PLR 1024068: IRS approved VEBA asset transfers and related tax rulings

Plain-English summary

The IRS approved a labor union's proposal to transfer excess assets from a catastrophic medical benefit account within its VEBA to a reserve for post-retirement health benefits for union employees. The IRS concluded that the transfer would not adversely affect the VEBA's tax-exempt status and that the reserve income could be excluded from unrelated business taxable income under the stated conditions. It also ruled that the specified employees were not officers, and therefore were not key employees, because their duties and authority did not meet the applicable standard. The ruling addressed the union's VEBA, its employee benefit plans, and the limits on the employees' authority to bind the union or control expenditures.

Ruling snapshot

• Question: Could the union transfer excess VEBA assets, exclude the reserve income from UBTI, and treat specified employees as non-officers for the key-employee test?
• Outcome: Approved
• Key authorities: IRC §§ 416(i), 501(c)(9), 511, and 512; Treas. Reg. §§ 1.416-1 and 1.501(c)(9)-2

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 201024068
Release Date: 6/18/2010

Contact Person:
Date: March 26, 2010
identification Number:
Telephone Number:
Employer Identification Number:

UIL: 416.07-01. 501.09-00, 512.01-00

Legend:

M =

N =

VEBA =

Dear

We have considered your request dated November 1, 2006, for a ruling concerning the federal
income and excise tax consequences of a proposed transfer of assets from one account to
another within a voluntary employees’ beneficiary association (VEBA).

Facts:

You are an independent labor union, recognized as tax-exempt under section 501(c)(5) of the
Internal Revenue Code (Code), that sponsors a voluntary employees’ beneficiary association
trust recognized as tax-exempt under section 501(c)(9) of the Code. You state that you have
been exempt from income tax throughout the preceding five years and that you have made
substantially all of the contributions to the VEBA. Your sole source of income is dues from
union members. M, the employer of the union members has no relationship to the VEBA, and,
therefore has never taken a tax deduction or contributed to the VEBA. An uncompensated
board of directors consisting of your members, but not your employees, governs the VEBA.

Currently, the VEBA holds, in separate accounts, the assets of four self-insured welfare benefit
plans. Three of the plans are contributory plans covering members and employees. The fourth
plan is a non-contributory plan, N, that provides catastrophic major medical benefits to VEBA
members. You also maintain, outside the VEBA, a self-insured group health plan that is
governed by a collective bargaining agreement between you and your employees. You
represent that all of the plans, including the health plan, provide benefits based on criteria that
do not provide for disproportionate benefits to officers, shareholders or highly compensated
employees. Your board of directors proposes to transfer excess assets from N to an account

within the VEBA to provide a reserve for retiree health benefits for union employees that
participate in your separate group health plan.

A few years ago, you negotiated improvements to the members’ employer-provided health
benefit plan. To encourage members to sign up for the improved plan, you amended the health
plan that you offer through the VEBA by eliminating some benefits and raising the deductibles,
which substantially reduced the amount of reserves necessary for the plan. Afterward, the
actuary certified an annual valuation of N’s assets that reported excess funds projected to
increase through the next four years. You decided to establish a new account in the VEBA and
transfer N’s excess funds to the new account to provide additional security for employees
whose post-retirement health benefits would otherwise depend upon your available cash flow.
Although the VEBA will hold the assets in the reserve, you will use the reserve to provide
benefits offered by your existing employee health plan outside the VEBA.

You operate in accordance with your constitution and bylaws that vest ultimate decision-making
power regarding union affairs in a group of union members (national officers) who are not
employed by the union. You have between 40 and 45 employees. Of those employees, the
highest ranking is the executive administrator. Article VIII of your bylaws provides that the
executive administrator shall:

1. Supervise all departments consistent with the Union Employee Handbook and the
   agreement between the union and the union staff employees association.

2. Present a report at all regularly scheduled board meetings concerning the operations of
   the union departments that are subject to the administrator’s direction and supervision.

3. Ensure that all laws, provisions of the union constitution and bylaws, and the resolutions
   of the board are faithfully executed as delegated by the board.

4. Operate the union within the budget as prepared by the secretary-treasurer and

approved by the board.

