department of the treasury internal_revenue_service washington d c tax exempt ang government entities dwvigion number release date date uil legend university system board management corp fund a endowment fund trust dear we have considered your ruling_request dated date and your amended ruling_request dated date conceming the federal_income_tax consequences under sec_512 of the internal_revenue_code_of_1986 as amended hereafter code related to a proposed contractual arrangement in the manner and for the purposes described below facts the university system has been established pursuant to the state's constitution and statutes to provide for the higher education of students within the state specifically the state's constitution provides for the establishment of the university system for the promotion of literature arts and sciences the board is the governing body of the university system with the state's university system composed of several academic and health-related institutions of higher education the university system is a governmental_unit described under sec_170 a v and c of the code and exempt from taxation the state's statutes provide that the board is specifically authorized and directed ta govern operate support and maintain the state's university system which includes promulgating and enforcing rules and regulations for the operation of the state's university system the state's constitution designates the board as the fiduciary over any endowment funds established to provide financial support for the various educational organizations that comprise the state’s university system as authorized by state statute the board assesses each endowment fund certain administration and management fees which fees provide funding for administrative costs directly related to the management of endowments and to ensure institutional compliance with the agreements made with endowment donors management corp was established by the board pursuant to the state’s constitution and statutes management corp has been recognized as a tax-exempt_entity under sec_601 of the code and as an entity described in sec_509 that is organized to support the state’s university system as a supporting_organization to the university system all directors of management corp other than the chancellor of the university system are pursuant to management corp 's appointed by and serve at the pleasure of the board_of incorporation its charitable purpose is to aid assist support and act on behalf of the university system which is governed by the board management corp’s articles of incorporation lists its specific purpose as investing funds under the control and management of the board which includes the management of fund a and endowment fund and the performance of such other activities or functions that the board determines as necessary to accomplish its charitable purpose except that it may not engage in any business other than investing funds designated by the board articles fund a is a general pooled endowment fund that is comprised of two sub funds one of neither fund a nor the endowment fund is a pooled_income_fund which is endowment fund as described in sec_642 of the code endowment fund is a pooled_fund for the collective investment of privately raised endowment funds all funds are held solely for the benefit of the university system and its controlled entities of higher education endowment fund is heavily diversified in bath domestic and international markets and utilizes alternative investment strategies to reduce the overall risk of the portfolio and to enhance investment returns much of the income earned by endowment fund consists of passive dividends interest rents and long-and short-term_capital_gains but some income is debt financed or otherwise is treated as unrelated_business_taxable_income as the managing and investing agent for the university system's funds including fund a and endowment fund management corp incurs expenses associated with the investment management and administration of these assets management corp represents that it submits an annual budget to the board reflecting all estimated expenses associated with the management of all assets under its control the budget includes management corp 's management fee which is comprised of i all operating_expenses associated with the general management of all funds under management ii a capital expenditures budget and ii the direct expense of the funds associated with strategy and analysis portfolio management custody and safekeeping accounting and other investment related functions after the budget is approved by the board the management fee is charged against the aggregate return of the funds including endowment fund management corp reports that all fees are charged at the fund level and no fees are charged to the individual unit holders the board is both the trustee and sole charitable_remainder beneficiary of trust trust is a charitable_remainder_unitrust described under sec_664 of the code under the terms of trust's agreement trust's donor is the income_beneficiary entitled fo an annual payout of a unitrust_amount equal to a percentage of the net fair_market_value of trust's assets pursuant to sec_643 of the gods the remainder_interest is distributable to the board for the benefit presently trust assets are of the university system upon the death of the income_beneficiary managed by various investment managers in accordance with a strategy developed by an outside for-profit advisor the board reports that as trustee and remainder beneficiary of trust's assets it desires to provide the level of diversification and rate of return on trust’s assets as those achieved on university system's endowment fund trust's diversification and investment return the board proposes to take advantage of the concept of economies of scale by entering into a contract with itself both as fiduciary of the university system's endowment fund and as fiduciary of trust’s assets and allow trust to commingle its assets with those of the endowment fund a higher rate of retum on trust’s assets would cause its donor to receive a higher unitrust payout and would cause the university system to ultimately receive a higher final payment as the remainder beneficiary therefore in an attempt to increase the board proposes to enable trust to participate in the university system's endowment fund through the acquisition of units the board proposes to create a contractual obligation pursuant to which it will issue to trust a contract right called units in the endowment fund in exchange for trust investing its assets in the endowment fund the number of units trust will receive will be in proportion to the value of trust's investment in the endowment fund the contract will provide that trust will receive an income payout based on the number of units owned and the payout rate established by the board for the endowment fund the board represents that any fund investment retum over and above the payout rate is credited to the principal_amount of the fund and is reflected as an increase in the value of each unit outstanding the value of the units both at the time of acquisition and redemption will be based on the value of all underlying investment_assets held in the endowment fund provides that trust could choose te either reinvest part of the payout or redeem additional units depending on trust's cash requirements the payout up to the endowment fund spending rate will be characterized as ordinary_income to trust regardless of whether the underlying income to the endowment fund is characterized as capital_gain ordinary_income or a return_of_capital the holding_period of a particular unit will be treated as beginning on the date the uri is issued tothe trust redemptions of units by trust over and above receipt of the payout rate will be treated as either long- or short-term_capital_gain or loss depending on the holding_period of the units furthermore the board will pay any_tax owed on unrelated_business_taxable_income eamed by the endowment fund the contract ‘the board represents that under the contract trust would not have any ownership_interest in the underlying assets of the endowment fund or any contract rights with respect to other trusts trust would have no power or right of any kind to contral direct supervise recommend or review the board's business activities operations or decisions with respect to the endowment fund except the right to review the payout computation trust would net have the right to veto or opt_out of any of the underlying investments in the endowment fund the contract would provide that with respect to the issuance of units neither the board nor the university system is a partner with trust or an agent of the trust trust would also never be or become liable for any cost expense or payment incurred or due by the board or for which the board is liable or responsible relating to the endowment fund or the underlying endowment assets and the board would indemnify and hold trust harmless from and against any liability arising out of any_action or inaction by the board with respect to the endowment fund or the underlying assets trust's liability will be limited to the risk of loss of its capital invested in the contract with the board as to the issue of fees and cost the board states that it will not charge the trusts a fee for administrative and management services the board represents that it will nat generate any income from the investment management of the trust even if there is a spread between the endowment funds’ earnings and the declared payout however the board represents that it is authorized by state statute to assess fees for the administration of the endowment fund ‘the board also represents that the investment management costs will be borne proportionally by each unit holder in the endowment fund and the payout will reflect these costs