PLR 200003054: Welfare fund return avoids retroactive revocation and the employer excise tax

Plain-English summary

A former hospital operator planned to end its voluntary employees' beneficiary association (VEBA). After paying claims, the fund would send 33 percent of its assets through the current hospital operator to eligible former employees, and return 67 percent to the former operator for its charitable program. The IRS ruled that the plan would not revoke the VEBA's earlier exemption retroactively and that the returned assets would not trigger the 100 percent employer excise tax under § 4976. The proposed amendment permitting an employer distribution would disqualify the VEBA under § 501(c)(9) when adopted, and the later transfer would also disqualify it. The excise tax analysis treats the exempt operator's contributions as not deductible under § 419 unless directly connected with an unrelated trade or business.

Ruling snapshot

• Question: Will the VEBA's planned distributions revoke its prior exemption or impose the § 4976 tax on the employer?
• Outcome: Approved as to no retroactive revocation and no § 4976 tax; current VEBA exemption ends with the amendment.
• Key authorities: IRC §§ 501(c)(9), 419, 4976(b)(1)(C), 4976(b)(3); Treas. Reg. § 1.501(c)(9)-4(d).

Full text (IRS public release)

200003054

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

Date: OCT 27 1999
In Reference to: OP:E:EO:T:2
Employer Identification Number:
LEGEND: M =

Dear Sir or Madam:

This is in reply to your letter requesting several rulings regarding the transfer of the assets of a
tax exempt health and welfare fund back to you.

You have been recognized as exempt from Federal income tax under section 501(c)(3) of the
Internal Revenue Code and are a public charity within the meaning of section 509(a)(3) of the Code.

You previously operated a hospital. You stopped operating the hospital several years ago and,
at that point in time, you entered into an operating agreement with several other unrelated health
care providers to continue to provide health care in the area and transferred your operations to
them. These entities have since merged and are now operating as M. M has been recognized as
exempt under section 501(c)(3) of the Code and currently is an active medical care provider and a
public charity for purposes of section 509(a). You continue to support M in carrying out its mission
to provide health care in the region. Your responsibilities under the operating agreement include
providing funding for capital expenditures and improvements needed for the existing health care
facility, including capital equipment. Although you intend to continue to operate as a charity, you
expect to ultimately need few or no employees to carry on your exempt charitable activities.

While you operated the hospital you established a voluntary employees’ beneficiary association
(VEBA) to provide for the payment of health and welfare benefits to your hospital employees. The
VEBA has been recognized as exempt from Federal income tax under section 501(c)(9) of the Code.
You intend to have the trustees of the VEBA trust amend its governing instruments to provide that
the VEBA be terminated. After the payment of any outstanding claims, the remaining funds will be
transferred to you and certain of your former employees. The amounts to be transferred are based
on the amounts originally contributed to the VEBA by each party. You have represented that 67
percent of the funds were contributed by you and 33 percent were contributed by your former
employees.
As represented in your letter of July 9, 1999, the VEBA will distribute 33 percent of the funds it
is holding (representing the amount employees contributed to the VEBA in 1995) to M and M will
distribute a lump sum payment on a pro rata basis to each eligible employee. The employees
eligible to participate in this transaction are those individuals who were employed by you as of the
last day of 1995, who are now on the payroll of M or any other organization related directly to M,
which is still providing services to M. Your former employees who are not now on the payroll of
the new hospital or a similarly situated related employer will not receive any benefit from this
transfer. In addition, a former employee who does not currently have to contribute to their current
health care plans will not receive any benefit.

You have represented that the new hospital will not receive any benefit from the distribution but
will receive a nominal savings on its administrative fee. You also represent that the employees who
shall benefit from the distribution of assets from the VEBA have been selected in a manner which
does not provide for disproportionate benefits to officers, shareholders, or highly compensated
employees.

You expect to use the remaining 67 percent of the fund (representing your contributions to the
VEBA in 1995) to carry on your charitable program. As previously stated, under the operating
agreement you have with M, among other responsibilities, you are required to provide the funding
for capital expenditures and improvements needed for the healthcare facility, including capital
equipment.

You have requested the following rulings:

1. whether the adoption of the proposed Amendment and subsequent transfer of assets to you
and your former employees will cause a retroactive revocation of your VEBA’s exempt section
501(c)(9) designation; and

2. whether the 100 percent excise tax allowed by section 4976 of the Code will apply to the
proposed transfer of assets from the VEBA back to you.

Section 501(a) of the Code provides an exemption from federal income tax for organizations
described in section 501(c).

Section 501(c)(9) of the Code describes a voluntary employees’ beneficiary association
("VEBA") providing for the payment of life, sick, accident or other benefits to its members or their
dependents or designated beneficiaries, and in which no part of its net earnings inure (other than
through such payments) to the benefit of any private shareholder or individual.

Section 1.501((c)(9)-4(a) of the Income Tax Regulations provides that no part of the net earnings
of an employees’ association may inure to the benefit of any private shareholder or individual other
than through the payment of permissible benefits. Whether prohibited inurement has occurred is a
question to be determined with regard to all the facts and circumstances.
Section 1.501(c)(9)-4(d) of the regulations provides that a distribution to members upon the
dissolution of the association will not constitute prohibited inurement if the amount distributed to
members are [is] determined pursuant to the terms of a collective bargaining agreement or on the
basis of objective and reasonable standards which do not result in either unequal payments to
similarly situated members or in disproportionate payments to officers, shareholders, or highly
compensated employees of an employer contributing to or otherwise funding the employees’
association. If the association’s corporate charter, articles of association, trust instrument, or other
written instrument by which the association was created, as amended from time to time, provides
that on dissolution its assets will be distributed to its members’ contributing employers, or in the
absence of such provision the law of the state in which the association was created provides for
such distribution to the contributing employers, the association is not described in section
501(c)(9).