Conduct regular staff meetings for the purpose of coordinating the efforts of the union.

Provide any other reports the board may require.

Have the ability to hire and fire employees from the director level on down, with

concurrence of the president of the union. In the event of a disagreement between the

president and the executive administrator regarding the termination of an employee, the

case will be decided by a majority vote of the board on a one man, one vote basis.

You provided job descriptions for each type of employee:

The director of representation provides legal counsel to the national officers, board of directors,
and all union committees involving policy and institutional matters, grievance, arbitration, and
negotiating strategy, contractual issues, internal and external administration of the collective
bargaining agreement, and other legal matters involving the union or individual union members.

The director of industry analysis provides economic and business analysis of M and
competitors’ current and historical operational performance and examines industry trends,
competitive positions, and competing business models. The director also provides economic
and contractual impact analysis of the components of the union/M contract as well as
competitors’ collective bargaining agreements.

The director of finance oversees financial strategy and planning, monitors and reports results,
advises the national officers and the board of directors with respect to financial reporting,
financial stability, liquidity and financial growth, including representation of financial information
at all regular board of director meetings and reviews financial results with the national officers
on a regular monthly basis.

The director of benefits identifies, analyzes and resolves with appropriate parties any non-
negotiated benefits or policy changes made by M for compliance with M/union contract
provisions and applicable benefits laws and regulations. The director also identifies, analyzes,
recommends and participates in negotiations of benefit issues on behalf of the union with M
primarily during contract negotiations.

You, the union, compensate the executive administrator, director of representation, director of
industry analysis, director of finance, and the director of benefits at levels that exceed the
threshold for classification as a “key employee” under section 416(i) of the Code.

Except as noted below for the director of finance, no union employee has actual, exercised, or
implied authority to bind the union to any agreement with third parties, or to sign checks or
authorize disbursement of funds on behalf of the union without prior approval of one or more
national officers. With regard to authorization for the disbursement of funds, one national officer
must approve projects for amounts exceeding $2,000 and two national officers must sign
projects exceeding $5,000. With regard to the VEBA, all disbursements from the VEBA require
approval from the director of benefits (or alternatively the director of finance) and a national
officer. Finally, no union employee has the independent ability to hire or fire any other union
employee without the national officer or board of directors’ approval.

You requested the following rulings:

1. The proposed transfer of the excess assets to a separate account under the VEBA trust
   will not adversely affect the VEBA’s tax exempt status,

2. The VEBA will not have to report unrelated business taxable income (UBTI) under
   section 511 and 512 of the Code for amounts that are set-aside (including contributions
   and earnings) in the reserve in excess of the deduction limitations, for taxable entities,
   described in sections 419 and 419A, and

3. That particular employees will not be considered “officers” and therefore not “key
   employees” within the meaning of section 416(i) of the Code.

Law:
Section 414(q)(5) of the Internal Revenue Code (Code) provides that for purposes of subsection

(r) and for purposes of determining the number of employees in the top-paid group, the following
employees shall be excluded —

A. Employees who have not completed 6 months of service,
B. Employees who normally work less than 17 1/2 hours per week,
C. Employees who normally work during not more than 6 months during the year,

D. Employees who have not attained age 21, and

E. Except to the extent provided in the regulations, employees who are included in a unit of
employees covered by an agreement which the Secretary of Labor finds to be a
collective bargaining agreement between employee representatives and the employer.

Except as provided by the Secretary, the employer may elect to apply subparagraph A, B,C, or
D by substituting a shorter period of service, smaller number of hours, or months, or lower age
for the period of service, number of hours or months, or age (as the case may be) than that
specified in such paragraph.

Section 416(i)(1)(A) of the Code provides that the term “key employee” means an employee
who, at any time during the plan year, is:

(i). An officer of the employer having an annual compensation greater than $130,000,

(ii). A five-percent owner of the employer, or

(iii).A one-percent owner of the employer having an annual compensation from the employer
of more than $150,000.