furthermore as to the issue of management corp 's expenses the board represents that management corp submits a annual budget to the board reflecting all estimated expenses associated with the management of all assets under its control only after the board approves the budget are any expenses charged to the funds with all expenses charged proportionally to each fund and not directly to the trust or individual unit holders you have requested the following rulings the issuance of endowment fund units by the board to trust the making or receipt of payments with respect to these units and the holding or redemption of these units will not generate unrelated_business_taxable_income to the board the issuance of endowment fund units by the board to trust the making or receipt of payments with respect to these units the participation of trust in fund a and the endowment fund including the payment of fees and expenses to management corp and the holding or redemption of these units will not generate unrelated_business_taxable_income to management corp the issuance of endowment fund units by the board to trust the making or receipt of payments with respect to these units and the holding or redemption of these units will not generate unrelated_business_taxable_income to trust the redemption of endowment fund units by trust will be treated as long- or short-term x capital_gain or loss depending upon the holding_period of these units law sec_501 c of the code in part provides for the exemption from federal_income_tax of organizations organized and operated exclusively for charitable educational scientific and certain other purposes sec_511 of the code in part imposes a tax on the unrelated_business_taxable_income of certain organizations_exempt_from_taxation including any college or university that is an agency or instrumentatity of any government sec_12 of the code defines the term unrelated_business_taxable_income as the gross_income derived by any organization from any unrelated_trade_or_business regularly carried on by it jess the allowable deductions which are directly connected with the carrying on of such trade_or_business both computed with the modifications provided in section dollar_figure b sec_512 of the code excludes from the definition of unrelated business taxable income all dividends interest payments with respect te securities loans as defined in subsection a amounts received or accrued as consideration for entering into agreements to make loans and annuities and all deductions directly connected with such income it also excludes all royalties including overriding royalties whether measured by production or by gross or taxable_income_from_the_property and all deductions directly connected with such income it also excludes certain rents sec_513 of the code defines the term unrelated_trade_or_business as any trade_or_business the conduct of which is net substantially related aside from the need of the organization for income or funds or the use it makes of the profits derived to the exercise or performance by such organization of its exempt_purpose or function sec_513 of the code provides that trade_or_business includes any activity which is carried on for the preduction of income from the sale_of_goods or the performance of services an activity does not lose its identity as a trade_or_business merely because it is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which may or may not be related to the exempt purposes of the organization sec_684 of the code defines a charitable_remainder_unitrust as a_trust a from which a fixed percentage which is not lass than percent nor more than percent af the net fair_market_value of its assets valued annually is to be paid not less often than annually to one or mare persons at least one of which is not an organization described in sec_170 c and in the case of individuals only to an individual who is living at the time of the creation of the trust for a term of years not in excess of years or for the life of lives of such individual or individuals b from which no amount other than the payments described in subparagraph a and other than qualified gratuitous transfers described in subparagraph c may be paid to or for_the_use_of any person other than an organization described in sec_170 c following the termination of the payments described in subparagraph a the remainder_interest in the trust is to be transferred to ar for_the_use_of an organization described in sec_170 or is to be retained by the trust for such a use or to the extent the remainder_interest is in qualified ‘employer securities as defined in subsection g all or part of such securities are to be transferred to an employee_stock_ownership_plan as defined in sec_4975 in a qualified_gratuitous_transfer as defined by subsection g and d with respect to each contribution of property to the trust the value determined under sec_7520 of such remainder_interest in such property is at least percent of the net fair_market_value of such property as of the date such property is contributed to the trust sec_1221 of the cade defines the term capital_asset as property held by the taxpayer regardless of whether it is connected with the taxpayer's trade_or_business unless the property meets one of eight listed exceptions inventory property of a character which is subject_to the allowance for depreciation provided in sec_167 or real_property used ina trade_or_business certain intangible_property accounts_receivable acquired in the ordinary course of a trade_or_business certain publications of the united_states government certain commodities financial derivatives certain hedging_transactions and supplies of a type regularly consumed by the taxpayer in the ordinary course of a trade_or_business of the taxpayer sec_1222 of the code provides that capital_gain or loss is generated upon a sale_or_exchange of a capital_asset sec_1234a of the code provides that gain_or_loss attributable to the cancellation lapse expiration or other termination of a right or obligation with respect to property which is or on acquisition would be a capital_asset in the hands of the taxpayer shall be treated as gain_or_loss fram the sale of a capital_asset sec_1_512_b_-1 of the income_tax regulations hereafter regulations defines certain investment_income to include dividends interest payments_with_respect_to_securities_loans as defined in sec_512 a annuities income from notional_principal_contracts as defined in sec_26 cfr or regulations issued under sec_446 other substantially_similar income from ordinary and routine investments to the extent determined by the commissioner and further provides that the foregoing investment_income and all deductions directly connected with the foregoing investment_income shall be excluded in computing unrelated_business_taxable_income sec_1_513-1 a of the regulations provides that gross_income of an exempt_organization subject_to the tax imposed by sec_511 of the code is includible in the computation of unrelated_business_taxable_income if itis income from a trade_or_business such trade_or_business is regularly carried on by the organization and the conduct of such trade_or_business is not substantially related other than through the production of funds to the organization's performance of its exempt functions sec_1_513-1 of the regulations pravides that the primary objective of adoption of the unrelated_business_income_tax was te eliminate a source of unfair competition by placing the unrelated business activities of certain exempt_organizations upon the same tax basis as the nonexempt business endeavors with which they compete in general any activity of a sec_511 organization which is carried on for the production_of_income and which otherwise possesses the characteristics required to constitute trade or business’ within the meaning of sec_162 - and which in addition is not substantially related to the performance of exempt functions - presents sufficient likelihood of unfair competition to be within the policy of the tax accordingly for purposes of section the term trade_or_business has the same meaning it has in sec_162 and generally includes any activity carried on for the production_of_income from the sale_of_goods or performance of services is not limited to integrated aggregates of assets activities and good will which comprise businesses for the purposes of certain other provisions of the internal_revenue_code of producing or distributing goods or performing services from which a particular amount of gross_income is derived do not lose their identity as a trade_or_business merely because they are carried on within a larger aggregate of similar activities ar within a larger complex of ather endeavors which may or may not be related to the exempt purposes of the organization thus for example the regular sale of pharmaceutical supplies to the general_public by a hospital pharmacy does not lose its identity as a trade_or_business merely because the pharmacy also furnishes supplies to the hospital and patients of the hospital in accordance with its exempt purposes or in compliance with the terms of sec_513 similarly activities of soliciting selling and publishing commercial advertising do not lose their identity as a trade_or_business ‘even though the advertising is published in an exempt_organization periodical which contains thus the term ‘trade or business in section activities editorial matter related to the exempt purposes of the organization sec_1_513-1 of the regulations provides that in determining whether a trade_or_business from which a particular amount of gross_income derives is regularly carried on’ within the meaning of sec_512 of the code regard must be had to the frequency and continuity with which the activities productive of the income are conducted and the manner in which they are pursued sec_1_513-1 of the regulations provides that in general