School district plan qualifies under section 457(b)

Plain-English summary

A school district adopted a nonqualified deferred-compensation plan for its employees and asked whether the plan qualified under section 457(b). The plan limited deferrals, allowed statutory catch-up contributions, followed required distribution rules, held assets in trust, and permitted qualifying loans, transfers, rollovers, Roth contributions, and emergency distributions. The IRS ruled that the plan was an eligible governmental deferred-compensation plan. Ordinary deferrals and earnings would be taxed when paid, while designated Roth deferrals or conversions would be taxed when contributed or converted. Loans made under the plan's compliant terms would not be current taxable distributions, and eligible rollover distributions would remain untaxed to the extent properly transferred to another eligible retirement plan.

Ruling snapshot

• Question: Does the school district's deferred-compensation plan qualify under section 457(b), and how are its deferrals, loans, and rollovers taxed?
• Outcome: Approved.
• Key authorities: IRC §§ 72(p), 401(a)(9), 402, 402A, and 457; Treas. Reg. §§ 1.457-4 through 1.457-10.

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201636018                                              Third Party Communication: None
Release Date: 9/2/2016                                         Date of Communication: Not Applicable
Index Number: 457.00-00
                                                               Person To Contact:
----------------------------------------                       ----------------------- , ID No. ----------------
--------------------------------------                         Telephone Number:
---------------------                                          --------------------
----------------------------                                   Refer Reply To:
                                                               CC:TEGE:EB:QP4
                                                               PLR-134714-15
                                                               Date:
                                                               April 18, 2016


Legend

School District            =       --------------------------------------
State S                    =       ------------
Plan                       =       ----------------------------------------------------------------------------------
                           ----------------------------------------------------------------------------------
                                  --------------------------
Dear --------------

This responds to your letter of August 25, 2015, requesting a letter ruling regarding the
Plan, which the School District intends to be an eligible deferred compensation plan
under section 457(b) of the Internal Revenue Code of 1986 (the Code), as amended
under the Tax Relief Reconciliation Act of 2001 (EGTTRA) and subsequent legislation,
and the regulations.

The following facts and representations have been submitted under penalties of perjury
in support of your request:

The Plan is a nonqualified deferred compensation plan adopted by the School District of
State S for the benefit of the employees of the School District. It is represented that the
School District is an eligible employer within the meaning of section 457(e)(1)(A).

Under the Plan, an employee becomes a participant by executing a deferral agreement
to defer compensation into the Plan. The election must be made prior to the beginning
of the month in which the employee’s compensation is paid or made available.

The Plan provides for a maximum amount that may be deferred by a participant in any
taxable year. It also provides for a catch-up contribution for amounts deferred for one or
more of the participant’s last three taxable years ending before he or she attains normal
retirement age under the Plan. In addition, the Plan provides for age fifty-plus catch-up
contributions described in section 457(e)(18) of the Code. The amounts that may be
PLR-134714-15                                  2

deferred under the annual maximum limitation and the catch-up provisions are within
the limitations of section 457(c).

With certain limitations, a participant or a beneficiary may elect the manner in which
their deferred amounts will be distributed. The Plan provides that the manner and time
of benefit payout must meet the distribution requirements of sections 401(a)(9) and
457(d) of the Code. The Plan allows participants and beneficiaries to take loans from
their plan accounts, subject to certain restrictions. Loans made under the Plan are
subject to rules in the Plan, section 72(p) and section 1.457-6(f)(2) of the Income Tax
Regulations (the regulations), including provisions restricting the maximum amount and
term of a plan loan.

Upon separation from service, a participant’s account will be paid in accordance with
the payment option elected by the participant. Benefits under the Plan will commence
no later than the later of: April 1 of the year following the calendar year in which the
participant attains age 70 ½; or April 1 of the year following the calendar year in which
the participant has a separation from service. The Plan provides that the manner and
time of benefit payout must meet the distribution requirements of section 401(a)(9) of
the Code.

Under the Plan, a participant (upon severance of employment) or beneficiary may elect
to have any portion of benefits deferred under the plan which constitute an eligible
rollover distribution described in section 402(c)(4) of the Code paid directly to another
eligible retirement plan described in section 402(c)(8)(B) such as an individual
retirement account (IRA) in a direct rollover, with nonspouse beneficiaries subject to
certain limitations set in section 402(c)(11).

With certain limitations, a participant or a beneficiary may elect the manner in which
their deferred amounts will be distributed. The Plan provides that the manner and time
of benefit payout must meet the distribution requirements of sections 401(a)(9) and
457(d) of the Code. However, a direct rollover of an eligible rollover distribution from a
Roth contribution account may only be made to another designated Roth account under
an applicable retirement plan described in section 408A and only to the extent the
rollover is permitted under section 402(c).