For purposes of clause (i), no more than 50 employees (or, if lesser, the greater of 3 or 10
percent of the employees) shall be treated as officers. In the case of plan years beginning after
December 31, 2002, the $130,000 amount in clause (i) shall be adjusted at the same time and
in the same amount as under section 415(d), except that the base period shall be the calendar
quarter beginning July 1, 2001, and any increase under that sentence which is not a multiple of
$5,000 shall be rounded to the next lower multiple of $5,000. Such term shall not include any
officer or employee of an entity referred to in section 414(d) (relating to governmental plans).
For purposes of determining the number of officers taken into account under clause (i),
employees described in section 414(q)(5) shall be excluded.

Section 501(c)(9) of the Code provides exemption from federal tax for voluntary employee
associations that provide for the payment of life, sick, accident, or other benefits to the members
of such association or their dependents or designated beneficiaries, if no part of the net
earnings of such association inures (other than through such payments) to the benefit of any
private shareholder or individual and certain other requirements are satisfied.

Sections 511(a)(1) and (2) of the Code imposes a tax for each taxable year on the unrelated
business taxable income (as defined in section 512) of every organization described in sections
401(a) and 501(c).

Section 512(a)(3) of the Code states that for an organization described in section 501(c)(9), the
term unrelated business taxable income means the gross income (excluding any exempt
function income) less the deductions allowed which are directly connected with the production of
the gross income (excluding exempt function income), computed with the modifications provided
in paragraphs (6), (10), (11), and (12) of subsection (b).

Section 512(a)(3)(B)(ii) of the Code states that the term “exempt function income” means all
income which is set aside, in the case of an organization described in section 501(c)(9), for the
payment of life, sick, accident, or other benefits.

Section 512(a)(3)(E)(i) of the Code states that in the case of any organization described in
section 501(c)(9), a set-aside for any purpose specified in clause (ii) of subparagraph (B) may
be taken into account under subparagraph (B) only to the extent that such set-aside does not
result in an amount of assets set aside for such purpose in excess of the account limit
determined under section 419A (without regard to subsection (f)(6) thereof) for the taxable year
(not taking into account any reserve described in 419A(c)(2)(A) for post-retirement medical
benefits).

Section 512(a)(3)(E)(iii) of the Code states that this subsection shall not apply to any
organization if substantially all the contributions to such organization are made by employers
who were exempt from tax under this chapter throughout the 5-taxable year period ending with
the taxable year in which the contributions are made.

Section 1.416-1, Q&A T-13 of the Income Tax Regulations (regulations) states that whether an
individual is an officer shall be determined upon the basis of all the facts, including, for example,
the source of his authority, the term for which elected or appointed, and the nature or extent of
his or her duties. Generally, the term officer means an administrative executive who is in
regular and continued service. The term officer implies continuity of service and excludes those
employed for a special transaction. An employee who merely has the title of officer but not the
authority of an officer is not considered an officer for purposes of the key employee test.
Similarly, an employee who does not have the title of an officer but has the authority of an
officer is an officer for purpose of the key employee test. In the case of one or more employers
treated as a single employer under sections 414(b), (c), or (m), whether or not an individual is
an officer shall be determined based upon his or her responsibilities with respect to the
employer or employers for which he or she is directly employed, and not with respect to the
controlled group of corporations, employers under common control or affiliated service group. A
partner or partnership will not be treated as an officer for purposes of the key employee test
merely because he or she owns a capital or profit interest in the partnership, exercises his or
her voting rights as a partner, and may, for limited purposes, be authorized and does in fact act
as an agent of the partnership.

Section 1.416-1, Q&A T-15 of the regulations states that for purposes of the top-heavy rules,
sole proprietorships, partnerships, associations, trusts, and labor organizations may have
officers. The rule is effective for purposes of determining whether a plan is top-heavy for plan
years that begin after February 28, 1985.

Section 1.501(c)(9)-2(a) of the regulations states that employees of a labor union also will be
considered to share an employment-related common bond with members of the union.

