Governmental excess benefit arrangements qualified under section 415(m)

Plain-English summary

A city employer asked whether excess benefit plans for its governmental retirement systems qualified under section 415(m). The plans would pay only the retirement benefits that could not be paid from the qualified systems because of section 415 limits, and participants could not elect to defer compensation. The IRS ruled that the plans were qualified governmental excess benefit arrangements because they met section 415(m)'s purpose, election, and separate-trust requirements. Benefits are included in a participant's income when paid or otherwise made available under the plans. Income accruing to the plans is exempt under sections 115 and 415(m)(1) as income from an essential governmental function.

Ruling snapshot

• Question: Did the city's excess benefit plans qualify under section 415(m), and how are plan benefits and trust income taxed?
• Outcome: Approved.
• Key authorities: IRC §§ 83, 115, 401, 402, 414, 415, 451, 501, and 671 through 679.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201643014 Third Party Communication: None
Release Date: 10/21/2016 Date of Communication: Not Applicable
Index Number: 415.12-00
Person To Contact:
--------------------------------------------------------- ------------------------, ID No. ------------------
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-------------------------- Telephone Number:
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Refer Reply To:
CC:TEGE:EB:QP4
PLR-135812-15
Date:
April 26, 2016

Legend

Retirement = ------------------------------------------------------------------------------------------
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Systems -----------------------------------------------

Boards = ------------------------------------------------

Excess Plans = -----------------------------------------------------------------------------------------

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City C = --------------------

State S = -------------------------

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

This letter is in response to your ruling request, submitted by your authorized
representative, dated October 1, 2015, with respect to the applicability of section 415(m)
of the Internal Revenue Code (“Code”) to the excess benefit plans (“Excess Plans”) and
the related federal tax consequences.
PLR-135812-15 2

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

The Retirement Systems were established by City C (the “Employer”) located in State
S. The Retirement Systems provide retirement plans and other funds that provide
medical, death, disability and retirement benefits on behalf of active and former state
employees, teachers, police, firefighters, judges, and volunteer firefighters.

The Retirement Systems were adopted by the Employer for benefit of eligible
employees and are administered by the respective Boards and the Employer. Your
authorized representatives have represented that the Retirement Systems are defined
benefit plans and governmental plans (qualified plans as described in section 414(d) of
the Code) and are intended to meet the qualification requirements of section 401(a).
Each Retirement System has established its own trust fund (“Retirement Funds”) which
are administered and invested by the respective Boards.

The Employer adopted the excess benefit plans (“Excess Plans”) for the Retirement
Systems. The Excess Plans are intended to be “qualified excess benefit arrangements”
within the meaning of section 415(m)(3) of the Code and will operate in accordance with
that section. Under the Excess Plans, a Participant means a member, retiree, or
beneficiary of the Retirement System who is entitled to benefits under the Excess Plans.
The Participants will be paid the amount of retirement income that would otherwise have
been payable to such Participant by the Retirement System, but could not be paid from
the Retirement System because of the limitations of section 415(b). The retirement
income benefits provided under the Excess Plans are hereinafter referred to as “Excess
Benefits.”

Employer contributions under the Excess Plans will be held in separate trusts
(collectively, “Excess Plan Trusts”). Employer will compute and pay the Excess
Benefits under the Excess Plans in the same form, at the same time, and to the same
persons as such benefits would have otherwise been paid as a monthly pension under
the Retirement Systems, except for the limitations of section 415 of the Code. Under
the Retirement Systems, and therefore under the Excess Plans, retirement benefits are
only payable to the Participants upon the occurrence of certain events permitting a
distribution under the Retirement Systems (i.e., retirement, death, disability, or other
termination of employment).

