)(5) of the regulations provides that a successor may receive
credit for wages paid to an employee by a predecessor only if immediately prior to the
acquisition the employee was employed by the predecessor in his trade or business
which was acquired by the successor and if immediately after the acquisition such
employee is employed by the successor in his trade or business (whether or not in the
same trade or business in which the acquired property is used). If the acquisition
involves only a separate unit of a trade or business of the predecessor, the employee
need not have been employed by the predecessor in that unit provided he was
employed in the trade or business of which the acquired unit was a part.

With regard to the three requirements sets forth in the regulations for successor status,
Authority has represented that it will acquire substantially all the assets of Hospital.
Hospital qualifies as a separate unit of a trade or business for purposes of the
underlying regulations. The employees who will be transferred are employed in the
trade or business of the predecessor immediately prior to the acquisition. Authority has
also represented that the employees will be employed by Authority in its trade or

PLR-138562-15                                13

business immediately after the asset acquisition. Wages are paid by County during the
calendar year prior to the acquisition.

Thus, provided the transfer of employment with respect to a particular employee is
immediately after the acquisition of the assets, Authority will qualify as a successor
employer under section 3121(a)(1) for purposes of determining whether remuneration
paid to the employee in the calendar year is in excess of the contribution and benefit
base for social security tax purposes. Thus, Authority may take into account wages
paid by the County before the acquisition in determining whether the section 3121(a)(1)
exception from wages for social security tax purposes applies.

CONCLUSIONS

(1) The income of Authority is excludable from gross income under section 115 of the
code.

(2) (a) Authority is a wholly owned instrumentality of County for purposes of section
3121(b)(7) and section 3306(c)(7).

(b) Remuneration for services in the employ of Authority is not subject to FUTA taxes
because Authority is a wholly owned instrumentality under section 3306(c)(7).

(c) Remuneration for services in the employ of Authority by an employee who is covered
under a section 218 agreement is subject to social security taxes.

(d) Remuneration for services in the employ of Authority by an employee who is not
covered under a section 218 agreement and who is a member of the County Defined
Contribution Plan and is deferring and has deferred compensation in accordance with
the terms of that plan is not subject to social security taxes.

(e) Remuneration for services in the employ of Authority by an employee who is not
covered under a section 218 agreement and who is a member of the County Defined
Benefit Plan is not subject to social security tax provided that the employee’s benefits
under such plan meet the requirements of the specific test set forth in section
31.3121(b)(7)-2(e)(2)(ii) of the regulations or that the employee’s benefits under the
plan meet one of the safe harbors described in Rev. Proc. 91-40, 1991-2 C.B. 694.

(3) Authority qualifies as a successor employer to County for purposes of determining
whether the exception under section 3121(a)(1) applies with respect to employees who
are employed by Authority immediately after the acquisition, and thus Authority may
take into account wages paid by County before the acquisition in the calendar year in
determining whether wages in excess of the contribution and benefit base have been
paid to such employees.

PLR-138562-15                                14

This ruling is limited to the facts and representations stated in this letter. Except as
expressly provided in this letter, 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 is directed only to the taxpayer that requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent. In accordance with the Power of
Attorney on file, we are sending a copy of this ruling letter to your authorized
representatives.

                                                                                Sincerely,

                                          _____________________________________
                                                                 Theodore R. Lieber
                                                           Senior Tax Law Specialist
                                                      Exempt Organizations Branch 1
                                                             Associate Chief Counsel
                                                (Tax Exempt and Government Entities)