An environmental-mitigation trust is a qualified settlement fund, and its investment income becomes § 115 tax-exempt once the company stops running it

Plain-English summary

A company that operates a facility caused an environmental incident and, under a court-approved consent decree with a state attorney general and environmental agency, set up a trust to fund mitigation projects, transferring a sum of money into it. The company asked the IRS two questions. First, is the trust a "qualified settlement fund" under Treas. Reg. § 1.468B-1(c), the regime that governs how court-approved claims-resolution funds are taxed? The IRS said yes: a court approved the trust and keeps jurisdiction over it, it was established to resolve claims arising from violations of state law, and it is a trust under state law. Second, is the trust's investment income excluded from federal gross income under § 115(1), which exempts income from an essential governmental function that accrues to a state? The IRS drew a line in time: while the company still serves as the trust's administrator it benefits more than incidentally (it is discharging its own legal obligation), so § 115 does not yet apply; but once the company and its affiliates are replaced as administrator by the independent trustee, the trust carries out the agency's programs as an essential governmental function and its income is excluded under § 115(1). Any funds left at dissolution go only to the state treasury. The upshot: the cleanup fund can grow tax-free once it is genuinely state-run, while the company stays taxable during the period it is working off its own liability.

Ruling snapshot

• Question: Is the mitigation trust a qualified settlement fund, and is its investment income excluded from gross income under § 115(1)?
• Outcome: approved (both rulings granted; the § 115 exclusion takes effect only once the company ceases to be administrator)
• Key authorities: IRC §§ 468B(g), 115(1); Treas. Reg. § 1.468B-1(c); Rev. Rul. 77-261; Rev. Rul. 90-74

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 202050003                                             Third Party Communication: None
Release Date: 12/11/2020                                      Date of Communication: Not Applicable
                                                              Person To Contact:
Index Number: 115.00-00, 115.03-00,                           --------------------, ID No. ---------------
              115.06-00, 468B.01-00                           Telephone Number:
                                                              --------------------
-----------------------------------------------------------   Refer Reply To:
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---------------------------------------------------           PLR-106126-20
                                                              Date:
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-----------------------------                                 September 14, 2020
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Legend

Trust                              = ----------------------------------------------------

Trust Agreement                    = --------------------------------------------------------------------------
                                     --------------------------------------------------------------------------
                                     -------

Trustee                            = ------------------------------

Administrator                      = --------------------------------------------------------------------------
                                     ---------------

Corporation                        = ----------------------------------------------

Incident                           = --------------------------------------------------------------------------
                                     ----------------------------------------

Facility                           = --------------------------------------------------------------------------

State X                            = -------------

State Y                            = -------------

Agency                             = ----------------------------------------------------

Action                             = --------------------------------------------------------------------------
                                     --------------------------------------------------------------------------
                                     --------
PLR-106126-20                                           2


 Year A                           = -------

 Court                            = ---------------

 Date 1                           = --------------------

 Date 2                           = -------------------------

 Date 3                           = --------------------------

 Date 4                           = -------------------------------------------

 Dollar Amount                    = -----------------

 State Y Code                     = -----------------------

 Mitigation Obligation            = ---------------

 State X Environmental            = ---------------------------
 Protection Law



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

This letter responds to the letter dated February 11, 2020, and subsequent
amendments and correspondence submitted on behalf of the Trust, requesting certain
rulings concerning the application of various sections of the Internal Revenue Code
(Code)1 and the Income Tax Regulations (Regulations) to the Trust. In particular, you
requested the following rulings:


1.       The Trust is a qualified settlement fund under Regulations section 1.468B-1(c).

2.       For any taxable period where neither Corporation nor any of its affiliates are
         Administrator of the Trust, investment income earned by the Trust is excluded
         from its gross income under section 115.

The Trustee represents the facts as follows.



1 The Internal Revenue Code of 1986, as amended, to which all subsequent section references are
made unless otherwise indicated.
PLR-106126-20                                3

FACTS

Corporation owns and operates Facility located in State X. In Year A, the Incident was
discovered at Facility. On Date 1 the Attorney General of State X filed the Action on
behalf of the people of State X and the Agency with the Court, seeking injunctive relief
and civil penalties against Corporation and full mitigation of the environmental impact of
the Incident. The Action alleged violation by Corporation of various provisions of State
X law. The parties to the Action also lodged a consent decree with the Court on Date 1.

