ATTACHMENT

[oLJIPER
MEMORANDUM
TO: FROM: DATE: RE: Dr. Joshua Starr, Secretary/Treasurer to the Board of Education of Montgomery County DLA Piper LLP (US) December 9, 2013 Tax Treatment of Certain Program Payments

You asked for our advice on whether certain payments made to students at Rock Terrace School by Montgomery County Public Schools ("MCPS") should be considered taxable income and/or wages subject to Federal and State income and employment tax withholding and reporting. Statement of Facts We have been advised that the relevant facts are as follows. One of the schools in the MCPS system, Rock Terrace School in Rockville, Maryland, is a separate public day school serving students from age 11 through 21 who have a wide range of significant physical and cognitive disabilities such as autism spectrum disorders, speech and language disorders, emotional impairment, and other health impairments. The school prepares students for independent living, integrated employment, and participation in the community using functional learning experiences, vocational skills training, transition to independent living preparation, and a modified MCPS program of studies. Rock Terrace School is composed of three academic levels: the Middle School (Grades 6, 7 and 8; ages 11-14); the High School (Grades 9, 10, 11 and 12; ages 15-17); and the three-year Upper School Transition Program (referred to, at Rock Terrace, as grades 13, 14 and 15; typically ages 18-21). Within each level, classes may contain students from various grades. Each student has an Individualized Education Program ("IEP"). Students typically require close supervision by faculty members to protect the students and provide special guidance and training. The Upper School Transition Program concentrates on teaching functional life skills with a curriculum designed to teach independent living skills, including skills related to potential employment following completion of the Transition Program. Rock Terrace offers two varieties of work experience programs: school-based programs and off-campus programs. Over the past several years, the curriculum of these various work experience programs has included a component designed to teach selected students the real-life skill of receiving and handling money and to simulate the connection between work and compensation. A part of this program included students receiving and handling certain limited amounts of funds provided by the school or the school

system. While the manner in which this program was implemented has changed over the years, the program was always intended to be solely for educational purposes and the funds used in and payments to students under the program were never intended to be, or structured as, compensation for services rendered by students. Any indication to the contrary would have been due only to the educational nature of the program and the attempt to create a "real-life experience" for students taking into account their cognitive disabilities and the purpose of the program.

School-based Work Experience Programs There are three school-based work experience programs: Culinary, Office Skills and Practices, and Home Survival Skills. These programs provide prevocational training in basic culinary skills, office work, and woodworking/home living skills and include various types of work training experience within the school itself. Students work in the food service cafe and catering program (culinary), the recycling/shredding program (office skills), and woodshop program. For example, with assistance of school staff, they sell coffee and snacks to students and staff in the morning, help prepare school lunches, and learn how to wash dishes as part of the culinary skills class. They learn to unpack boxes, stack paper and supplies, and use the shredder as part of the office skills class. They learn how to change a light bulb, use a hammer, and other rudimentary household chores. In order to teach about money, the school periodically paid selected students small amounts based on the number of these prevocational classes taken and their level of performance/participation.1 In the earlier years of this program, the school wrote separate checks made payable to each student in the program. To teach the student about banking, a faculty member would help the student open an account at the Montgomery County Teachers' Credit Union ("MCTCU"), which had a physical branch at the Rock Terrace School until 2010, and make deposits of these checks into that account. Due to complaints by MCTCU, in later years the school wrote a single check representing the amounts for several students, and that faculty member would then assist students in depositing amounts into separate MCTCU accounts. While all banking records are not yet available for these MCTCU accounts and transactions, it appears that prior to 2008, these accounts were established as joint accounts naming the student and a faculty member as the accountholders. As a result of some incident that raised a concern about liability of the faculty member named as joint owner on the accounts, beginning in 2008, it was no longer the practice for faculty members to be listed as joint owners of these accounts and some faculty member names were taken off of existing accounts. Sometime in 2009 or 2010, MCTCU indicated that it would not continue the in-school banking program. Thereafter, the amounts students were deemed to earn in the school-based work experience programs were credited to a sub-account in the school's Independent Activity Fund ("IAF"). The IAF is an audited account established by the school to promote the general welfare, education, and morale of students as well as to finance the recognized extracurricular activities of the student body. The school's principal is the fiduciary agent of the IAF charged with determining the manner in which funds are raised and expended for activities such as field trips, admission events and fundraisers. It is unclear whether these amounts paid to the students pursuant to the program actually belonged to the students. It is our understanding that some of the faculty members who administered the program understood that the funds at all times belonged to the school and the funds were given to students to teach them about money. Presumably this would be no different from giving students textbooks and other educational materials to use in the education process. This understanding of the program funds would be consistent with the fact that at various times the school made withdrawals from the accounts with MCTCU and from the IAF sub-account to pay for educational and school activities and student programs that may or may not have directly benefited or been used for activities that involved the student to whose accounts the funds were allocated. We also understand that other faculty members understood that the funds paid to students belonged to the students, even though the amounts were not Prior to 2008, students were given up to $2.00 per class period. From 2008 until 2012, the amounts were based on grades: an "A"= $1.00; "B" = $0.80; and a "C" = $0.70 per class. Beginning in 2012, this system was simplified to be $1.00 per class if the student earned a grade of 85% or better.
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intended to be compensation for any services performed by the students. Prior to 2010, there were instances where students were given any unexpended funds in their accounts upon graduation. That practice was discontinued in 2010, however, when the amounts were credited to a sub-account in the school's IAF.