Participants in the Excess Plans may elect a form of benefit under one or more of the
Retirement Systems, which dictates the form of payment under the Excess Plans.
However, under the terms of the Excess Plans, participants are not provided an election
to defer compensation under the plan, either directly or indirectly. The Excess Plans
also provides that a participant’s interests under the Excess Plans prior to distribution
PLR-135812-15 3

may not be subject to execution, attachment, or garnishment or otherwise subject to any
other process whatsoever.

The Excess Plan Trusts are separate and apart from the Retirement Fund and will be
established solely for the purpose of holding Employer contributions intended to pay
Excess Benefits under the Excess Plans. Your authorized representative has
represented that the Excess Plan Trusts will be grantor trusts under state law and for
federal income tax purposes. Employer is the grantor of the Excess Plan Trusts, within
the meaning of sections 671 through 679 of the Code. Accordingly, the assets of the
Excess Plan Trusts, which are held for benefits under the Excess Plans, are subject to
the claims of the Employer’s general creditors under federal and state law in the event
of the insolvency of the Employer.

The Excess Plan Trusts will be funded on a “pay-as-you-go” basis and begin paying
benefits as necessary to ensure compliance with the applicable limitations of section
415 of the Code. All assets held in Excess Plan Trustsand all property rights and
beneficial interests acquired through the use of the Excess Plans assets will be held
separate and apart from other funds of the Employer. Under the terms of the Excess
Plans, participants in the Excess Plans receive no property rights, legal or beneficial, in
any of the assets held in Excess Plan Trusts. The provisions of the Excess Plans
explicitly provide that contributions to Excess Plan Trusts will be held separate and
apart from the funds comprising the Retirement Fund and will not be commingled with
assets of the Retirement Fund, and must be accounted for separately.

The Employer will determine the amount necessary to pay the Excess Benefits for each
calendar plan year (“Plan Year”). The required contribution for the Employer will be the
aggregate of the excess benefits payable under the Excess Plans to all Participants for
the Plan Year and an amount determined by Employer to be a necessary and
reasonable expense of administering the Excess Plans and the Excess Benefit Trusts.
No employee contributions are permitted under the Excess Plans.

Contributions to the Excess Plans will not be calculated in a manner designed to pay
future Excess Benefits. Any contributions not used to pay the Excess Benefit for a
current Plan Year, together with any income accruing to Excess Benefit Trusts will be
used to pay the administrative expenses of the Excess Plans for the Plan Year.
However, any contributions not used to pay Excess Benefits for the current Plan Year
that remain after paying administrative expenses of the Excess Plans for the Plan Year
will be used to fund administrative expenses or Excess Benefits in future Plan Years.

Participants will automatically participate in the Excess Plans for a Plan Year if their
retirement benefits from the Qualified Plan for the Plan Year would exceed the
limitations imposed by section 415(b) of the Code. Participation in the Excess Plans
ends for any Plan Year in which the retirement benefit of a Participant is not limited by
section 415(b) and when all benefit obligations under the Excess Plans to the
PLR-135812-15 4

Participant for that Plan Year have been satisfied. Neither the trustees of the Excess
Benefit Trusts nor the Employer is responsible for paying Excess Benefits other than
from contributions from the Employer.

Based on the above facts and representations, you request the following rulings:

   1. That the Excess Plans establish a qualified governmental excess benefit
      arrangement within the meaning of section 415(m) of the Code;

   2. That the benefits payable under the Excess Plans will be includible in gross
      income for the taxable year or years in which such benefits are paid or
      otherwise made available to a Participant or a Participant’s Beneficiary in
      accordance with the terms of the Excess Plans; and

   3. That income accruing to the Excess Plans is exempt from federal income tax
      under sections 115 and 415(m)(1) of the Code as income derived from the
      exercise of an essential governmental function.

Section 415(b) of the Code and section 1.415(b)-1 of the Income Tax Regulations
(“regulations”) set forth the limitations on annual benefits for participants in defined
benefit plans.