Analysis:

You propose to create a reserve by transferring excess assets from the catastrophic medical
benefit account for union members to a separate account to create a reserve for post-
retirement medical benefits for union employees. Union members who participated in the
catastrophic medical plan will now receive their benefits from the more favorable employer-
provided health benefit plan. Since union employees share an employment-related common

bond with union members under section 1.501(c)(9)-2(a) of the regulations, the use of the
excess funds to pay their post-retirement benefits is a permissible payment for the VEBA. The
information you provided shows that the VEBA will continue to use the excess funds for the
purpose and for eligible participants for which the VEBA was established. Therefore, the
transfer of excess funds within the VEBA will not have an adverse impact on the VEBA’s
exempt status.

Generally, an organization that is described in section 501(c)(9) of the Code must pay tax on its
unrelated business taxable income (UBTI) each year. Although section 512(a)(3)(B)(ii) exempts
all income set aside for the payment of permissible benefits from UBTI, section 512(a)(3)(E)(i)
sets limits on the amount of assets that may be set aside for that purpose. However, section
512(a)(3)(E)(iii) states that the set-aside limits in section 512(a)(3)(E)(i) do not apply to an
organization if substantially all of its contributions are made by tax-exempt employers who were
exempt from tax throughout the 5-year taxable period ending with the year in which the
contributions are made. You plan to transfer the excess funds in N to a reserve for the provision
of permissible benefits to eligible employees. You state that you are a tax-exempt organization
which made substantially all of the contributions to the VEBA, excluding member contributions,
for the preceding five years. Even though you made contributions to N on behalf of your
members as a labor union and not on behalf of your employees as their employer, the income of
the VEBA that is used to provide benefits to the union employees as described herein will be
exempt function income not subject to the limitation under section 512(a)(3)(E)(i) and thus the
income may be excluded from the VEBA’s UBTI under section 512(a)(3).

Section 416(i)(1)(A)(i) of the Code states that a key employee is an employee who is an officer
of the employer having an annual compensation greater than $130,000 (adjusted for inflation for
plan years beginning after December 31, 2002). Section 1.416(i)-1, Q & A T-13 of the
regulations states that whether an individual is an officer is determined upon the basis of all the
facts, including the source of his or her authority, the term for which elected or appointed, and
the nature or extent of his or her duties. Q & A T-13 states further that the term officer generally
means an administrative executive who is in regular and continued service and that an
employee who merely has the title of an officer but not the authority of an officer is not
considered an officer for purposes of the key employee test. Similarly, an employee who does
not have the title of an officer but has the authority of an officer is considered an officer for
purposes of the key employee test.

In the instant case, each of the particular employees has the title of an officer. However, their
duties are generally not those of officers. In brief, the executive administrator supervises union
employees, the director of representation provides legal counsel to national officers, and other
union members, and the directors of industry analysis, finance, and benefits provide information
to the national officers and the board of directors.

Moreover, none of the particular employees has the authority of an officer. Specifically, none of
the particular employees can bind the union to any agreement or sign any report required by
law, or, without the concurrence of a national officer, authorize the expenditure of more than
$2,000, sign a check for more than $5,000, or hire or fire any employee of the union.

Accordingly, because neither the duties nor the authorities of the particular employees are those

of officers, the particular employees are not officers within the meaning of section 416(i) of the
Code.

Conclusion:
Based on the foregoing, we rule as follows:

1. The proposed transfer of the excess assets to a separate account within the VEBA will
   not adversely affect the VEBA’s tax exempt status,

2. The VEBA will not have to report unrelated business income tax under sections 511 and
   512 of the Code for amounts that are set-aside (including contributions and earnings) in
   the reserve in excess of the limitations described in sections 419 and 419A of the Code,
   and

3. That particular employees will not be considered “officers” and therefore not “key
   employees” within the meaning of section 416(i) of the Code.

This ruling will be made available for public inspection under section 6110 of the Code after
certain deletions of identifying information are made. For details, see enclosed Notice 437,
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 437. If you disagree with our proposed
deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) 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 material changes in these facts. This ruling does not address the applicability of any
section of the Code or regulations to the facts submitted other than with respect to the sections
described. Because it could help resolve questions concerning your federal income tax status,
this ruling should be kept in your permanent records.

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.

8
If you have any questions about this ruling, please contact the person whose name and
Sincerely,

Manager, Exempt Organizations
Technical Group 2

Enclosure
Notice 437