Territory-funded trust income excluded under section 115

Plain-English summary

A United States territory created and exclusively funded a trust to hold assets for benefits the territory owed to recipients. The trust could distribute money only to the territory for those benefit payments and administrative costs, and any remaining assets would return to the territory when the trust ended. The IRS found that all trust income accrued to the territorial government and was excluded from gross income under section 115(2). It also classified the arrangement as a trust because the trustees protected and conserved property for the territory as beneficiary. Since the trust had no gross income subject to tax, the IRS ruled that section 6012(a)(4) did not require an annual income tax return.

Ruling snapshot

• Question: Was a territory-funded benefits trust's income excluded under section 115(2), and did the trust need to file annual income tax returns?
• Outcome: approved
• Key authorities: IRC §§ 115(2), 6012(a)(4), 7701; Treas. Reg. §§ 301.7701-1, 301.7701-4; Rev. Ruls. 77-261, 90-74

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202405002                                              Third Party Communication: None
 Release Date: 2/2/2024                                         Date of Communication: Not Applicable
 Index Number: 115.00-00, 115.03-00,
               115.06-00, 6012.00-00,                           Person To Contact:
               6012.05-01                                       ---------------------, ID No.
                                                                Telephone Number:
 ------------------------------------------------------------   --------------------
 -------------------                                            Refer Reply To:
                                                                CC:EEE:EOET:EO2
                                                                PLR-110121-23
                                                                Date:
                                                                November 03, 2023




LEGEND

Trust or         = ---------------------------------------------------------------------------------------------
Taxpayer
Territory        = ------------------------------------------------
Date 1           = -----------------------
Board 1            -------------------------------------------------------------------------------------------------
                   ------------------------------------------------------------------------------------------------
Benefits         = -------------------------------------------------------------------------------------------------
                   -------------------------------------------------------------------------------------------------
                   -------------------
Recipients       = -------------------------------------------------------------------------------------------------
                   ----------------------------------------------------------------------------------
Date 2           = ------------------
X                = ----
Board 2          = --------------------------------------
Board 3          = ----------------------------------------

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

This letter responds to a letter from your authorized representative, dated May 5, 2023,
requesting rulings that (1) Trust’s income is excludable from gross income under section
115(2) of the Internal Revenue Code (Code); and (2) Trust is not required to file an annual
income tax return because any income realized by it is excluded from gross income under
section 115. The Taxpayer represents the following facts:
                                               2
PLR-110121-23


Trust was established on Date 1, by the Territory, by and through Board 1 as the
Territory’s representative. Trust is organized under the law of the Territory as a charitable
or public trust.

Trust is funded exclusively by contributions made by the Territory (or on the Territory’s
behalf). Trust assets consist of contributions and earnings on investments.

Trust was established solely to make distributions to the Territory, its sole beneficiary, as
necessary for the Territory to pay Benefits it is obligated to pay to Recipients. Trust holds
assets irrevocably for the exclusive purposes of (1) paying Trust’s operating and
administrative expenses, and (2) beginning Date 2 (at the earliest), making disbursements
to the Territory as needed for the Territory to pay Benefits to Recipients. Trust assets may
not be distributed to Recipients.

Board 2 members serve as Trust's trustees and are responsible for investing and
managing Trust assets. A separate body, Board 3, is responsible for monitoring the
funding of and withdrawals from the Trust.

Board 2, Board 3, and the Territory have the right, separately or jointly, to request
amendments to the Trust that are consistent with the Trust’s purpose. The U.S. District
Court with jurisdiction in the Territory has sole authority to approve any Trust amendment.
Pursuant to the Trust document, Trust terminates X calendar days after the date all funds
held in Trust are withdrawn or when the Benefits owed to all Recipients have been paid,
whichever occurs first. Upon termination of Trust, any remaining assets in it are
transferred to the Territory.

LAW AND ANALYSIS

Section 115(2) provides that gross income does not include income accruing to the
government of any possession of the United States, 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.

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
                                               3
PLR-110121-23

participate in or benefit from the organization; and 3) the organization’s income accrues to
political subdivisions.