The Court approved the consent decree on Date 2, pursuant to which the Corporation
entered into a mitigation agreement with Agency and the Attorney General (Mitigation
Agreement). The Mitigation Agreement includes the terms governing the Corporation’s
discharge of its Mitigation Obligation, as determined by Agency. The Court approved
the establishment of the Trust to comply with certain obligations under the consent
decree, and the Trust remains subject to the continuing jurisdiction of the Court.

The Trust was created by the Trust Agreement under State Y law entered into on Date
3 by Corporation and the Trustee. Agency is the sole beneficiary of the Trust. The
citizens of State X and State X are indirect beneficiaries of the Trust. The Trustee was
selected by Corporation with the approval of Agency. Under State Y Code, the Trustee
may be removed on petitioning the applicable court of State Y by Agency. Corporation
is the settlor and Administrator of the Trust. The Administrator’s duties include
managing the assets of the Trust in accordance with Mitigation Agreement and the
Trust Agreement by negotiating all necessary agreements for the investment of the
assets.

On Date 4, Corporation transferred Dollar Amount to the Trust. The Trust will use these
funds for the purpose of making loans to (or other investments in) projects designed to
mitigate the harm caused by the Incident (Mitigation Projects), as defined in and in
accordance with the Trust Agreement and the Mitigation Agreement. The Administrator
will act as the administrative agent and negotiate, manage and oversee the loan
agreements of the Mitigation Projects. The Mitigation Projects are consistent with and in
furtherance of Agency’s programs under State X Environmental Protection Law.

Under the terms of the Trust Agreement and the Mitigation Agreement, Corporation will
automatically cease to be the Administrator when Agency determines that the Mitigation
Projects have met the Corporation’s mitigation requirement. Upon satisfaction of the
Mitigation Obligation, under the terms of the Trust Agreement, the Trustee becomes the
successor Administrator and will manage the Trust in accordance with the Trust
Agreement and Mitigation Agreement until the final disposition of the funds of the Trust.
The Trust will ultimately distribute any funds not needed for the expenses incurred with
winding up and dissolving the Trust solely to treasury accounts of State X in accordance
with the Trust Agreement.
PLR-106126-20                                  4

RULINGS REQUESTED

1.     The Trust is a qualified settlement fund under Regulations section 1.468B-1(c).

2.     For any taxable period where neither Corporation nor any of its affiliates are
Administrator of the Trust, investment income earned by the Trust is excluded from its
gross income under section 115(1).

LAW AND ANALYSIS

Issue 1 – Qualified Settlement Fund - Regulations section 1.468B-1(c)


Section 468B(g)(1) provides that “[n]othing in any provision of law shall be construed as
providing that an escrow account, settlement fund, or similar fund is not subject to
current income tax.” Section 468B(g)(1) authorizes the issuance of regulations
providing for the taxation of any such account or fund whether as a grantor trust or
otherwise. Regulations sections 1.468B-1 through 1.468B-5 regarding qualified
settlement funds were issued pursuant to section 468B(g).

Regulations section 1.468B-1(a) provides that a qualified settlement fund is a fund,
account, or trust that satisfies the three requirements of Regulations section 1.468B-
1(c). First, Regulations section 1.468B-1(c)(1) requires that the fund, account, or trust is
established pursuant to an order of, or it is approved by, the United States, any state
(including the District of Columbia), territory, possession, or political subdivision thereof,
or any agency or instrumentality (including a court of law) of any of the foregoing and is
subject to the continuing jurisdiction of that governmental authority. Second,
Regulations section 1.468B-1(c)(2) requires that the fund, account, or trust is
established to resolve or satisfy one or more contested or uncontested claims that have
resulted or may result from an event (or related series of events) that has occurred and
that has given rise to at least one claim asserting liability (i) under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980; (ii) arising out of a
tort, breach of contract, or violation of law; or (iii) designated by the Commissioner in a
revenue ruling or revenue procedure. Third, Regulations section 1.468B-1(c)(3)
provides that the fund, account, or trust must be a trust under applicable state law, or its
assets must be otherwise segregated from other assets of the transferor (and related
persons).