gross_income derives from an unrelated_trade_or_business within the meaning of sec_513 of the code if the conduct of the trade_or_business which produces the income is not substantially related other than through the production of funds to the purposes for which exemption is granted the presence of this requirement necessitates an examination of the relationship between the business activities which generate the particular income in question - the activities that is of producing and distributing the goods or performing the services involved - and the accomplishment of the organization's exempt purposes sec_1_513-1 of the regulations provides that a trade_or_business is related to exempt purposes in the relevant sense only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes other than through the production_of_income and is substantially related for purposes of sec_513 of the code only if the causal relationship is a substantial one thus for the conduct_of_a_trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of the services from which the gross_income is derived must contribute importantly to the accomplishment of those purposes where the production or distribution of the goods or the performance of the services does not contribute importantly to the accompiishment of the exempt purposes of an organization the income from the sale of the goods or the performance of the services does not derive from the conduct of related trade_or_business whether activities productive of gross_income contribute importantly to the accomplishment of any purpose for which an organization is granted exemption depends in each case upon the facts and circumstances revrul_69_528 1969_2_cb_127 describes an organization that was formed to participant's interests and distriouted the proceads fo the participant the provide investment services on a fee basis exclusively to organizations exempt under section the organization received funds from participating exempt_organization sec_501 c of the code and invested the proceeds in stocks reinvested the income and realized appreciation and upon request liquidated service held that providing investment services on a regular basis for a fee is a trade_or_business ordinarily carried on for profit the service further held that the activity would constitute an unrelated_trade_or_business even if the services were regularly provided by one tax-exempt_organization for other tax-exempt organizations thus the service concluded that the organization was not tax exempt under sec_801 because it was regularly carrying ‘on a business of providing investment services that would be an unrelated_trade_or_business if carried on by any of the tax-exempt organizations on whose behalf it operated 304_f2d_125 cir the court held that the taxpayer's surrender of a lease of a play constituted the sale_or_exchange of a capital_asset despite the fact that receipts from the play would have been ordinary_income government's argument against capital_gain treatment the court noted that there was no equivalence between amounts paid for the surrender of the lease and the income that would have been realized by its retention in its rejection of the commissioner y gillette motor transport inc 384_us_130 citing 287_us_103 the united_states supreme court found it evident that not harmel everything which can be called property in the ordinary sense and which is outside the statutory exclusions of sec_1221 qualifies as a capital_asset rather the term ‘capital asset’ is to be construed narrowly in accordance with the purpose of congress to afford capital-gains treatment only in situations typically involving the realization of appreciation in value accrued over a substantial period of time 356_us_260 the united_states supreme court denied capital_gain treatment on the disposition of certain mineral payments carved out of established oil_and_gas interests elliot v united_states 431_f2d_1149 cir the court denied capital_gain treatment for the lump sum payment representing the surrender of rights to future sales commissions 455_f2d_1146 cir the court denied capital_gain treatment for the lump sum payment representing unpaid commissions due under an employment contract guggenheim v commissioner c the tax_court focused on whether the taxpayer transferred substantial investment risks in the sale of undivided interests in a stallion there the court noted that if the value of the stallion subsequently increased the taxpayer would not share in that increase with regard to the interests transferred instead the new owners received all the benefits of an increase in value of the stallion and all the burdens of a decrease in value thus the court found that the taxpayer had transferred substantial investment risks and was entitled to capital_gain treatment on the sale of the interests 303_f2d_687 cir the court denied capital_gain treatment for the payment for interest in films to be produced by taxpayer 313_us_28 the taxpayer inherited a building and subsequently one of the tenants canceled their lease paying the taxpayer a cancellation fee the united_states supreme court held that the cancellation fee was ordinary_income because the cancellation of the lease involved nothing more than relinquishment of the right to future rental payments in return for a present substitute payment and possession of the leased premises 437_f3d_399 cir the court denied capital_gain treatment for interests relating to payment for annual instaliments of a lottery prize 131_f2d_50 cir the court denied capital_gain treatment for interests relating to the right to a declared dividend 324_f2d_56 cir the court distinguished between proceeds from the present sale of the future right to eam income which is capital_gain and the present sale of the future right to gamed income income the court found that the sale of an income-producing asset was not merely the sale of the right to income already earned instead the taxpayer had an asset that would produce income in the future thus the court held that the taxpayer's sale of the asset generated capital_gain which is ordinary 381_us_54 the court denied capital_gain treatment for interests relating to income earned on criginal issue discount analysis ruling the issue is whether the board will incur unrelated_business_taxable_income upon the issuance of endowment fund units to trust upon the making or receipt of payments with respect to these units and upon the holding or redemption of these units sec_511 of the code imposes a tax on the income earned by a governmental_unit described under sec_170 a and of the code and exempt from taxation if an the income results from the operation of the organization's unrelated_trade_or_business organization that engages in a trade_or_business will have unrelated_trade_or_business taxable_income if three conditions are satisfied the trade_or_business generates income the trade_or_business is regularly carried on and the trade_or_business is unrelated to the organization's exempt_purpose or function see sec_512 section a of the regulations the term trade_or_business has the same meaning for purposes of sec_513 as it does for sec_162 and generally includes any activity carried on for the production_of_income from the sale_of_goods or performance of services sec_1_513-1 such an activity would constitute a trade_or_business under sections generally an organization that otherwise qualifies for recognition of tax-exemption and provides investment services on a reqular basis for a fee to other exempt or nonexempt ‘organizations would be engaged in an unretated trade_or_business under section a see rey rul supra and b of the regulations and would be regularly carried on under sec_512 and sec_1_513-1 thus if the board charged a fee for investment management services provided to organizations unrelated to it or generated income from the management of the funds invested by such organizations these activities could resutt in unrelated_business_taxable_income under sec_512 here howaver the board is not charging a fee for its services and not otherwise receiving income from the services it provides to the trust under these circumstances the board will not receive unrelated_business_taxable_income under sec_512 a thus the fact that the board will engage in the investment activity for the benefit of an be individual who is a co-beneficiary of the trust at the same time that it engages in investment activity for its own benefit as the charitable_remainder beneficiary limits the scope of the service provided to others and distinguishes it from a commercial venture the relationship between the board and trust is also distinguishable from revrul_69_258 in which the service held that providing investment services on a regular basis for a fee is a trade_or_business ordinarily carried on for profit and that the activity would constitute an unrelated_trade_or_business even if the services were regularly provided by one tax-exempt_organization for the benefit of other tax-exempt organizations because the board is nat charging any fees over and above its costs for investing in the endowment fund and because the board is investing funds on its own behaff as sole remainder beneficiary and as trustee revrul_69_258 is not applicable ruling the issue is whether management corp will incur unrelated business taxable inoome upon the issuance of endowment fund units by the board to trust the making or receipt of payments with respect to the units the participation of trust in fund a and endowment fund including the payment of fees and expenses to management corp and the holding or redemption of units as stated fully above sec_511 of the cade imposes a tax on the income earned by organizations recognized as tax-exempt if the income results from the operation of the organization's unrelated_trade_or_business see sec_512 a sec_1_513-1 of the regulations the proposed