County captive reinsurer's income excluded under section 115

Plain-English summary

A nonprofit captive insurance company was wholly owned by an authority whose members were counties. The authority operated a self-insurance pool for the counties, and the captive provided reinsurance for their risks, investing premiums to pay claims and operating costs. Service providers and vendors were unrelated and paid fair market value. On dissolution, the captive's assets would pass to the authority, whose property would then pass to the member counties. The IRS ruled that providing reinsurance to political subdivisions was an essential governmental function, the income accrued to political subdivisions, and private interests benefited no more than incidentally. The captive's income was therefore excluded from gross income under section 115(1).

Ruling snapshot

• Question: Was the captive reinsurer's income excludable under section 115(1) as income from an essential governmental function accruing to political subdivisions?
• Outcome: approved
• Key authorities: IRC § 115(1); Rev. Rul. 77-261; Rev. Rul. 90-74

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 202403004                                             Third Party Communication: None
Release Date: 1/19/2024                                       Date of Communication: Not Applicable
Index Number: 115.00-00, 115.03-00,
              115.06-00                                       Person To Contact:
                                                              ----------------------, ID No.
---------------------------------------------------           Telephone Number:
                                                              --------------------
                                                              Refer Reply To:
                                                              CC:EEE:EOET:EO2
                                                              PLR-108779-23
                                                              Date:
                                                              October 18, 2023




LEGEND

Agreement        =   ---------------------------------------------------------------------------------------
Authority        =
Counties         =   -----------------------------
State            =
Taxpayer         =   ---------------------------------------------------
X                =
Year 1           =   -------
Year 2           =

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

This letter responds to a letter from your authorized representative dated April 3, 2023,
and supplemental documentation dated August 7, 2023, and August 25, 2023,
requesting a ruling under section 115(1) of the Internal Revenue Code. 1

FACTS

Taxpayer was formed by Authority in Year 1 as a State nonprofit corporation, is a wholly
owned subsidiary of Authority, and is recognized by State’s insurance department as a
captive insurance company. Authority is an unincorporated agency formed in Year 2
under the Agreement. Authority’s bylaws restrict its membership to the X Counties that
signed the Agreement and any future Counties that sign the agreement.

Authority’s purpose is to enable the Counties to share risk, pool reserves, or otherwise
secure insurance. Authority administers a self-insurance pool that provides the Counties
with an initial level of coverage with respect to their insured risks. If this initial level of

1
  Unless otherwise noted, all section references are to the Internal Revenue Code of 1986, as amended
(the “Code”).

PLR-108779-23                                 2

coverage is insufficient, Authority also maintains reinsurance policies through
commercial insurers for the balance of the coverage needs. Authority created Taxpayer
to operate as a captive insurance company to assist with Authority’s reinsurance needs.
Taxpayer provides reinsurance to the Counties pursuant to risk-specific agreements
under which Taxpayer agrees to provide reinsurance in exchange for annual premiums.
The premiums are invested to produce additional income used to pay claims and cover
operational expenses. Premiums and investment income are Taxpayer’s only sources
of income.

Taxpayer and Authority each pay professional service providers for services necessary
to conduct their respective operations. These services include actuarial, legal, and audit
services. Payments are also made to vendors for risk minimization training courses
offered to the Counties and to third-party insurers for commercial reinsurance policies.
All service providers and vendors are unrelated to Taxpayer and Authority, and all
payments are at arm’s length for fair market value. Additionally, Taxpayer and Authority
are permitted to reimburse reasonable expenses incurred by members of their
respective boards of directors to attend meetings.

Taxpayer’s articles of incorporation provide that Taxpayer’s net assets are distributable
to its sole shareholder, Authority, upon dissolution. The Agreement provides that upon
Authority’s dissolution, its property is distributable to its members (the Counties).

RULING REQUESTED

Taxpayer’s income is excludable from gross income under section 115(1) because
Taxpayer’s income is derived from its exercise of an essential governmental function
and such income accrues to a state or any political subdivision thereof.

LAW AND ANALYSIS

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.

In Rev. Rul. 77-261, 1977-2 C.B. 45, the Internal Revenue Service ruled that income
generated by an investment fund established by a state for the temporary investment of
cash balances of the state and its political subdivisions is excludable from gross income
under section 115(1) because such investment constitutes an essential governmental
function and the fund’s income accrues to the state and political subdivisions thereof.
The ruling explains that section 115(1) is intended to apply 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 a state or political subdivisions thereof.

PLR-108779-23                                 3

In Rev. Rul. 90-74, 1990-2 C.B. 34, the Internal Revenue Service ruled that the income
of an organization formed, funded, and operated by political subdivisions to pool their
casualty risks or other risks arising from obligations concerning public liability, workers’
compensation, and employees’ health is excludable from gross income under section
115(1) because: 1) pooling risks of political subdivisions constitutes an essential
governmental function; 2) except for certain incidental benefits, private interests do not
participate in or benefit from the organization; and 3) the organization’s income accrues
to political subdivisions.

By providing reinsurance to political subdivisions, Taxpayer performs an essential
governmental function. See Rev. Rul. 90-74. And because Taxpayer’s net assets are
distributable to Authority upon Taxpayer’s dissolution, and Authority’s property is
distributable to its members (the Counties) upon Authority’s dissolution, Taxpayer’s
income accrues to political subdivisions. Additionally, private interests do not benefit
from Taxpayer’s activities or Authority’s activities more than incidentally.

RULING

Taxpayer’s income is excludable from gross income under section 115(1) because
Taxpayer’s income is derived from its exercise of an essential governmental function
and such income accrues to a state or any political subdivision thereof.

                                            ****

The ruling contained in this letter is based upon information and representations
submitted by or on behalf of Taxpayer and accompanied by penalties of perjury
statements executed by an individual with authority to bind Taxpayer and upon the
understanding that there will be no material changes in the facts. See Rev. Proc. 2023-1
§ 7.01(16), 2023-1 I.R.B. 1. This office has not verified any of the materials submitted in
support of the request for this ruling, and such materials are subject to verification on
examination. The Associate Chief Counsel (Employee Benefits, Exempt Organizations,
and Employment Taxes) will revoke or modify a letter ruling and apply the revocation
retroactively if: 1) there has been a misstatement or omission of controlling facts; 2) the
facts at the time of the transaction are materially different from the controlling facts on
which the letter ruling was based; or 3) the transaction involves a continuing action or
series of actions and the controlling facts change during the course of the transaction.
See Rev. Proc. 2023-1 § 11.05, 2023-1 I.R.B. 1.

This letter does not address the applicability of any section of the Code or regulations
thereunder other than those sections specifically described. Except as expressly
provided herein, no opinion is expressed or implied concerning the federal tax
consequences of any fact or issue discussed or referenced in this letter. Specifically, no
opinions are expressed regarding whether Authority is a political subdivision or whether
Authority or Taxpayer provides insurance or reinsurance or is an insurance company for
federal income tax purposes.

PLR-108779-23                                           4


This letter is directed only to Taxpayer. 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 Taxpayer’s authorized representatives.

If you have any questions about this ruling, please contact the person whose name and
telephone number are shown in the heading of this letter.

                                           Sincerely,



                                           Randall Thomas
                                           Senior Counsel
                                           Exempt Organizations Branch 2
                                           (Employee Benefits, Exempt Organizations, and
                                           Employment Taxes)




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