The Plan also provides for a distribution due to an unforeseeable emergency that is a
severe financial hardship resulting from extraordinary and unforeseeable circumstances
beyond the control of the participant under section 457(d)(2) of the Code and the
regulations thereunder.

The Plan provides for acceptance of transfers of a participant’s account balance from
another eligible deferred compensation plan. The Plan provides for permissive plan to
plan transfers or rollovers of all or a portion of a participant’s account to another eligible
governmental plan if the participant has terminated service and is a participant of the
PLR-134714-15                                 3

other eligible plan. The Plan provides that amounts of compensation deferred under the
Plan are to be promptly remitted to and invested in a trust as described in section
457(g) of the Code for the exclusive benefit of the participants and their beneficiaries.

Section 457 of the Code provides rules for the deferral of compensation by an individual
participating in an eligible deferred compensation plan as defined in section 457(b).

Section 457(a)(1)(A) of the Code provides that in the case of a participant in an eligible
governmental deferred compensation plan, any amount of compensation deferred under
the plan and any income attributable to the amounts so deferred shall be includible in
gross income only for the taxable year in which such compensation or other income is
paid to the participant or beneficiary. Section 457(b) provides that the term “eligible
deferred compensation plan” means a plan established and maintained by an eligible
employer in which only individuals who perform service for the employer may be
participants and which meet the deferral limitations described in section 457(c); which
meets the distribution requirements described in section 457(d); which provides for
deferral elections described in section 457(b)(4); and, in the case of a governmental
plan, which requires the plan assets and income to be held in trust for the exclusive
benefit of participants and beneficiaries as described in section 457(g).

Under section 402A(a) of the Code, applicable retirement plans may include a qualified
Roth contribution program. Section 402A(e)(1) provides that eligible governmental
deferred compensation plans are applicable retirement plans. Section 402A(a)(1)
provides that elective deferrals of compensation which are designated Roth
contributions under qualified Roth contribution programs are not excluded from income
in the year of deferral. Section 402A(d)(1) provides that qualified distributions from
designated Roth accounts are not includable in gross income.

Section 457(b)(4) of the Code provides that compensation will be deferred for any
calendar month only if an agreement providing for such deferral has been entered into
before the beginning of such month. An eligible plan may provide that if a participant
enters into an agreement providing for deferral by salary reduction under the plan, the
agreement will remain in effect until the participant revokes or alters the terms of the
agreement.

Section 457(b)(2) of the Code provides the basic limits on the amount of eligible annual
deferrals. However, a catch-up amount described in section 457(b)(3) may be added to
this amount for participants that are within three years of the normal retirement age or,
for participants age 50 or older, a catch-up amount may be added as described in
section 457(e)(18). A participant eligible for both catch-up provisions is entitled to use
the higher limit of the two. The total annual eligible deferral amount is limited by section
457(c). Coordination of the basic limits and the catch-up limits is described in section
1.457-4(c) of the regulations.
PLR-134714-15                                  4

Section 1.457-4(c)(3)(v)(A) of the regulations provides that a plan may define the
normal retirement age for purposes of the last-three-years catch-up provision as any
age that is on or after the earlier of age 65 or the age at which participants have the
right to retire and receive, under the basic defined benefit pension plan of the State or
tax-exempt entity (or a money purchase pension plan in which the participant also
participates if the participant is not eligible to participate in a defined benefit plan),
immediate retirement benefits without actuarial or similar reduction because of
retirement before some later specified age, and that is not later than age seventy and a
half. Alternatively, a plan may provide that a participant is allowed to designate a
normal retirement age within these ages. For purposes of the three-year catch-up
provision an entity sponsoring more than one eligible plan may not permit a participant
to have more than one normal retirement age under the eligible plans it sponsors.
Section 1.457-4(c)(3)(v)(B) provides a special exception for qualified police and
firefighters to retire as early as age forty for purposes of the three-year catch-up
provision.

Section 1.457-5 of the regulations provides that the eligible-deferral amount limitation of
section 457(c) of the Code is applied to all eligible plans in which a participant
participates in a tax year and is determined on an aggregate basis. If a participant has
annual deferrals under more than one eligible plan and the applicable catch-up amount
is not the same for each such eligible plan for the taxable year, section 457(c) is applied
using the catch-up amount under whichever plan has the largest catch-up amount
applicable to the participant. To the extent that the combined annual deferral amount
exceeds the maximum deferral limitation, the amount is treated as an excess deferral
under section 1.457-4(e). For purposes of determining whether there is an excess
deferral resulting from a failure of a plan to apply the deferral limitations, all plans under
which an individual participates by virtue of his or her relationship with a single employer
are treated as a single plan (without regard to any differences in funding).