contractual relationship between the board and trust in which trust will invest in the university system's endowment fund which fund is managed by management corp will not give rise to unrelated_business_taxable_income to the board under the facts presented whether or not the board manages the fund directly or has a supporting_organization manage the fund on the board's behalf management corp is a supporting_organization of the state's university system dedicated solely to the management of investment_assets under the control of the board these assets include fund a and the endowment fund management corp reports that it does not eam any net_income from its management duties rather pursuant to board's approval of management corp ’s annual budget management corp only recovers its management fee’ as a charge against the aggregate retum of the funds it manages this management fee is comprised of i all operating_expenses associated with the general management of all funds under management i a capital expenditures budget and il the direct expense of the funds associated with strategy and analysis portfolio management custody and safekeeping accounting and other investment related functions management corp furthers its tax-exempt purpose by engaging in investment activity solely on behalf of the board which is both the trustee and remainder beneficiary of trust and management corp 's supported_organization the university system as such trust's donor as life_beneficiary becomes an incidental beneficiary to management corp 's management corp 's activities from those of the organization described in rev rut ‘therefore management corp 's activities do not give rise to unrelated_business_taxable_income activities distinguishing ruling the issue is whether the issuance of endowment fund units by the board to trust the making or receipt of payments with respect to the units and the holding or redemption of the units will generate unrelated_business_taxable_income to trust as stated above under the contract trust would neither have any ownership_interest in the underlying assets of the endowment nor any contract rights with respect to other trusts trust would have no power or right of any kind to control direct supervise recommend or review m's business activities operations or decisions with respect to the endowment except the right to review the payout computations trust would not have any right to veto or opt_out of any of the underlying endowment investments the contract would provide that with respect to the issuance of endowment fund units neither the board nor the university system is trust's partner or agent and that trust would never be or become liable for any cost expense or payment incurred or due by the board or for which the board is liable or responsible relating to the endowment or the underlying endowment assets and finally the board would indemnify and hold trust harmless from and against any liability arising out of any_action or inaction by the board with respect to the endowment or the underlying endowment assets the trust does not have a position of ownership in the underlying assets of the endowment because the contractual relationship between the board and trust is not in the nature of a partnership or agency the income eared by trust from the payout established for the units reflects ordinary incame and does not take on the character of the income of the undertying assets or of debt-financed_income or of unrelated_business_taxable_income the board would pay any_tax owed on unrelated_business_taxable_income eamed by the endowment portfolio with no deduction taken against unrelated_business_taxable_income for any payments made to the trust therefore trust will not incur unrelated_business_taxable_income upon investing in the university system's endowment fund through fund a assuming that trust does not incur an acquisition_indebtedness with respect to the investment giving rise to unrelated_debt-financed_income under sec_512 and sec_514 of the code as discussed below in greater detail gain_or_loss from the redemption of units will give rise to dispositions of property described in sec_512 ruling the issue is whether the redemption of units by trust will be treated as long- or short- term capital_gains or loss depending upon the holding_period of the trust units sec_1222 provides that capital_gain or loss is generated upon a sale_or_exchange of a capital_asset sec_1234a provides that gain_or_loss attributable to the cancellation lapse expiration of other termination of a right or obligation with respect to property which is or on acquisition would be a capital_asset in the hands of the taxpayer shall be treated as gain of loss from the sale of a capital_asset sec_1221 defines the term capital_asset as property held by the taxpayer t regardless of whether it js connected with the taxpayer's trade_or_business unless the property meets one of eight listed exceptions inventory property of a character which is subject_to the allowance for depreciation provided in sec_167 or real_property used in a trade_or_business certain intangible_property accounts_receivable acquired in the ordinary course of a trade_or_business certain publications of the united_states government certain commodities financial derivatives certain hedging_transactions and supplies of a type regularly consumed by the taxpayer in the ordinary course of a trade_or_business of the taxpayer based upon the transaction described above none of the listed exceptions in sec_1221 of the code apply however although sec_1221 appears to give broad meaning to the term capital_asset the supreme court has found it evident that not everything which can be called property in the ordinary sense and which is outside the statutory exclusions of section qualifies as a capital_asset rather the term ‘capital asset’ is to be construed narrowly in accordance with the purpose of gongress to afford capital-gains treatment only in situations typically involving the realization of appreciation in value accrued over a substantial period of time commissioner v gillette motor transport inc 384_us_130 citing bumet v harmel 287_us_103 accordingly the court has held that certain interests that are concededly property in the ordinary sense are not capital assets on this basis capital_gain treatment has been denied for transactions involving payments in return for interests carved out of or related to an interest retained by the taxpayer ‘see eg 356_us_260 denying capital_gain treatment on the disposition of certain mineral payments carved out of established oil_and_gas interests 313_us_28 denying capital_gain treatment on the disposition of a term of years carved out from a fee simple the courts have also denied capital_gain treatment for transactions on the basis that the payments at issue were a substitute_for_ordinary_income in hort for example the taxpayer inherited a building and one of the tenants canceled its lease paying the taxpayer a cancellation fee the court held that the cancellation fee was ordinary_income because the cancellation of the lease involved nothing mere than relinquishment of the right to future rental payments in return for a present substitute payment and possession of the leased premises id pincite the court bolstered this substitute-for-ordinary-income doetrine in p g lake stating t he ump sum consideration seems essentially a substitute for what would otherwise be received at a future time as ordinary_income p g lake u s pincite consistent with the substitute-for-ordinary-incame doctrine courts have denied capital_gain treatment for transactions involving interests related to compensation_for past or future personal services see e a 455_f2d_1146 cir lump sum representing unpaid commissions due under an employment contract elliot v united_states 431_f2d_1148 cir lump sum paid for the surrender of right to future sales commissions halt v commissioner 303_f2d_687 cir payment for interest in films to be producad by taxpayer similarly courts have denied capital_gain treatment for interests relating to income already eamed or about to be earned ses g united_states v midland- ross corp u s f 3d cir lump sum payment for annual installments of lottery prize 131_f2d_50 cir right to declared dividend earned original_issue_discount lattera v commissioner on the other hand as the courts have noted simply because the property transferred will produce ordinary_income and such income is a major factor in determining the value of the property does not necessarily mean that the amount received for the property is essentially a lump-sum substitute_for_ordinary_income 46_tc_559 in guggenheim the court focused on whether the taxpayer transferred substantial investment risks in the sale of undivided interests in a stallion there the court noted that if the value of the stallion subsequently increased the taxpayer would not share in that increase with regard to the interests transferred id instead the new owners received all the benefits of thus the an increase in value of the stallion and all the burdens of a decrease in value id court found that the taxpayer had transferred substantial investment risks and was entitled to capital_gain treatment on the sale of the interests id id in 324_f2d_56 cir the court distinguished between proceeds from the present sale of the future right to eam income which is capital_gain and the present sale of the future right to eamed income which is ordinary there the court found that the sale of an income-producing asset was not income id pincite merely the sale of the right to income already eamed instead the taxpayer had an asset that would produce income in the future id thus the court held that the taxpayer's sale of the asset generated capital_gain 1d similarly in 304_f2d_125 cir the court held that the taxpayer's surrender of a lease of a play constituted the sale_or_exchange of