Government deferred compensation plan qualifies under Section 457(b)

Plain-English summary

A political subdivision adopted a deferred compensation plan for employees and independent contractors. The plan provided for pre-tax and Roth deferrals, contribution limits and catch-ups, required distributions, emergency withdrawals, rollovers, transfers, and a trust holding assets exclusively for participants and beneficiaries. The IRS ruled that the plan was an eligible governmental deferred compensation plan under Section 457(b). Deferred compensation and earnings would generally enter income when paid, while qualifying rollovers and qualified Roth distributions would not. Assuming the trust was valid under state law, the trust would be tax-exempt under Section 501(a).

Ruling snapshot

• Question: Did the governmental deferred compensation plan qualify as an eligible plan under Section 457(b), with the stated income, rollover, trust, and Roth treatment?
• Outcome: Approved; the plan qualified, subject to its terms and the stated assumptions.
• Key authorities: IRC §§ 402, 402A, 457, and 501(a); 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: 201822004 Third Party Communication: None
Release Date: 6/1/2018 Date of Communication: Not Applicable
Index Number: 457.00-00
Person To Contact:
---------------------------- --------------------------, ID No. ----------------
------------------------------------------------------------ -----------------
---------- Telephone Number:
--------------------------------------- ----------------------
------------------------------------------ Refer Reply To:
------------------------------ CC:TEGE:EB:QP3
PLR-127193-17
Date:
February 28, 2018

District A = San Francisco Bay Area Rapid Transit District
Plan = San Francisco Bay Area Rapid Transit Deferred Compensation Plan
State S = California

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

This responds to your letter of --------------------------, and subsequent correspondence
dated --------------------------, requesting a ruling concerning the Plan, which District A
intends to be an eligible deferred compensation plan under section 457(b) of the
Internal Revenue Code (the Code).

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

District A is political subdivision of State S and an eligible employer within the meaning
of section 457(e)(1)(A). The Plan is a nonqualified deferred compensation plan and
related trust adopted by District A for the benefit of its employees and their
beneficiaries.

Under the Plan, an employee or independent contractor may become a participant by
executing a participation agreement to defer compensation into the Plan. The
participation agreement may include a designation that all or a portion of the deferral
elected by the participant shall be treated as Roth contributions in accordance with
section 402A. The election must be made prior to the beginning of the month in which
the compensation is paid or made available. A new employee or independent
contractor may defer compensation payable in the calendar month during which the
participant first becomes an employee or independent contractor if an agreement
providing for the deferral is entered into on or before the first day on which the
participant becomes an employee or independent contractor.

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 catch-up
contributions described in section 457(e)(18). The amounts that may be deferred under
the annual maximum limitation and the catch-up provisions are within the limitations of
section 457(c).

Upon separation from service, a participant may elect a form of distribution of benefits
from that participant’s account. Benefits under the plan will commence no later than the
latter 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 sections 401(a)(9) and 457(d).

Under the Plan, a participant (upon severance from employment) or beneficiary may
elect to have any portion of benefits deferred under the Plan that constitutes an eligible
rollover distribution described in section 402(c)(4) paid directly to another eligible
retirement plan described in section 402(c)(8)(B), such as an individual retirement
account, in a direct rollover, with nonspouse beneficiaries subject to certain limitations
set forth in section 402(c)(11). 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 402A(e)(1) or to
a Roth IRA 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)(1)(A)(iii) and §1.457-6(c) of
the Income Tax Regulations.

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 of all or a portion of a participant's Pre-Tax Contributions to a
defined benefit governmental plan, in accordance with section 457(e)(17).

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)(1) for the
exclusive benefit of the participants and their beneficiaries. Each participant shall direct
the investment of his or her benefit amount.

Section 457 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) 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).

Section 457(e)(1) 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(b)(4) 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.

Under section 402A(a), 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)(2) 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 §1.457-
4(c).