Section 1.415(b)-1(b)(1)(ii) of the regulations provides in part that the annual benefit
does not include the annual benefit attributable to either employee contributions or
rollover contributions (as described in sections 401(a)(31), 402(c)(1), 403(a)(4),
403(b)(8), 408(d)(3), and 457(e)(16)) of the Code, determined pursuant to the rules of
paragraph (b)(2) of this section. This section further states that the treatment of
transferred benefits is determined under the rules of paragraph (b)(3) of this section.

Section 1.415(b)-1(b)(3)(ii) of the regulations addresses elective transfer of distributable
benefits and states in part that the annual benefit provided by the transferee defined
benefit plan does not include the annual benefit attributable to the amount transferred.

Section 415(m)(1) of the Code provides that, in determining whether a governmental
plan (as defined in section 414(d)) meets the benefit limitations of section 415, benefits
provided under a qualified governmental excess benefit arrangement shall not be taken
into account. Section 415(m)(1) also states that income accruing to a governmental
plan (or to a trust that is maintained solely for the purpose of providing benefits under a
qualified governmental excess benefit arrangement) shall constitute income derived
from the exercise of an essential governmental function upon which such governmental
plan (or trust) shall be exempt from tax under section 115.

Section 415(m)(2) of the Code describes the tax treatment of benefits payable under a
qualified governmental excess benefit arrangement. Under section 415(m)(2), the
PLR-135812-15 5

taxable year or years for which amounts in respect of a qualified excess benefit
arrangement are includible in gross income by a participant, and the treatment of such
amounts when so includible by the participant, are determined as if such qualified
governmental excess benefit arrangement were treated as a plan for the deferral of
compensation that is maintained by a corporation not exempt from tax and which does
not meet the requirements for qualification under section 401.

Section 415(m)(3) of the Code defines a qualified governmental excess benefit
arrangement as a portion of a governmental plan that meets the following three
requirements:

(A) Such portion is maintained solely for the purpose of providing to participants in
the plan that part of each participant’s annual benefit otherwise payable under
the terms of the plan that exceeds the limitations on benefits imposed by section
415 of the Code;
(B) Under such portion, no election is provided at any time to the participant (directly
or indirectly) to defer compensation; and
(C) Such benefits in excess of the limitations under section 415 of the Code are not
paid from a trust forming a part of such governmental plan unless such trust is
maintained solely for the purpose of providing such benefits.

With respect to your first requested ruling, according to the represented facts, the
Qualified Plans are governmental plans as described in section 414(d) of the Code.
Furthermore, under the represented facts, the only purpose of the Excess Plans is to
provide affected employees of City C of State S and its qualifying governmental units
who participate in the Qualified Plans that portion of their retirement benefits that would
otherwise be payable under the terms of the Qualified Plans except for the limitations on
benefits imposed by section 415(b), as applicable to governmental plans. Participation
in the Excess Plans is limited to Participants receiving benefits under the Qualified
Plans that would otherwise exceed the limits of section 415.

Consequently, we find that the Excess Plans are portions of the Retirement Systems,
which are governmental plans, and are maintained solely for the purpose of providing
employees of City and its qualifying governmental units who participate in the
Retirement Systems that part of their benefits otherwise payable under the terms of the
Retirement Systems that exceed the benefit limitations of section 415 of the Code.
Accordingly, we conclude that the Excess Plans meet the requirements of section
415(m)(3)(A).

Your authorized representatives have stated that participation in the Excess Plans is
mandatory and automatic, and that there are no employee contributions to the Excess
Plans. Your representatives also assert that, while participants may elect a form of
benefit under the Retirement Systems, which dictates the form of payment under the
Excess Plans, no direct or indirect election to defer compensation is provided to any
PLR-135812-15 6

participant in the Excess Plans. Therefore, because no direct or indirect election is
provided at any time to Participants to defer compensation under the Excess Plans, the
requirements of section 415(m)(3)(B) of the Code are met.