Section 457(d)(1)(A) of the Code provides that amounts distributed under an eligible
plan will not be made available to participants or beneficiaries earlier than (i) the
calendar year in which the participant attains age 70 1/2, (ii) when the participant has a
severance from employment with the employer, or (iii) when the participant is faced with
an unforeseeable emergency.

Section 1.457-6(c)(2) of the regulations provides the requirements for a unforeseeable
emergency distribution. An unforeseeable emergency must be defined in the plan as a
severe financial hardship of the participant or beneficiary resulting from an illness or
accident of the participant or beneficiary, the participant’s or beneficiary’s spouse, or the
participant’s or beneficiary’s dependent; loss of the participant’s or beneficiary’s
property due to casualty (including the need to rebuild a home following damage to a
home not otherwise covered by homeowner’s insurance, e.g., as a result of a natural
disaster); or other similar extraordinary and unforeseeable circumstances arising as a
result of events beyond the control of the participant or the beneficiary. Whether a
PLR-134714-15                                 5

participant or beneficiary is faced with an unforeseeable emergency is determined
based on the relevant facts and circumstances of each case. However, a distribution on
account of unforeseeable emergency may not be made to the extent that such
emergency is or may be relieved through reimbursement or compensation from
insurance or otherwise, by liquidation of the participant’s assets, to the extent the
liquidation of such assets would not itself cause severe financial hardship, or by
cessation of deferrals under the plan. Further, distributions because of an
unforeseeable emergency must be limited to the amount reasonably necessary to
satisfy the emergency need (which may include any amounts necessary to pay any
federal, state, or local income taxes or penalties reasonably anticipated to result from
the distribution).

Section 457(d)(2) of the Code requires a plan to meet the minimum distribution
requirements of section 401(a)(9). These requirements are described in sections
1.401(a)(9)-1 through 1.401(a)(9)-9 of the regulations.

Section 457(e)(1) of the Code provides that the term “eligible employer” means a State,
political subdivision of a State, and any agency or instrumentality of a State or political
subdivision of a State, and any other organization (other than a governmental unit)
exempt from income tax.

Section 457(e)(10) of the Code provides that a participant shall not be required to
include in gross income any portion of the entire amount payable to such participant
solely by reason of the transfer of such portion from one eligible deferred compensation
plan to another eligible deferred compensation plan. Section 1.457-10(b)(1) of the
regulations provides that an eligible government plan may transfer amounts to, and
receive amounts from, an eligible government plan if certain conditions are met.

With regard to transfers from an eligible governmental plan to another eligible
governmental plan of the same employer, section 1.457-10(b)(4) of the regulations
provides that a transfer from an eligible governmental plan to another eligible
governmental plan is permitted if the following conditions are met: (i) the transfer is from
an eligible governmental plan to another eligible governmental plan of the same
employer; (ii) the transferor plan provides for transfers; (iii) the receiving plan provides
for the receipt of transfers; (iv) the participant or beneficiary whose amounts deferred
are being transferred will have an amount deferred immediately after the transfer at
least equal to the amount deferred with respect to that participant or beneficiary
immediately before the transfer; and (v) the participant or beneficiary whose deferred
amounts are being transferred is not eligible for additional annual deferrals in the
receiving plan unless the participant or beneficiary is performing services for the entity
maintaining the receiving plan.

Section 457(e)(16) of the Code provides that with respect to an eligible retirement plan
established and maintained by a governmental employer, if (i) any portion of the
PLR-134714-15                                 6

balance to the credit of an employee in the plan is paid to him/her in an eligible rollover
distribution, (ii) the employee transfers any portion of the property received in such
distribution to an eligible retirement plan described in section 402(c)(8)(B), and (iii) in
the case of a distribution of property other than money, the amount so transferred
consists of the property distributed, then such distribution (to the extent so transferred)
shall not be includible in gross income for the taxable year in which paid.

Under section 1.457-10(e) of the regulations, an eligible governmental plan that permits
eligible rollover distributions made from another eligible retirement plan to be paid into
the eligible governmental plan is required to provide that it will separately account for
any eligible rollover distributions it receives. Amounts contributed to an eligible
governmental plan as eligible rollover distributions are not taken into account for
purposes of the annual limit on annual deferrals by a participant but are otherwise
treated in the same manner as amounts deferred under the plan. Section 1.402(c)-2(b)
provides that a distributee other than the employee or the employee’s surviving spouse
(or a spouse or former spouse who is an alternate payee under a qualified domestic
relations order) is not permitted to roll over distributions.