Off-campus Work Experience Programs There were two types of off-campus work experiences. The first was unique to a limited number of Rock Terrace students who attended class for the first and last periods of the day and, in the interim, went off-site to "work" for business partners such as CVS, Kohl's and Giant, where they could learn real life work skills. The school provided all training and all on-site supervision. For example, for a hotel partner, the student might learn to do laundry; for a supermarket partner, the student might learn how to stock shelves, unload trucks, and unpack boxes; for a retail business partner, the student might learn to fold clothes; for an office partner, the student might learn to copy and collate. It depended on the type of business partners available at a given time and the interests, capability, and skill level of the individual students. The students' activities were solely for training purposes, did not take the place of services that would otherwise be performed by regular employees, and the students' quality of work was not expected to meet the same standards as employees. The students' services were not subject to termination by the business partners, and the school maintained the sole right to control the students and the performance of services in the context of the educational purpose of the program. There were no payments from the business partners to the students in connection with this training, and this program did not involve payments from the school similar to those made to students in the school-based programs to teach them about money.2 There is a second off-campus work experience program that is operated by the school system's Transition Services Unit.3 This program is for select students who have successfully completed the inschool vocational programs, the off-campus work experiences, and, consistent with the students' IEPs, skills, and abilities, are deemed to have the potential for independent, outside employment in the private sector. These students prepare for a mock job interview, learn to fill out job applications, and generally go through a mock "real world" job application and hiring process before they are placed in positions with business partners or MCPS. The work activities are on a daily basis, and the nature of the training depends on the operations of the business partner. The students' activities in this program are solely for training purposes, do not take the place of services that would otherwise be performed by regular employees of the business partner or MCPS, and the students' quality of work is not expected to meet the same standards as employees. The school system is solely responsible for supervision of these students. The degree of supervision and support from school staff declines as the students become more proficient and are able to perform their assigned tasks independently. The goal is to enable students to be hired by that business partner or another private employer when they graduate.4 Students in this program are not employed or paid for their labor by the business partner or MCPS. However, as part of this training program, to teach the student about money and the relationship SYMS was a business partner for this program and it made donations directly to the school based generally on a formula based on the number of students and the number of hours those students "worked" per day/week. Information from staff estimated that SYMS donated approximately $500-$600 per month and a total of $10,000 over the period in which it was a business partner. These donation amounts were not intended to be compensation paid to students and the donations were not in fact paid to the students who participated in this off-campus work program. SYMS did not issue Forms W-2 for the students who participated in this program at SYMS. 3 Although Rock Terrace had as many as ten (10) students participate in the past, more recently approximately three (3) students per year participate in the Transition Services Program where students are paid through the MCPS payroll system. This work experience program operates in a number of MCPS high schools, not just Rock Terrace. 4 It is possible for a student to be hired by the employer before the student's education terminates at the end of the school year in which the student becomes 21 years of age. Students who are hired and paid by the private employer before their education ends continue to attend school, but on a part-time basis. -32

between work and pay, MCPS issues a "paycheck" to these students through the MCPS payroll system. Students in this program receive $3.65 for each day worked for a business partner or MCPS; it was intended that the students could keep these amounts. Solely for internal MCPS systems purposes, in order to issue these checks, these students were listed in the payroll system as "temporary, part-time workers" even though they did not in fact qualify as such under MCPS regular classifications. MCPS did not withhold or pay any income or employment taxes on these amounts paid to the students in this program. The funds used to make the payments to the students were drawn from a line item in the school system's budget for special education. Where possible, these checks generated by the MCPS payroll system were direct deposited into the students' individual accounts at the MCTCU or elsewhere. Because these payments were made using the MCPS payroll system, that system automatically generated Forms W-2, even though there was no intent that these students be treated as employees who earned wages from MCPS. MCPS failed to separate the Forms W-2 generated with respect to amounts paid in connection with this educational program from the Forms W-2 generated with respect to amounts paid to employees, and those system-generated W-2s were inadvertently sent to the IRS along with the W-2s for employees. MCPS did not intend that any such amounts would be treated as W-2 income with respect to any student receiving these Transitional Service Unit payments. To the extent that these payments made to students in the Transition Services Unit program were deposited into joint MCTCU accounts established prior to 2008, it is possible that amounts were commingled with amounts attributable to the school-based programs and withdrawn to pay program expenses. That appears to be unlikely, however, because students in the Transition Services Unit program would not have participated in most of the school-based activities that were funded with amounts attributable to those accounts.