Based on the facts represented by the Trust, the three requirements of Regulations
section 1.468B-1(c) are satisfied, and as such, the Trust is a qualified settlement fund
for Federal income tax purposes. First, the Court entered an order approving the
establishment of the Trust and the Trust remains subject to the continuing jurisdiction of
the Court. See Treas. Reg. § 1.468B-1(c)(1). Second, the Trust was established to
resolve or satisfy claims of State X that arose from Corporation’s violations of State X
laws which have given rise to at least one claim asserting liability. See Treas. Reg.
PLR-106126-20                                 5

§ 1.468B-1(c)(2). Third, the Trust was organized as a trust under applicable state law.
See Treas. Reg. § 1.468B-1(c)(3).

Issue 2 – Income Exclusion – Section 115


Section 115(1) 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 from an investment fund,
established under a written declaration of trust by a state, for the temporary investment
of cash balances of the state and its participating political subdivisions, is excludable
from gross income for federal income tax purposes under section 115(1). The ruling
reasons that the investment of cash balances by a state or political subdivision thereof
in order to receive some yield on the funds until needed to meet expenses is a
necessary incident of the power of the state or political subdivision to collect taxes and
other revenue to fund government expenses. 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 which are within the ambit of a sovereign
properly to conduct.

In Rev. Rul. 90-74, 1990-2 C.B. 34, the Internal Revenue Service determined that an
organization formed, funded, and operated by political subdivisions to pool various risks
(casualty, public liability, workers' compensation, and employees' health) performs an
essential governmental function because it protects the financial interests of the political
subdivisions. The income of the organization is used to reimburse casualty losses
incurred by the political subdivision or to reduce the annual fees that the member
political subdivisions would otherwise be required to pay to the organization.
Furthermore, upon dissolution, the organization will distribute its assets to its members.
Accordingly, the income accrues to a state or political subdivision, and therefore its
income is excludable from gross income under section 115(1). In Rev. Rul. 90- 74,
private interests neither materially participate in the organization nor benefit more than
incidentally from the organization.

Trust will use its assets and income from its investments to fund the Mitigation Projects.
The Mitigation Projects are consistent with and in furtherance of Agency’s programs and
policies required under State X Environmental Protection Law. The sole beneficiary of
the Trust is Agency, on behalf of State X.

While the Corporation is participating in the Trust as the Administrator, the Trust is not
performing an essential governmental function because the Corporation is benefiting
more than incidentally from its participation as Administrator in satisfying its legal
obligations under the Mitigation Agreement. However, upon meeting its Mitigation
PLR-106126-20                                 6

Obligation, Corporation will be replaced as Administrator by an unrelated third-party, the
Trustee. At such time, when neither the Corporation nor any of its affiliates is the
Administrator, under the terms of the Trust Agreement and based on the
representations, the Trust will be performing an essential governmental function by
carrying out Agency’s programs and policies.

Upon dissolution under the terms of the Trust Agreement, the Trustee will distribute any
funds not needed for the expenses incurred with winding up and dissolving the Trust
solely to treasury accounts of the State, in accordance with the Trust Agreement. None
of Trust's assets will be distributed or revert to any entity whose income is not excludible
from gross income under section 115(1).

Based solely on the facts and representations submitted by the Trustee, we conclude
that when neither the Corporation nor any of its affiliates is participating in the Trust as
the Administrator and is otherwise not benefiting more than incidentally from the Trust,
the Trust is exercising an essential governmental function, with its income accruing to a
state, a government of any possession of the United States, or political subdivision
thereof. Therefore, at that time the Trust's income will be excludable from gross income
under section 115(1)

This ruling letter is based on information and representations submitted on behalf of the
Trust and accompanied by a penalty-of-perjury statement executed by an individual with
the authority to bind the Trust, and on the understanding that there will be no material
changes in the facts. This office has not verified any of the supporting materials
submitted with this ruling request, and such materials are subject to verification on
examination. The Associate office will revoke or modify a letter ruling retroactively if
there has been a misstatement or omission of controlling facts; if the facts at the time of
the transaction are materially different from the controlling facts on which the ruling
letter 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. 2020-1, § 11.05.

This letter does not address the applicability of any section of the Code or Regulations
to the facts submitted, other than those sections specifically described. Further, 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 of income discussed or
referred to in this letter.

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

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.
PLR-106126-20                                         7

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


                                                Sincerely,




                                                David L. Marshall
                                                Senior Counsel
                                                Exempt Organizations Branch 1
                                                (Employee Benefits, Exempt Organizations, and
                                                Employment Taxes)


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