a capital_asset despite the fact that receipts from the play would have been ordinary_income ferrer pincite inits rejection of the government's argument against capital_gain treatment the court noted that there was no equivalence between amounts paid for the surrender of the lease and the income that would have been realized by its retention id pincite based on the above authorities the proper characterization under sec_1221 of the code as to the units to be held by the trust is that the bundle of contract rights represented by each unit is proparty and may be treated as a capital_asset for purposes of sec_1221 the ‘most important characteristic of the unit is that significant investment risks are associated with and included in each unit with respect to each unit there is an opportunity for appreciation as well as a risk of loss each unit represents a substantial investment by the trust and each unit has an ascertainable basis investment performance poor performance will detract from the value of a unit while performance above the payout rate set by the scard will increase the value of each unit the opportunity for appreciation risk of loss and basis in each unit are characteristics similar to other contract rights that are treated as capital assets for example other financial derivatives mutual_fund shares or corporate stock each unit are similar to those associated with property held to be capital assets in guggenheim dresser and ferrer the value of each unit is directly tied to the endowment fund’s further the benefits and burdens associated with in addition although the trust will receive ordinary_income in the form of the periodic payouts that are based in part upon the number of units owned by the trust consideration received upon a redemption of a unit is not a substitute for what would otherwise be received as an ordinary_income payout whether due and payable cr about to be due and payable to the trust under the terms of the contract rather the amount_paid for a unit upon a redemption is ‘equal to the value of the unit on the date of redemption unit value on any given date is equal to overall asset value of the endowment fund divided by the number of units outstanding the unit is not an interest related to compensation_for past or future personal services the unit is an asset that will produce income in the future also instead finally the unit does not represent a carve-out of a larger estate retained by the trust ‘the appreciation of each unit is attributable to overall endowment fund properly appreciation much of which in turn is attributable to increases in the value of capital assets in the endowment fund the contract provides specifically that the trust does not have any ownership_interest or rights to the endowment fund interest carved out of an interest retained by the trust thus the unit does not represent an we conclude that the unit is a capital_asset for purposes of sec_1221 of the code furthermore sec_1234a will apply to treat gain_or_loss from the cancellation lapse expiration or other termination of the unit as gain_or_loss from the sale of a capital_asset thus in general the redemption of the unit by the trust will generate short-term or long-term_capital_gain or loss to the trust depending on the holding_period of the unit conclusion accordingly based on the information submitted in your ruling_request we rule as follows the issuance of endowment fund units by the board to trust the making or receipt of payments with respect to these units and the holding or redemption of these units will not generate unrelated_business_taxable_income to the board the issuance of endowment fund units by the board to trust the making or receipt of payments with respect to these units the participation of the trust in fund a and endowment fund including the payment of fees and expenses to management corp and the holding or redemption of these units will not generate unrelated_business_taxable_income to management corp the issuance of endowment fund units by the board to trust the making or receipt of payments with respect to these units and the holding or redemption of these units will not generate unrelated_business_taxable_income to the trust the redemption of endowment fund units by trust will be treated as long- or short-term_capital_gain or toss depending upon the holding_period of these units this letter supersedes our letter_ruling dated date in which we erroneously described the university system as recognized under sec_501 of the gode rather than a8 governmental_unit under sec_170 except as we have ruled above we express no opinion as to the tax consequences of the transaction under the cited provisions of the code or under any other provisions of the code this ruling will be made available for public inspection under sec_6110 of the code after certain deletions of identifying information are made for details see enclosed notice notice of intention to disclose a copy of this ruling with deletions that we intend to make available for public inspection is attached to notice if you disagree with our proposed deletions you should follow the instructions in notice this ruling is directed only to the organization that requested it sec_6110 of the code provides that it may not be used or cited by others as precedent this ruling is based on the facts as they were presented and on the understanding that there will be no materiat changes in these facts this ruling does not address the applicability of any section of the cade or regulations to the facts submitted other than with respect to the sections described because it could help resolved questions concerning your federal_income_tax status this ruling should be kept in your permanent records ifyou have any questions about this ruling please contact the person whose name and telephone number are shown in the heading of this letter in accordance with the power_of_attorney currently on file with the internal_revenue_service we are sending a copy of this letter to your authorized representative sincerely robert c harper jr manager exempt_organizations technical group enclosure notice


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi plr-130037-03 date date legend taxpayer owner state foreign_country date dear this letter responds to a letter dated date and subsequent correspondence submitted on behalf of taxpayer requesting a ruling under sec_301_9100-3 of the procedure and administration regulations granting an extension of time allowing taxpayer to file an election effective date to be treated as a disregarded_entity for federal tax purposes facts according to the information submitted taxpayer is a limited_liability entity formed under the laws of foreign_country taxpayer filed a form_8832 entity classification election electing to be treated as a disregarded_entity later at a date that was more than days after date it was discovered that the form_8832 was improperly filed plr-130037-03 law and application sec_301_7701-2 provides that a business_entity is any entity recognized for federal tax purposes that is not properly classified as a_trust under sec_301_7701-4 or otherwise subject_to special treatment under the internal_revenue_code sec_301_7701-3 provides that a business_entity that is not classified as a corporation under sec_301_7701-2 or may elect its classification for federal tax purposes an eligible_entity with a single owner may be classified as either an association_taxable_as_a_corporation or as a disregarded_entity sec_301_7701-3 provides the default status for a foreign eligible_entity that does not file an election sec_301_7701-3 provides that unless the foreign eligible_entity elects otherwise the entity is classified as an association if all members have limited_liability consequently in the absence of a valid election taxpayer is classified as an association under the rules of this section sec_301_7701-3 provides in part that an eligible_entity may elect to be classified other than as provided under sec_301_7701-3 by filing form_8832 entity classification election with the service_center designated on the form sec_301_7701-3 provides in part that an election made under sec_301_7701-3 will be effective on the date specified on form_8832 or on the date filed if no such date is specified on the election form the effective date specified on form_8832 cannot be more than days prior to the date on which the election is filed and can not be more than months after the date on which the election is filed sec_301_7701-3 provides that if an eligible_entity classified as an association elects under sec_301_7701-3 to be disregarded as an entity separate from its owner the following is deemed to occur the association distributes all of its assets and liabilities to its single owner in liquidation of the association sec_301_7701-3 provides that for purposes of sec_301_7701-3 if an election under sec_301_7701-3 is made to change the classification of an entity each person who was an owner on the date that any transactions under sec_301_7701-3 are deemed to occur and who is not an owner at the time the election is filed must also sign the election sec_301_9100-1 permits the commissioner to grant a reasonable extension of time for making certain elections sec_301_9100-3 provides that an extension of time to file certain elections will be granted if the taxpayer is able to establish that it acted reasonably and in good_faith and the grant of relief will not prejudice the interests of the government plr-130037-03 conclusion based solely on the facts and representations submitted we conclude that the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied accordingly taxpayer is granted an extension of time of days from the date of this letter to file form_8832 effective on date with the philadelphia service_center a copy of this letter should be attached to the election a copy is enclosed for this purpose except for the specific ruling above no opinion is expressed or implied concerning the federal_income_tax consequences of the facts of this case under any other provision of the internal_revenue_code this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent sincerely heather c maloy associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes cc


