Internal Revenue Service Department of the Treasury

Number: 200130015 Washington, DC 20224

Release Date: 7/27/2001
Index Number: 451.14-00 Person to Contact:

Telephone Number:

Refer Reply To:

PLR-128287-00/CC:TEGE:EB:EC
Date:
April 26, 2001

X =
Plan =

Employees =

This is in response to your request for a ruling for X, a municipality, regarding the
cashout of future vacation leave under the Plan by employees of X. Vacation leave is
earned on a monthly basis on the first day of each month. Employees may carry over
unused vacation hours into following years, subject to maximum limitations. Within a
calendar year, employees are allowed to accrue vacation hours beyond the maximum
limits only if used within that year. Employees with unused vacation time on the date of
their separation from service receive a cash distribution equal to the number of hours of
unused vacation leave multiplied by their then current rate of pay.

X has entered into a collective bargaining agreement with certain bargaining unit
employees. Under the terms of the agreement, employees will be allowed to cash out
some excess vacation hours prior to separation from service under the terms of the
Plan. Under the Plan, an employee would have an opportunity to elect irrevocably at
any time on or before December 31st of each year to receive cash for part or all of the
amount of vacation hours that would otherwise accrue in the immediately following six
month period, but not to exceed 40 hours for each six month period. For example, in
Year 1, an eligible employee can irrevocably elect to receive payment for 40 hours that
will be earned from January 1 through June 30, Year 2, and payment for another 40
hours that will be earned from July 1 through December 31, Year 2. To be eligible to
make the election, the employee must have at least 56 hours of accrued but unused
vacation leave to carryover to the year in which the vacation is cashed out. Any
vacation time actually taken by the employee will be subtracted first from any carryover
hours which existed at the end of the prior year and then from vacation hours accrued
in the current year for which no election has been made. The election shall be made by
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filing a written notice with X. The election is only valid for one year, therefore, an
employee must make a new election by December 31st with respect to vacation accrued
during the next calendar year. The election is irrevocable, and the employee can
neither increase (if fewer than 40 hours were originally to be paid out) nor decrease the
number of hours for which payment will be made.

In addition, any employee who has both completed at least 16 years of service
with X and who has also reached the maximum number of carryover vacation hours
may, in lieu of the election discussed above, elect at any time on or before December
31st of any eligible year to receive payment for all vacation hours that would otherwise
accrue in a defined 36 consecutive month period (the “increased pay period”), starting
as of the first of the month in the following year and continuing for 36 months. The
employee must meet both the service and maximum hours requirements at the time the
election is made. The foregone vacation hours would be valued and paid out monthly
at the hourly rate then-applicable to the employee during each month. This election
can be exercised only once during an employee’s career. If an employee who has
made this election continues in service after the end of the initial 36-month period, the
employee can irrevocably elect before the end of the first increased pay period to
extend the election for up to an additional 36 consecutive months. This extension
would be allowed only once. The only paid vacation time available to an employee
during the increased pay period would be from vacation hours accrued before and
carried over to the increased pay period. The employee can elect to discontinue
payment of vacation earned during the increased pay period. This election would apply
beginning on January 1 of the following year during the increased pay period. The
election to discontinue the cash-out of foregone vacation hours is irrevocable for the
remainder of the employee’s service with X.

Section 451(a) of the Internal Revenue Code and section 1.451-1(a) of the
Income Tax Regulations provide that an item of gross income is includible in gross
income in the taxable year in which it is actually or constructively received by a taxpayer
using the cash receipts and disbursements method of accounting. Under section
1.451-2(a) of the regulations, income is constructively received in the taxable year
during which it is credited to a taxpayer's account, 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.

In general, where a taxpayer has entered into a binding contract or agreement to

defer income before it is earned, the amounts deferred are not includible in income by a
cash basis taxpayer until it is received. See Veit v. Commissioner, 8 T.C.M. 919
(1949); Oates v. Commissioner, 18 T.C. 570 (1952), aff’d 207 F.2d 711 (7th Cir. 1953).

Under the Plan, an employee makes an election to receive payment for vacation
in the year before the vacation is earned. This mere right to make the election does not
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trigger the constructive receipt of income for eligible employees.

Based on the information provided and the representations made, we conclude
that:

1. Under the constructive receipt doctrine of section 451 of the Code, the mere
right of an employee to make an election under the Plan shall not result in taxable
income for the employee under the cash receipts and disbursements method of
accounting if the employee chooses not to make such an election.

2. Under the constructive receipt doctrine of section 451 of the Code, an

election under the Plan made by an employee to cash out part or all of the employee’s
vacation leave that will be earned in a future year shall not result in taxable income for
the employee under the cash receipts and disbursements method of accounting until
the taxable year in which the amounts are actually paid or otherwise made available.

This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.

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

The rulings contained in this letter are based upon information and
representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

Sincerely,
Charles T. Deliee
Chief, Executive Compensation Branch
Office of the Associate Chief Counsel
(Tax Exempt and Government Entities)