Section 415(m)(3)(C) of the Code requires that the trust from which the excess benefits
of a qualified governmental excess benefit arrangement are paid not form a part of the
governmental plan that contains the excess benefit arrangement, unless such trust is
maintained solely for the purpose of providing such benefits. Under the facts of this
case, the Excess Plans will be funded on a “pay-as-you-go” basis. The Excess Plan
Trusts will be established solely for the purpose of holding employer contributions
intended to pay excess benefits to Participants. The represented facts further state that
contributions to the Excess Benefit Trusts will consist only of the amounts required to
pay the excess benefits and related administrative expenses. The provisions of the
Excess Plans explicitly provide that contributions to the Excess Benefit Trusts will be
held separate and apart from the funds comprising the Retirement Fund and will not be
commingled with assets of the Retirement Fund, and must be accounted for separately.
Based on these representations and the provisions of the Excess Plans, we have
determined that the requirements of section 415(m)(3)(C) are met.

With respect to your first requested ruling, since the Excess Plans satisfy the
requirements of sections 415(m)(3)(A), (B) and (C) of the Code, we conclude that the
Excess Plans are qualified governmental excess benefit arrangement within the
meaning of section 415(m).

Your second ruling request asks whether the benefits payable under the Excess Plans
will be includible in gross income for the taxable year or years in which such benefits
are paid or otherwise made available to a Participant in accordance with the terms of
the Excess Plans. In response to your first ruling request, we concluded that the
Excess Plans meets the legal requirements of Code section 415(m) of the Code and,
therefore, constitutes qualified governmental excess benefit arrangements.
Accordingly, under section 415(m)(2), the tax treatment of benefits payable under the
Excess Plans is determined as if the Excess Plans were plans for the deferral of
compensation that is maintained by a corporation not exempt from tax and that does not
meet the requirements for qualification under section 401.

Section 83(a) of the Code provides the rules for inclusion in gross income of the value
of property transferred to an employee as compensation for his or her services. The
excess of the fair market value of property so transferred over the amount paid for the
property is includible in the gross income of the person who performed services for the
first taxable year in which the property becomes transferable or is not subject to a
substantial risk of forfeiture.

Section 1.83-3(e) of the regulations defines “property” as including real and personal
property other than money or an unfunded and unsecured promise to pay money or
PLR-135812-15 7

property in the future. Under section 1.83-3(e), property also includes a beneficial
interest in assets (including money) transferred or set aside from claims of the
transferor’s creditors in a trust or escrow account.

Section 402(b) of the Code provides that contributions made by an employer to an
employee’s trust that is not exempt from tax under section 501(a) are included in the
employee’s gross income in accordance with section 83, except that the value of the
employee’s interest in the trust will be substituted for the fair market value of the
property in applying section 83. Under section 1.402(b)-1(a)(1) of the regulations, an
employer’s contributions to a nonexempt employee’s trust are included as
compensation in the employee’s gross income for the taxable year in which the
contribution is made, but only to the extent the employee’s interest in such contribution
is substantially vested, as defined in the regulations under section 83.

Section 451(a) of the Code and section 1.451-1(a) of the regulations provide that an
item of gross income is includible in gross income for the taxable year in which actually
or constructively received by a taxpayer using the cash receipts and disbursements
method of accounting. Under section 1.451-2(a), income is constructively received in
the taxable year during which it is credited to a taxpayer’s account, set apart, or
otherwise made available so that the taxpayer may draw on it at any time. However,
section 1.451-2(a) further provides that income is not constructively received if the
taxpayer’s control of its receipt is subject to substantial limitations or restrictions.