Section 1.457-4(c)(3)(v)(A) 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 provides that the section 457(c) eligible-deferral amount limitation 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 §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) 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 ½, (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(b)(2) provides that an independent
contractor is considered to have a severance from employment with the eligible
employer upon the expiration of the contract (or in the case of more than one contract,
all contracts) under which services are performed for the eligible employer if the
expiration constitutes a good-faith and complete termination of the contractual
relationship. An expiration does not constitute a good faith and complete termination of
the contractual relationship if the eligible employer anticipates a renewal of a contractual
relationship or the independent contractor becoming an employee.

Section 1.457-6(c)(2) 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 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) requires a plan to meet the minimum distribution requirements of
section 401(a)(9). These requirements are described in §1.401(a)(9)-1 through
1.401(a)(9)-9.

Section 457(d)(3) provides that a governmental plan will not fail to meet the distribution
requirements if it provides for in-service distributions of a limited-dollar amount which
meet the requirements of section 457(e)(9)(A) and §1.457-6(e) of the regulations.
Section 1.457-6(e) is satisfied if the participant's total amount deferred (the participant's
total account balance) which is not attributable to rollover contributions is not in excess
of the dollar limit under section 411(a)(11)(A) (i.e., $5000 adjusted for inflation), no
amount has been deferred under the plan by or for the participant during the two-year
period ending on the date of the distribution, and there has been no prior distribution
under the plan to the participant of this kind.

Section 457(e)(10) 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) 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, §1.457-10(b)(4) 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) provides that, with regard to rollover distributions, for an eligible
deferred compensation plan if (i) any portion of the balance to the credit of an employee
in such plan is paid to such employee in an eligible rollover distribution (within the
meaning of section 402(c)(4)), (ii) the employee transfers any portion of the property
such employee receives 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. Section 402(c)(11) provides that nonspousal beneficiaries may elect to
have an eligible rollover distribution paid directly to an inherited IRA.

Under §1.457-10(e), 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.

Consistent with section 414(p)(10), §1.457-10(c) provides for distributions made
pursuant to a qualified domestic relations order. If a distribution or payment is made
from an eligible plan to an alternate payee pursuant to a qualified domestic relations
order, rules similar to the rules of section 402(e)(1)(A) apply to the distribution. Section
414(p)(8) provides that the term "alternate payee" means any spouse, former spouse,
child or other dependent of a participant who is recognized by a domestic relations
order as having a right to receive all, or a portion of, the benefits payable under a plan
with respect to such participant.

Section 457(e)(17) 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 1.457-10(b)(8)(i) clarifies that such a transfer may be
made before severance from employment.

Section 457(g) 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).

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).

   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) in the recipient’s gross income for
             the taxable year or years in which amounts are paid to a participant or
             beneficiary in accordance with the terms of the Plan.

   3.        Amounts distributed from the Plan in an eligible rollover distribution
             (within the meaning of section 402(c)(4)), shall not be includible in gross
             income for the taxable year in which paid to the extent the payment is
             transferred to an eligible retirement plan (as defined in section
             402(c)(8)(B)) in accordance with section 457(e)(16).

   4.        Assuming that it is a valid trust under State S law, the trust established
             as part of the Plan is an organization exempt from tax under section
             501(a) in accordance with section 457(g)(2)(A), and benefits paid from
             the trust shall be includable in the gross income of the participant or
             beneficiary in the taxable year in which paid.

   5.        Qualified distributions from the qualified Roth contribution program
             maintained pursuant to the Plan’s provisions will not be included in
             income under section 402A(d)(1).

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) provides
that it may not be used or cited as precedent.

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

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, as specified in Rev. Proc. 2018-1, 2018-1 I.R.B. 1,
§ 7.01(16)(b). This office has not verified any of the material submitted in support of the
request for ruling, and such material 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, § 11.05.

                                  Sincerely,



                                  Cheryl Press
                                  Senior Counsel
                                  Qualified Plans Branch 4
                                  (Tax Exempt & Government Entities)