Rev. Rul. 68-294

The Internal Revenue Service has been asked whether the death benefit exclusion provided by section 101(b) of the Internal Revenue Code of 1954 applies to amounts received as death benefits by the beneficiary of a public school teacher pursuant to an annuity contract purchased for him by a public school system under section 403(b) of the Code.

The public school system, an integral part of a local government, purchased an annuity contract for a teacher pursuant to an arrangement that met the requirements of section 403(b) of the Code. The teacher made no contributions toward the purchase of the annuity contract and had a nonforfeitable right, while living, to the amounts contributed. The teacher died and his beneficiary received the proceeds of the contract as a death benefit.

Section 101(b) of the Code provides that gross income does not include an amount up to 5,000 dollars received by the beneficiaries or the estate of an employee, if such amount is paid by or on behalf of an employer by reason of the death of the employee. However, that section does not apply to amounts with respect to which the employee possessed, immediately before his death, a nonforfeitable right to receive the amounts while living, unless the total distributions payable are paid within one taxable year of the distributee by reason of the employee's death, under one of the arrangements specified in section 101(b)(2)(B) of the Code.

One of the arrangements specified in section 101(b)(2)(B) of the Code involves payment under an annuity contract purchased under section 403(b) by an employer which is an organization referred to in section 503(b)(1), (2), or (3) of the Code and which is exempt from Federal income tax under section 501(c)(3) of the Code.

Revenue Ruling 60-384, C.B. 1960-2, 172, discusses the circumstances under which an organization may be an employer described in section 501(c)(3) of the Code and, therefore, may be granted exemption thereunder, regardless of the fact that it is also a wholly-owned state or municipal instrumentality and, as such, would not be subject to Federal income tax. That Revenue Ruling holds that a state or municipality itself will not qualify as an organization described in section 501(c)(3) of the Code since its purposes are clearly not exclusively those described in that section. Thus, where the particular branch or department under whose jurisdiction the activity in question is being conducted is an integral part of a state or municipal government the provisions of section 501(c)(3) of the Code would not be applicable. For example, a public school, college, university, or hospital that is an integral part of a local government cannot meet the requirements for exemption under section 501(c)(3).

Since the public school in the instant case is an integral part of a local government, it does not meet the requirements for exemption under section 501(c)(3) of the Code. Accordingly, the death benefit exclusion granted under section 101(b) of the Code does not apply to amounts received as death benefits by the teacher's beneficiary. Neither does the estate tax exclusion under section 2039(c) of the Code nor the gift tax exclusion under section 2517 apply.