Summary of Conclusions
Based on these facts and for the reasons stated below, we believe that there is a reasonable basis to conclude that the amounts that MCPS paid to Rock Terrace School students as part of their work experience training should not be considered gross income and/or wages subject to Federal or State income or employment tax withholding, payment or reporting.

Analysis Status as School Funds

Under Section 451 (a) of the Internal Revenue Code of 1986, as amended (the "Code"), an amount is treated as gross income for a taxable year in which it is actually or constructively received. While in most circumstances, the receipt of an amount clearly results in that amount being taxable to the recipient, under certain circumstances the result is not so clear. For example, in some circumstances, where an individual receives funds that may belong to or may be subject to claims of others, he may not be taxable on the amount. In Ill. Power Co. v. Comm., 58 AFTR 2d 86-5122 (792 F.2d 683) (1986), the court stated that gross income does not include amounts for which an individual may be a mere custodian with no claim of right to the funds. Likewise, an individual may not be taxable on amounts credited to his account where the facts indicate that the individual does not know about it or derive any benefit from the funds. For example, in Roberts v. U.S., 66 AFTR 2d 90-5109 (734 F. Supp. 314) (1990), taxpayers were not required to pay tax on funds erroneously credited by their brokerage firm to their personal options trading account where they were not aware the funds were credited and did not treat the funds as belonging to them. The fact that the taxpayers could have used the money while it was in the account was irrelevant. Because the taxpayers derived no benefit, profit, or gain from the funds, the court found that the funds were not taxable income to the individuals. Id. Based on this authority, there appears to be a reasonable basis to conclude that the students should not have been taxable on the payments made for instructional purposes only pursuant to the school-based work experience programs. While we understand that the facts related to these payments are not clear and there are inconsistent views about the ownership of the funds, there are several facts which do support the conclusion that the funds did not belong to the students. First, the purpose of the

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payments indicates that amounts were not earned for services rendered but were a tool for teaching these students basic concepts related to the receipt and handling of money. In this respect, the payments to the students may be similar to providing them with textbooks or other educational tools that are the property of the school. Second, the fact that the amounts were deposited into joint bank accounts prior to 2008 indicates that the school intended to, and did, maintain control over and ownership of these amounts. The fact that the amounts were later maintained in a sub-account in the IAF, which is an account maintained and owned by the school, also is consistent with the understanding that the amounts belonged to the school and not the student. Third, the school from time to time withdrew and used money from these accounts for programmatic purposes that benefited students other than the student named on the account, which indicates that the funds were not intended to belong solely to the student listed on the account. These facts indicate that the funds used for the payments belonged to the school, not to the students who received them. Ill. Power Co. v. Comm., supra. Moreover, even if ownership of the funds may be contested and subject to differing interpretations, to the extent that the student receiving the payments under the program did not actually derive a benefit from the funds because they were used for the benefit of other students, the student should not be taxable on those amounts. Roberts v. U.S., supra. General Welfare Exemption Section 61 of the Code provides that, unless an exemption applies, gross income means all income from whatever source derived. Through rulings, however, the IRS has established a "general welfare exemption" from treatment of amounts as gross income. Under the general welfare exemption, disbursements by a governmental unit that are made to individuals in the interest of the general welfare, where services are not rendered, are excludable from the recipient's gross income. In Revenue Ruling 75-246, 1975-1 CB 24, the IRS addressed whether allowances paid to participants in a work training program should be considered gross income or exempt general welfare payments. The IRS stated that the determination of whether payments under the work training programs are includable in the participant's gross income "rests on whether the activity for which the payments are received is basically the performance of services or is only participation in a training program that promotes the general welfare. If the activity engaged in is basically the performance of services, the payments are compensation for services rendered, and are includible in the gross income of the recipient. Conversely, if the activity amounts only to participation in a training program, the payments are in the nature of relief payments made for the promotion of the general welfare and are excludable from the gross income of the recipient." The IRS ruled that where private and public agencies provided training designed to upgrade occupational skills, and the trainee performed no services for the agencies, payments received by the trainee from the agencies as an allowance were in the nature of relief payments made for the promotion of the general welfare and were not includible in the recipient's income. Id. The Rock Terrace School programs should be treated as work training programs for this purpose. Based on the facts as we understand them, the payments that participants receive appear to be based on the educational purpose of the program and not for the performance of any valuable services. The payments to students in the school-based programs are nominal amounts based on attendance or academic performance, and payment to students in the Transition Services Unit training program is no more than $3.65 per day. In all cases, the amounts bear no relation to the minimum wage or the performance of services. The payments are intended only to help students learn how to handle money. Based on these facts, it should be reasonable to conclude that any payments deemed to have been received by students as part of the Rock Terrace School school-based or off-campus training program should be exempt from gross income based on the general welfare exemption described in Revenue Ruling 75-246 because the payments are associated only with participation in the program and not the performance of services.