Section 457(e)(17) of the Code provides that no amount shall be includible in gross
income by reason of a direct trustee-to-trustee transfer to a defined benefit
governmental plan (as defined in section 414(d)) if such transfer is for the purchase of
permissive service credit (as defined in section 415(n)(3)(A)) under such plan or a
repayment to which section 415(k)(3) does not apply.

Section 457(g) of the Code provides that a plan maintained by an eligible governmental
employer shall not be treated as an eligible deferred compensation plan unless all
assets and rights purchased with such deferred compensation amounts and all income
attributable to such amounts, property, or rights of the plan are held in trust for the
exclusive benefit of participants and their beneficiaries. Section 457(g)(2)(A) provides
that a trust described in section 457(g)(1) shall be treated as an organization exempt
from tax under section 501(a).

Section 1.457-7(b)(3) of the regulations provides that, in accordance with section 72(p)
of the Code, the amount of any loan from an eligible governmental plan to a participant
or beneficiary is generally treated as having been received as a plan distribution under
section 72(p)(1) except to the extent set forth in section 72(p)(2) and section 1.72(p)(1)
(relating to loans that do not exceed a maximum amount and that are repayable in
accordance with certain terms). Thus, except to the extent a loan from a governmental
section 457(b) plan satisfies sections 72(p)(2), 1.72(p)-1, and 1.457-6(f)(2), any amount
loaned from an eligible governmental plan to a participant or beneficiary is includible in
the gross income of the borrower for the taxable year when the loan is made. If a loan
made under the Plan meets the requirements established under the Plan, the loan
would satisfy the requirements of sections 72(p)(2), 1.72(p)-1, and 1.457-6(f)(2), and
PLR-134714-15                                7

thus would not be treated as a taxable distribution under section 72(p)(1) solely
because the loan was made.

Based upon the information submitted and the representations made, we conclude as
follows:

      1.        The Plan is an eligible deferred compensation plan as defined in section
                457(b) of the Code as amended under EGTTRA and subsequent
                legislation, and the regulations.

      2.        Amounts of compensation deferred in accordance with the Plan,
                including any income attributable to the deferred compensation, will be
                includible under section 457(a)(1)(A) of the Code in the recipient’s gross
                income for the taxable year or years in which amounts are paid to a
                participant or beneficiary pursuant to the provisions of the Plan unless
                the participant elects to have the deferrals made as after-tax deferrals
                to a designated Roth account. If the deferrals are made to designated
                Roth accounts in compliance with the Small Business Jobs Act of 2010
                or are later converted through in-plan conversions as after tax deferrals,
                the deferrals will be taxed in the taxable year or years in which they
                were deferred or converted.

      3.        Provided that loans from the Plan are made in accordance with the
                Plan’s provisions, the making of such loans will not be treated as
                distributions subject to current taxation under section 72(p)(1) of the
                Code.

      4.        Any payment made from the Plan in the form of an eligible rollover
                distribution (as defined in section 402(c)(4) of the Code), including a
                direct rollover, will not be includible in gross income in the year paid to
                the extent the payment is transferred to an eligible retirement plan (as
                defined in section 402(c)(8)(B)) within 60 days, including any property
                distributed from the Plan, in accordance with section 457(e)(16).

Except as expressly provided herein, no opinion is expressed or implied concerning the
federal tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. If the Plan is significantly modified, this ruling will not
necessarily remain applicable.

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.

Temporary or final regulations pertaining to one or more of the issues addressed in this
ruling have not yet been adopted. Therefore, this ruling will be modified or revoked by
PLR-134714-15                                 8

the adoption of temporary or final regulations; to the extent the regulations are
inconsistent with any conclusion in the letter ruling. See section 11.04 of Rev. Proc.
2016-1, 2016-1 I.R.B. 1, 59. However, when the criteria in section 11.06 of Rev. Proc.
2016-1, 2016-1 I.R.B. 1, 60, are satisfied, a ruling will generally not be revoked or
modified retroactively.

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.

The rulings contained in this letter are 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 request for rulings, it is subject to verification on examination.

                                       Sincerely,

                                       //   Cheryl E. Press //
                                       Cheryl E. Press
                                       Senior Counsel, Qualified Plans Branch 4
                                       (Employee Benefits)
                                       (Tax Exempt & Government Entities)