internal_revenue_service number release date index number ------------------------------------------ ------------------------------------ --------------------------------- ------------------------- ----------------------------- - department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------ id no ------------- telephone number --------------------- refer reply to cc psi b01 plr-134711-04 date date ------------------------------------------ ----------- ---------------- -------------------------- legend legend x --------------------------------------------------- country entity date --------- dear ---------------------- requesting a ruling that x be granted an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election under sec_301_7701-3 to be treated as a disregarded_entity for federal tax purposes facts this letter responds to a letter dated date written on behalf of x according to the information submitted x is a country entity x intended to elect to be treated as a disregarded_entity for federal tax purposes effective date however the form_8832 entity classification election inadvertently was not timely filed x represents that it is an entity that is eligible to elect under sec_301_7701-3 to be a disregarded_entity for federal_income_tax purposes sec_301_7701-3 provides in part that a business_entity that is not law and analysis classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes as provided in sec_301_7701-3 plr-134711-04 sec_301_7701-3 provides guidance on the classification of a foreign eligible_entity for federal tax purposes generally a foreign eligible_entity is treated as an association_taxable_as_a_corporation if all members have limited_liability unless the entity makes an election to be treated otherwise if a foreign eligible_entity has one owner it may elect to be treated as a disregarded_entity pursuant to the rules in sec_301_7701-3 if a foreign eligible_entity has more than one owner it may elect to be treated as a partnership pursuant to the rules in sec_301_7701-3 sec_301_7701-3 provides that an entity classification election must be filed on form_8832 and can be effective up to days prior to the date the form is filed or up to months after the date on which the form is filed under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as including an election whose deadline is prescribed by a regulation published in the federal_register sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-1 sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 conclusion based solely on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to file form_8832 with the appropriate service_center and elect to be treated as a disregarded_entity for federal tax purposes effective date a copy of this letter should be attached to the election except as specifically set forth above no opinion is expressed or implied as to the federal_income_tax consequences of the transactions described above under any other provision of the code plr-134711-04 this ruling is directed only to the taxpayer on whose behalf it was requested sec_6110 of the internal_revenue_code provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file with this office a copy of this letter is being sent to the first representative listed sincerely a heather c maloy heather c maloy associate chief_counsel passthroughs and special industries enclosures cc ------------------------ copy of this letter copy for sec_6110 purposes -------------------------------- ---------------------------------------- ---------------------------------- ---------------------------------- -------------------------------------------------------------------------------------------- -------------------------------------------- ----------------------------------


internal_revenue_service number release date index number dollar_figure ------------------------------ ---------------------- -------------------------------------------------- ---------------------------------------------------- department of the treasury washington dc person to contact ---------------------- id no - telephone number ------------------- refer reply to cc tege eb qp - plr-125319-03 date september state x ------------ ein ---------------- dear --------------------- this is in response to your letter of ------------------- and subsequent correspondence on behalf of state x regarding its proposal to amend its leave program state x currently has a comprehensive leave program which offers its employees annual leave personal leave school participation leave and sick leave state x wants to increase the amount of annual leave under state x s leave program this increase in leave will result from negotiations between state x and its collective bargaining units these units cover a significant number of state x s employees this additional annual leave will result in concessions by state x s collective bargaining units and may lower state x s budget costs the concessions may include unpaid hours forgone salary increases longevity payment reductions changes in health premium payments or other similar concessions employees not in the collectively-bargained units will be offered the same leave options similar concessions will also be made applicable to non-exclusively represented employees as approved by state x s civil service commission the program of additional leave that state x will be offering after amendments of its leave program will be referred to herein as part b state x represents that employees will be able to use all of the leave offered under the new leave program no individual employee will have any election or choice regarding whether or to what extent they wish to participate in part b not only will participation by all affected state x employees be mandatory but the amounts of leave time granted under part b will be fixed without employee choice either by agreement of the bargaining representatives or as set by the state for non-exclusively represented employees as under the state s current leave program hours accumulated under part b may be taken in_kind as paid leave time off at any time during the year in which they are accumulated or in any later year up until the time the employee retires or otherwise terminates employment under part b the value of any unused leave remaining at retirement or termination based on the employee s then current wage rate will be contributed to state x s defined_contribution_plan which is qualified under sec_401 a plan or its eligible sec_457 plan b plan the a plan currently provides for both employer nonelective and matching_contributions as well as elective_deferrals grandfathered under sec_401 the b plan currently permits elective contributions and is designed and intended to satisfy all of the requirements of sec_457 for an eligible_deferred_compensation_plan and the trust requirement of g that is applicable to governmental plans amendments to both the a and b plans to permit these contributions under the part b program will be adopted this allocation among the state s plans will be made automatically pursuant to part b and without any employee choice or election involved subject_to any applicable limits on contributions under sec_415 and sec_457 an exception to this is that the value of part b hours which are not eligible for nonelective_contribution treatment under this ruling may at separation death or retirement from state service be taken in cash or contributed to the state’ sec_401 or sec_457 plan by making an election before the amounts become currently available in the case of the a plan and before the beginning of the month in which the amount would otherwise be paid in the case of the b plan it is anticipated that these plan contributions will be made in the year that the employee retires or terminates but contributions may be made in the year immediately preceding retirement termination if the employee provides advance notice thereof the state projects that contributions would otherwise exceed the applicable limits for the final year and such contribution would otherwise meet the requirements of sec_401 or sec_457 in the event that an employee fails to use all of his accumulated part b leave time and the applicable_plan limits prevent the value of the remaining leave time from being contributed to the state sec_401 or sec_457 plans the balance of any unused leave time will be forfeited rulings requested state x also offers an approved leave of absence an approved leave of absence is unpaid leave for medical family-related educational military service political candidacy union service or similar restricted purposes as set forth in the rules and regulations promulgated by the state x civil service commission and approved by state x you have requested the following rulings state x s comprehensive annual and sick leave program constitutes a abona fide leave program under sec_457 the primary function of which is to provide eligible employees with paid time off from work for vacation illness or other personal reasons and the rules of sec_457 are not applicable to the program at any time except at the time and to the extent that the value of any such leave time is actually contributed to state x sec_457 plan neither the accumulation of annual and sick leave program leave time nor the state s contribution of the value of any unused part b leave remaining at the time of an employee s retirement or termination of employment to the state sec_401 plan or b plan as limited by sec_415 and sec_457 or respectively will result in