Section 4976(a)(2) of the Code imposes an excise tax on an employer equal to 100 percent of
any disqualified benefit provided by an employer-maintained welfare benefit fund.

Section 4976(b)(1)(C) of the Code defines “disqualified benefit" to include any portion of a
welfare benefit fund reverting to the benefit of the employer.

Section 4976(b)(3) of the Code provides that section 4976(b)(1)(C) does not apply to any
amount attributable to a contribution to the fund that is not allowable as a deduction under section
419 for the taxable year or any prior taxable year.

The information submitted establishes that you intend to terminate the VEBA you had
established to provide for the payment of health and welfare benefits to the employees who worked
for you while you operated a hospital. You intend to have the VEBA transfer 33 percent of the
funds, through M, to certain of your former employees and transfer the remaining 67 percent to you
to be used to carry on your charitable program. You have represented that the employees
benefitting from the distribution of assets from the VEBA have been selected in a manner which
does not provide for disproportionate benefits to officers, shareholders, or highly compensated
employees of the employer.

Section 1.501(c)(9)-4(d) of the regulations recognizes that distributing funds to the participants
in a terminating VEBA is an accepted manner of terminating a section 501(c)(9) VEBA. The eligible
employees have been selected in a reasonable manner and the transfer will not provide for the
payment of disproportionate benefits to the owners or highly compensated employees.

Accordingly, it is clear that the transfer of 33 percent of the funds held by the VEBA to the eligible
employees is permissible upon termination of this VEBA. Therefore, based on the submitted
information, we have concluded that this aspect of the proposed termination of your VEBA does not
constitute inurement and will not affect, in any manner, the tax-exempt status of the VEBA prior to
the transfer.
Because the proposed Amendment will provide that on dissolution of the trust, trust assets will
be distributed to you, the VEBA will be disqualified under section 501(c)(9) when the proposed
Amendment is adopted. See section 1.501(c)(9)-4(d) of the regulations. Additionally, when the
assets are transferred to you, the VEBA will be disqualified under section 501(c)(9). Although the
adoption of the proposed Amendment and transfer of assets will affect the tax-exempt status of the
VEBA, they will not affect, in any manner, the tax-exempt status of the VEBA prior to the adoption
of the proposed Amendment and subsequent transfer of assets.

You also intend to have the VEBA transfer the remaining 67 percent of the funds in the trust
back to yourself. This 67 percent represents the contributions you made into the VEBA on behalf
of your employees when you operated a hospital. These funds are to be used by you to carry on
your current charitable programs which support the operations of M. When you transferred these
funds to the VEBA you were acting as an employer and were making contributions to the VEBA to
provide for the payment of health and welfare benefits to your employees. As a general rule the
return of any portion of a welfare benefit fund for the benefit of an employer is a disqualified benefit
and subject to the 4976(a)(2) excise tax.

However, under section 4976(b)(3), the excise tax does not apply if the amount reverting to the
employer is attributable to contributions that were not allowable as a deduction under section 419
for any tax year. In considering how this provision applies to a tax-exempt employer, we note that
the section 4976 excise tax was enacted to establish a meaningful sanction that would prohibit an
employer from deducting contributions to a qualifying trust, accumulating the assets in the trust on
a tax free basis, and subsequently distributing the assets to itself or otherwise misapplying them. It
was felt that the previously existing sanctions, loss of exemption or deductions for future
contributions, were an insufficient deterrent. But no tax deduction is possible for an exempt
organization for a contribution to a VEBA (other than in connection with an unrelated trade or
business), and earnings on amounts held by the tax-exempt employer are not taxed whether or not
transferred to a VEBA. In the case of a tax-exempt employer, therefore, we conclude that amounts
contributed to a fund, unless directly connected with an unrelated trade or business are "not
allowable as a deduction under section 419" within the meaning of section 4976(b)(3).
Accordingly, section 4976(b)(1)(C) does not apply to any assets that may revert to you.

Similarly, any savings M could realize by reason of this transfer are not inconsistent with the
accomplishment of its exempt purposes. ~

Accordingly, based on the information you have submitted we have concluded that:

1. The adoption of the proposed Amendment and subsequent transfer of assets to you by the
VEBA and your former employees will not cause a retroactive revocation of the VEBA’s exempt

status under section 501(c)(9) of the Code; and

2. the 100 percent excise tax allowed by section 4976 of the Code will not apply to the
proposed transfer of assets from the VEBA back to you.

This ruling is directed only to the organization that requested it. Section 6110(j)(3) of the Code
provides that it may not be used or cited as precedent.

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We are informing your key District Director of this ruling. Because this letter could help resolve
any question about your exempt status, you should keep it in your permanent records.

If you have any question about this ruling, please contact the person whose name and telephone
number are shown in the heading of this letter. For other matters, including questions concerning
reporting requirements, please contact your key District Director.

Sincerely Yours,

Garland A. Carter
Chief, Exempt Organizations
Technical Branch 2