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Gift Exemption

Section 102 of the Code excludes gifts from income. Neither the Code nor the regulations thereunder define the term "gift" for this purpose. Moreover, the courts have not provided any comprehensive definition. Rather, they have tended to apply a broad definition that looks at "all of the factors" and relies on "practical human experience", recognizing that "reasonable men could reach differing conclusions" in many cases. Commissionerv. Duberstein, 363 U.S. 278, 287-8, 291-2 (1960). To the extent that the funds paid to students belonged to the school, we understand that prior to 2010, in some cases, the funds used in the school-based instructional programs were given to students upon graduation. If and to the extent that the funds paid to students belonged to students at any prior point in time as a result of these educational programs, the school does not appear to have been under any obligation to pay those amounts. Rather, the facts indicate that these amounts were paid solely for educational purposes and not as compensation for services rendered or other consideration which resulted in any economic benefit to the school. We are not aware of any binding obligation of the school to make these payments or to allow the students to keep them. Given the non-technical nature of the term "gift" under the Code, we believe that a court could reasonably conclude that, under these circumstances and considering the disabled nature of the students involved, allowing them to keep small amounts that were paid to them solely to teach them about money would constitute a gift for Federal income tax purposes. Classification as "Wages" for Reporting and Tax Withholding Purposes For the reasons set forth above, we do not believe that the amounts received by students as part of the Rock Terrace School school-based or off-campus training program should be treated as taxable income. However, even if they were so treated, those amounts should not be treated as "wages" paid by MCPS subject to income and employment tax withholding and reporting. In a number of rulings, the IRS has recognized that an employer-employee relationship does not exist where the primary purpose of the arrangement is for training and an employer-employee relationship is not intended. See e.q., Rev. Rul. 65-165, 1965-1 CB 446 (administrative exclusion from employee status for certain disabled individuals performing services in a sheltered workshop) and Private Letter Ruling (PLR) 8040025 ("[t]he fact that the [sheltered workshop] requires the trainee to provide services in an employment-type atmosphere does not create a legal relationship of employer and employee because it is done only to give the trainee a truer sense of the work experience."). Although many of the rulings involve unique facts, based on the facts set out above, we believe that the primary purpose of the MCPS program is training and that no employer-employee relationship is intended. Maryland State Taxes Pursuant to Md. Code Ann. Tax-Gen. section 10-203, an individual's Maryland state gross income subject to tax starts with gross income for Federal tax purposes, and pursuant to Md. Code Ann. Tax-Gen. section 10-905(e-1), Maryland generally follows the Federal tax definition of wages subject to withholding. Therefore, although there is no specific authority on point regarding the treatment of these programs under Maryland tax laws, it is reasonable to conclude that the tax treatment under Maryland law should be the same as under the Code as described above.

*** The analysis in this memorandum is based on our understanding of the statement of facts provided to us and set forth herein. We have not performed an independent investigation of the facts or reviewed any documents related to the facts stated above. Any change to the facts or misstatement of the facts could change the conclusions and therefore, in that case, this analysis would not apply. In addition, the facts are general in nature, may have changed from year to year, and may be different for

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each student. Therefore, the analysis herein may not be relied upon by MCPS, the Board of Education, or any student as tax advice with respect to the treatment of any amounts paid to that student. This memorandum is based on regulations, rulings, and decisions generally available as of the date hereof. Because the facts are unique, and we did not find any guidance directly addressing the specific facts described herein, the conclusions in this memorandum cannot be said to be entirely free from doubt. The IRS, state, or any court, if called upon to address these issues, could reach a different conclusion. This memorandum, which is addressed solely to you as the Secretary/Treasurer to the Board of Education of Montgomery County, may not be used, circulated, quoted or otherwise relied upon by any other person or entity or for any other purpose.

Circular 230 Notice: In compliance with U.S. Treasury Regulations, please be advised that any tax advice given herein (or in any attachment) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax penalties or (ii) promoting, marketing or recommending to another person any transaction or matter addressed herein.

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