the inclusion of the value of such leave time in the employee s income under sec_451 or sec_457 or under the constructive receipt economic benefit or anticipatory_assignment_of_income doctrines for any of the year s prior to or during the year in which such amounts are so contributed employee has voluntarily taken leave without pay other than for an approved leave of absence at a time when the employee has unused part b paid leave available the state s contribution of any unused part b leave to the state sec_401 plan is not an elective contribution that is made pursuant to a cash or deferred election within the meaning of sec_401 and sec_1_401_k_-1 of the income_tax regulations rather the state s contribution of such part b leave time to the a plan under the program is a nonelective employer_contribution except to the extent that following the inception of the part b program an employee has voluntarily taken leave without pay other than for an approved leave of absence at a time when the employee has unused part b paid leave available no amounts of part b leave time accumulated or contributed in accordance with the annual and sick leave program will be includible in the employee s gross wages for purposes of federal_insurance_contributions_act fica_taxes under sec_3121 except at the time and to the extent that the value of any such leave time is actually contributed to the state sec_457 plan except to the extent that following the inception of the part b program an analysis our analysis of ruling_request one is as follows sec_457 provides rules regarding the taxation of deferred_compensation plans of eligible employers for this purpose the term eligible_employer is defined in sec_457 as a state political_subdivision of a state and any agency_or_instrumentality of a state or political_subdivision of a state state x is an eligible_employer within the meaning of sec_457 sec_457 and sec_1_457-2 set forth the requirements for an eligible_deferred_compensation_plan including rules for participation deferral of compensation and payment of benefits pursuant to sec_457 an eligible_deferred_compensation_plan must provide that the maximum amount that may be deferred under the plan shall not exceed the lesser_of the applicable_dollar_amount dollar_figure in or percent of the participant s includible_compensation under sec_457 a bona_fide sick or vacation_leave plan is treated as not providing for the deferral of compensation_for purposes of sec_457 the service has not issued formal published guidance as to what constitutes a bona_fide sick or vacation_leave program however in determining whether a program is bona_fide some of the factors that may be considered are whether the amount of annual leave or the total amount of leave offered is excessive whether the program is available only to a limited number of employees and whether the facts indicate that there is a reasonable expectation that employees will be able to use all of the leave provided under the program for example factors that would tend to indicate that a program is bona_fide and not a mere device to defer compensation would include whether a leave program is collectively bargained or broad-based in the present case the relevant facts and circumstances indicate that state x’s comprehensive annual and sick leave program is a bona_fide sick or vacation_leave plan within the meaning of sec_457 accordingly the rules of sec_457 are not applicable to the program except at the time and to the extent the value of any such leave is actually contributed to state x sec_457 plan our analysis of the second ruling_request is as follows sec_83 provides that the excess if any of the fair_market_value of property transferred in_connection_with_the_performance_of_services over the amount_paid if any for the property is includible in the gross_income of the person who performed the services for the first taxable_year in which the property becomes transferable or is not subject_to a substantial_risk_of_forfeiture sec_83 provides that sec_83 does not apply to a transfer to a_trust described in sec_401 sec_402 provides that any amount actually distributed to any distributee by any employees trust described in sec_401 which is exempt from tax under sec_501 shall be taxable to the distributee in the taxable_year of the distributee in which distributed under sec_72 relating to annuities sec_1_402_a_-1 provides that if an employer makes a contribution for the benefit of an employee to a_trust described in sec_401 for the taxable_year of the employer which ends within or with a taxable_year of the trust for which the trust is exempt under sec_501 the employee is not required to include such contribution in gross_income except for the year or years in which such contribution is distributed or made available to him it is immaterial in the case of contributions to an exempt trust whether the employee s rights in the contributions to the trust are forfeitable or nonforfeitable either at the time the contribution is made to the trust or thereafter sec_451 and sec_1_451-1 provide that an item_of_gross_income is includible in the gross_income for the taxable_year in which it is actually or constructively received by a taxpayer using the cash_receipts_and_disbursements_method of accounting under sec_1_451-2 income is constructively received in the taxable_year during which it is credited to a taxpayer s account or set apart or otherwise made available so that the taxpayer may draw on it at any time however income is not constructively received if the taxpayer s control of its receipt is subject_to substantial limitations or restrictions under the economic_benefit_doctrine an employee has currently includible income from an economic or financial benefit received as compensation though not in cash form the economic_benefit_doctrine applies when assets are unconditionally and irrevocably paid into a fund or trust to be used for the employee s sole benefit 16_tc_244 aff d per curiam 194_f2d_51 6th cir revrul_60_31 situation 1960_1_cb_174 revrul_75_539 1975_2_cb_45 addressed two fact patterns under which sick leave accumulated by a retiring employee could be applied to the cost of accident_and_health_insurance in the first fact pattern a retiring employee could receive a cash payment for accumulated sick leave or have the payment applied to the cost of the insurance the ruling concludes that unused sick leave credits that are received in cash are includible in the retiree s gross_income under sec_61 further a retiree s ability to relinquish the right to the cash payment and have such an amount applied to the payment of health insurance premiums results in constructive receipt of such amount under sec_451 in the second fact pattern the employer will place accumulated sick leave credits in an escrow account to pay the health insurance premiums until such amounts are exhausted and the retiring employee cannot elect to receive accumulated sick leave in cash the ruling concludes that since the value of the accumulated unused sick leave credits is placed in escrow by the employer solely for the payment of health insurance premiums and may not in any event be received in cash by the employee or the employee s dependents or beneficiaries such amounts are not constructively received under sec_451 under the proposed arrangement the conversion of accumulated unused vacation_leave into a plan contribution is automatic and mandatory the employee s receipt of the accumulated vacation_leave is not constructively received because under no circumstances will an employee be eligible to receive any of the unused vacation_leave credits accumulated before separation_from_service or retirement in cash under the assignment_of_income_doctrine a gratuitous anticipatory_assignment_of_income does not shift the burden of taxation and the donor is taxable when the income is received by the donee see 311_us_112 and lucas v earl 218_us_111 in 356_us_260 the taxpayers assigned the right to a specified sum of money payable out of a specified percentage of oil or the proceeds received from the sale of such oil if as and when produced in return for cash the court concluded that while the oil payments were interest in land the consideration received for the oil_payment rights was taxable as ordinary_income because the lump sum consideration was essentially a substitute for what would otherwise be received at a future time as ordinary_income in other words the taxpayer converted future income into present income and was taxable on such present income under the proposed arrangement each employee s unused vacation_leave will be converted automatically into a contribution to either the a plan or the b plan distributions of amounts contributed will be subject_to the rules for a plans and b plans under the code under no circumstances will an employee be eligible to receive any of the unused vacation_leave credits accumulated before separation_from_service or retirement in cash therefore an employee cannot voluntarily forego future taxable_income for other consideration and the plan contributions will not be a substitute for amounts that the employee would otherwise receive as current compensation accordingly neither the accumulation of part b leave time nor state x s contribution of any unused part b leave remaining at the time of an employee s retirement or termination of employment to the state sec_401 plan or b plan as limited by sec_415 and sec_457 or respectively will result in the inclusion of the value of such leave time in the employee s income under sec_451 or sec_457 or under the constructive receipt economic benefit or anticipatory_assignment_of_income doctrines for any of the years prior to or during the year in which such amounts are so contributed our analysis of the third ruling_request is as follows sec_401 provides in pertinent part that a qualified_cash_or_deferred_arrangement