Under section 115(2), gross income does not include income accruing to the government
of any possession of the United States, or any political subdivision thereof. Though Trust
is not an instrumentality of the Territory, which is a possession of the United States, the
income it generates accrues solely to the Territory. Trust was created solely for the benefit
of the Territory, its sole beneficiary, and will only provide funds to the Territory as needed
to satisfy Territory’s obligation to pay Benefits to Recipients, an activity within the ambit of
a sovereign to conduct. See Rev. Rul. 77-261. Funds in Trust will not be paid to any
Recipients. Trust’s assets cannot be used for any purpose other than disbursements to
the Territory and paying related administrative expenses of Trust. See Rev. Rul. 90-74. As
all of Trust’s income accrues to the Territory, either through distributions or upon the
Trust’s termination, the requirements of section 115(2) are satisfied, and therefore this
income is excluded from Trust’s gross income.

Regarding Trust’s obligation to file tax returns, section 301.7701-1(b) of the Procedure
and Administration Regulations provides that the classification of organizations that are
recognized as separate entities is determined under sections 301.7701-2 through -4,
unless a provision of the Code provides for special treatment of that organization. Section
301.7701-4(a) provides, in general, that an arrangement will be treated as a trust under
the Code if it can be shown that the purpose of the arrangement is to vest in trustees the
responsibility for the protection and conservation of property for beneficiaries who cannot
share in the discharge of this responsibility and, therefore, are not associates in a joint
enterprise for the conduct of business for profit.

Trust enables the Territory to set aside funds and make distributions to the Territory, as
necessary, so that Territory may satisfy its obligation to pay Benefits to Recipients. The
Trustees are charged with the responsibility to protect and conserve Trust assets for the
benefit of the Territory in its capacity as Trust beneficiary. The Territory cannot share in
the discharge of the Trustee’s responsibility to protect and conserve Trust assets, and
therefore, is not associated in a joint enterprise for the conduct of business for profit.
Thus, Trust is treated as a trust under section 301.7701-4(a).

Section 6012(a)(4) provides that every trust having taxable income for the tax year, or
having gross income of $600 or more for that year regardless of the amount of taxable
income, must file a return with respect to income taxes under subtitle A.

We conclude that Trust is classified as a trust within the meaning of section 7701(a) and
section 301.7701-4(a).
                                               4
PLR-110121-23


Based solely on the facts and representations submitted by the Taxpayer, we rule that (1)
Trust’s income is excluded under section 115(2) because it accrues to the government of
Territory, a possession of the United States; and (2) because Trust's income is excluded
from gross income under section 115(2), Trust is not required by section 6012(a)(4) to file
an annual income tax return.

The rulings contained in this letter are based upon information and representations
submitted by or on behalf of the Taxpayer and accompanied by a penalty of perjury
statement executed by an individual with authority to bind the Taxpayer, and upon the
understanding that there will be no material changes in the facts. While this office has
not verified any of the material submitted in support of the request for a ruling, it 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. 2023-1, section 11.05.

This letter does not address the applicability of any section of the Code or Regulations
to the facts submitted other than with respect to the sections specifically described.
Further, except as expressly provided in this letter, no opinion is expressed or implied
concerning the tax consequences of any aspects of any transaction or item of income
discussed or referenced in this letter.

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

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to the Taxpayer’s authorized representatives.

This ruling letter is directed only to the Taxpayer. According to section 6110(k)(3), this
ruling letter may not be used or cited as precedent.

A copy of this letter must be attached to any tax return to which it is relevant.
Alternatively, if the Taxpayer files a return electronically, this requirement may be
satisfied by attaching a statement to the return that provides the date and control
number of this ruling letter.
PLR-110121-23                                            5


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,


                                             Taina Edlund
                                             Senior Technician Reviewer
                                             Exempt Organizations Branch 2
                                             (Employee Benefits, Exempt Organizations, and
                                             Employment Taxes)




cc: ---------------
    ---------------------------------------------
    ------------------------------

     ---------------------------------------------------------------------------------------------
     ----------------------------------------------
     ------------------------------

       -----------------------------------
     ----------------------------------
     --------------------
     -------------------------------
     ----------------------------------