The Service has also addressed the issue of constructive receipt as it applies to
nonqualified plans of deferred compensation, including excess benefit plans, in various
revenue rulings. In Rev. Rul. 60-31, Situations 1 – 3, the Service held that a mere
promise to pay, not represented by notes or secured in any way, does not constitute
receipt of income by a cash basis taxpayer. Rev. Rul. 60-31, 1960-1 C.B. 174, as
modified by Rev. Rul. 64-279, 1964-2 C.B. 121, and Rev. Rul. 70-435, 1970-2 C.B. 100;
see also Rev. Rul. 69-650, 1969-2 C.B. 106, Rev. Rul. 69-649, 1969-2 C.B. 106; and
Rev. Rul. 71-419, 1971-2 C.B. 220.

Under the economic benefit doctrine, an employee is taxable in a year in which any
economic or financial benefit is conferred upon the employee as compensation. Sproull
v. Commissioner, 16 T.C. 244 (1951), aff’d per curiam, 194 F.2d 541 (6th Cir. 1952). An
economic benefit is conferred on an employee when assets are unconditionally and
irrevocably paid into a fund or trust to be used for the employee’s sole benefit. In Rev.
Rul. 72-25, 1972-1 C.B. 127, and Rev. Rul. 68-99, 1968-1 C.B. 193, an employee does
not receive income as a result of the employer’s purchase of an insurance contract to
provide a source of funds for deferred compensation because the insurance contract is
the employer’s asset, subject to the claims of the employer’s creditors.

Based on the foregoing, with respect to the second ruling request, we conclude that the
benefits payable under the Excess Plans will be includible in gross income for the
PLR-135812-15 8

taxable year or years in which such benefits are paid or otherwise made available to a
Participant or a Participant’s Beneficiary in accordance with the terms of the Excess
Plans.

With respect to your third requested ruling, section 415(m)(1) of the Code provides that
income accruing to a governmental plan (or to a trust that is maintained solely for the
purpose of providing benefits under a qualified governmental excess benefit
arrangement), in respect of a qualified governmental excess benefit arrangement, will
constitute income derived from the exercise of an essential governmental function upon
which such governmental plan (or trust) will be exempt from tax under section 115 of
the Code. We have determined, in connection with your first ruling request, that the
Excess Plans meets the legal requirements of section 415(m) for qualified governmental
excess benefit arrangements. Therefore, under section 415(m)(1), with respect to your
third requested ruling, we conclude that income accruing to the Excess Plans is exempt
from federal income tax under sections 115 and 415(m)(1) as income derived from the
exercise of an essential government function.

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 request for rulings, it is subject to verification on examination.

This letter ruling is directed only to the taxpayer who requested 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 letter ruling have
not yet been adopted. Therefore, this letter ruling will be modified or revoked by 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
IRB 1, 59. If the taxpayer can demonstrate that the criteria in section 11.06 of Rev.
Proc. 2016-1 I.R.B. 1, 60, are satisfied, the revocation or modification of a letter ruling is
generally not applied retroactively.

This ruling is based on the assumption that the Retirement Systems will be
governmental plans as described in section 414(d) of the Code, and qualified under
section 401(a), and that the related Retirement Fund will be exempt from tax under
section 501(a) at all times relevant to this ruling.

This ruling letter is based on the assumption that the after-tax contributions, rollovers
and trustee-to-trustee transfers described above are excluded from the determination of
annual benefit within the meaning of section 1.415(b)-1(b)(1)(ii) of the regulations.

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
PLR-135812-15 9

referenced in this letter. If the Excess Plan is significantly modified, this ruling will not
necessarily remain applicable.

For purposes of this letter ruling, it is assumed that the Excess Plan Trusts established
by the Excess Plans constitute valid trusts under state law, and that all of the material
provisions of the Excess Plan Trusts, including the creditors’ right clause, are
enforceable under appropriate state laws.

No opinion is expressed concerning the timing of the inclusion in income of amounts
deferred under any deferred compensation plan other than the plan described above. In
addition, this ruling applies only to deferrals made after the date of this ruling.

Pursuant to a power of attorney on file with this office, a copy of this letter ruling is being
sent to your authorized representatives.

                                                  Sincerely,



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

Enclosures:
Deleted copy of ruling letter

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