is any arrangement which is part of a profit sharing plan or stock_bonus_plan a pre-erisa_money_purchase_plan or a rural_cooperative_plan which meets the requirements of sec_401 and under which a covered_employee may elect to have the employer make payments as contributions to a_trust under the plan on behalf of the employee or to the employee directly in cash sec_1_401_k_-1 provides that a cash or deferred election is any election by an employee to have the employer either a provide an amount to the employee in the form of cash or some other taxable benefit that is not currently available or b contribute an amount to a_trust or provide an accrual or other benefit under a plan deferring the receipt of compensation a cash or deferred election includes a salary reduction agreement between an employee and employer under which a contribution is made under a plan only if the employee elects to reduce cash compensation or to forgo an increase in cash compensation sec_1_401_k_-1 defines nonelective contributions as employer contributions other than matching_contributions with respect to which the employee may not elect to have the contributions paid to the employee in cash or other_benefits instead of being contributed to the plan sec_1 m - f defines matching_contributions as a any employer_contribution including contributions made at the employer s discretion to a defined_contribution_plan on account of an employee s contribution to a plan maintained by the employer b any employer_contribution including a contribution made at the employer s discretion to a defined_contribution_plan on account of an elective_deferral as defined in sec_1_402_g_-1 and c any forfeiture allocated on the basis of employee contributions matching_contributions or elective contributions under part b of state x s leave program except to the extent that following the inception of the part b program an employee has voluntarily taken leave without pay other than for an approved leave of absence at a time when the employee has unused part b paid leave available an employee does not have a choice to receive a cash payment or other taxable benefit for this leave an employee s only choice is to use the leave or have its value contributed to the a plan or the b plan thus subject_to the exception in the first sentence of this paragraph the contribution of the value of part b leave to the a plan is not an elective contribution pursuant to a cash or deferred election moreover the value of part b leave contributed to the a plan is not based upon any contribution by an employee therefore the contribution is not a matching_contribution in view of the foregoing we conclude with respect to ruling_request number three that under current regulations except to the extent that following the inception of the part b program an employee has voluntarily taken leave without pay other than for an approved leave of absence at a time when the employee has unused part b paid leave available the contribution of the value of part b leave to state x sec_401 plan is a nonelective_contribution rather than an elective contribution pursuant to a cash or deferred election with respect to the fourth ruling_request we note the following sec_3121 excludes service for a state_or_local_government from employment for fica purposes however sec_3121 provides an exception to sec_3121 if the employee is not a member of a state retirement_system whether a retirement arrangement is a state retirement_system generally depends upon whether the retirement arrangement provides benefits equivalent to social_security_benefits if the employees are members of a retirement_system and therefore exempt from fica tax under sec_3121 they may nevertheless be subject_to the medicare portion of fica_taxes under sec_3121 all state_or_local_government employees hired after date are subject_to medicare_tax regardless of membership in a retirement_system even though state_or_local_government employees are covered under a retirement_system within the meaning of sec_3121 the state may also choose to cover its employees under social_security by entering into an agreement with the social_security administration these agreements are commonly referred to as a sec_218 agreements under sec_3121 service covered under a sec_218 agreement is excepted from the sec_3121 exclusion for purposes of this response we assume that the state x employees at issue are covered under fica by reason of sec_3121 or sec_3121 or if the employees are members of a state retirement_system within the meaning of sec_3121 because the state has entered into a sec_218 agreement with the social_security administration given this assumption the rules regarding the fica tax treatment of qualified_retirement_plan benefits and state_or_local_government retirement_plan benefits govern in determining whether and when retirement benefits provided under the leave program will be subject_to fica tax with respect to contributions to be made to the a plan our analysis is as follows sec_3121 excludes from wages any payments made to or from a_trust that is part of a qualified_plan this exception applies regardless of whether the employer is a state_or_local_government however sec_3121 provides that any employer contributions under a qualified_cash_or_deferred_arrangement as defined in sec_401 are not excepted from wages under sec_3121 to the extent such contributions are not included in gross_income by reason of sec_402 excluding elective_deferrals from gross_income thus employee elective_deferrals are subject_to fica tax at the time of the contribution to the trust accordingly whether contributions to the a plan pursuant to the leave program are fica wages depends upon whether the contributions are elective_deferrals since we have concluded that under current regulations except to the extent that following the inception of the part b program an employee has voluntarily taken leave without pay other than for an approved leave of absence at a time when the employee has unused part b paid leave available the part b contributions to the a plan under the leave program are not elective_deferrals they are subject_to the same exception not subject_to fica taxation with respect to contributions to be made to the b plan our analysis is as follows sec_3121 provides that payments made under or to an exempt_governmental_deferred_compensation_plan as defined in sec_3121 are not wages sec_3121 provides that the term exempt_governmental_deferred_compensation_plan means any plan providing for deferral of compensation other than any plan to which inter alia sec_457 applies sec_457 defines a plan to which sec_457 applies notices 2000_2_cb_174 and 2003_19_irb_894 state that payments under a sec_457 plan are subject_to fica tax based upon sec_3121 and the regulations thereunder thus payments to a sec_457 plan are fica taxable if sec_3121 is properly applied distributions from a sec_457 plan are not fica taxable based upon the nonduplication rule under sec_3121 regarding timing sec_3121 provides special timing rules that determine when amounts deferred under a nonqualified_deferred_compensation_plan including employers contributions are required to be taken into account under this section an amount deferred under a nonqualified_deferred_compensation_plan including a sec_457 plan is required to be taken into account for purposes of fica_taxes as of the later of when the services are performed or when there is no substantial_risk_of_forfeiture of the rights to such amount notice_2003_20 part vi c example describes a sec_457 plan that provides for elective_deferrals from current salary as well as a one percent of salary nonelective_contribution for each employee all deferrals and contributions including the state’s contributions are described as fully and immediately vested the example concludes that because these contributions are not subject_to a substantial_risk_of_forfeiture and the services to which they relate have already been performed the elective_deferrals are required to be taken into account as wages at the time of the deferral and the state’s nonelective contributions are required to be taken into account as wages at the time of the contribution for purposes of fica tax except as specifically ruled upon above no opinion is expressed as to the plr-125319-03 contributions to state x’ sec_457 plan will not be subject_to a substantial_risk_of_forfeiture and the services to which they relate will have already been performed thus the contributions will be subject_to fica tax at the time of contribution no amounts of part b leave time accumulated or contributed in accordance with state x’s leave program will be includible in the employee’s gross wages for purposes of fica except at the time and to the extent that the value of any such leave time is actually contributed to the state’ sec_457 plan federal_income_tax consequences of the leave program under any other provision of the code if the program is modified this ruling will not necessarily remain applicable this ruling is directed only to state x and applies only to the program submitted by a transmittal letter dated date as revised by amendments submitted on date and date sec_6110 of the code provides that it may not be used or cited as precedent in this ruling have not yet been adopted therefore this ruling may be modified or revoked if the adopted temporary or final regulations are inconsistent with any conclusions in this ruling see section dollar_figure of revproc_2003_1 2003_1_irb_1 however when the criteria in section dollar_figure of revproc_2003_1 2003_1_irb_1 are satisfied a ruling is not revoked or modified except in rare or unusual circumstances temporary or final regulations pertaining to one or more of the issues addressed sincerely yours robert d patchell chief qualified_plans branch two office of the division counsel associate chief_counsel