PLR 1121028: IRS approves a VEBA's plan to use remaining funds for employee benefits

Plain-English summary

The IRS ruled that a voluntary employees' beneficiary association (VEBA) could wind up after its sponsoring trade association ended its sponsorship and all participating employers obtained other coverage. The VEBA may use its remaining fund balance, after expenses, to prepay employee benefits through successor group plans, provided the funds do not revert to employers and the plans do not provide disproportionate benefits to officers, shareholders, or highly compensated employees. The IRS also ruled that the proposed transfers would not create a disqualified benefit subject to the 100% excise tax under IRC § 4976. Because the fund balance was represented to be exempt function income, the transfers would not create unrelated business taxable income under IRC § 511.

Ruling snapshot

• Question: May a terminating VEBA use its remaining exempt function funds to prepay permitted employee benefits without jeopardizing its exemption or creating tax for the employers?
• Outcome: Approved.
• Key authorities: IRC §§ 501(c)(9), 4976, 511, 512, and 6110; Treas. Reg. §§ 1.501(c)(9)-1, 1.501(c)(9)-3, and 1.501(c)(9)-4.

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Release Number: 201121028 Contact Person:

Release Date: 5/27/2011

Date: March 1, 2011 Identification Number:
XXXXXXXXXXX Telephone Number:
XXXXXXXXXXX

XXXXXXXXXXXX Employer Identification Number:
XXXXXXXXXX

Uniform Issue List
501.09-00
511.00-00
4976.00-00

Legend:
A =
B =
Z =

Dear

This is in response to your ruling requests as to the federal tax consequences of the proposed
transactions under the Internal Revenue Code and Federal Tax Regulations.

FACTS:

You are an organization recognized as exempt under section 501(a) of the Internal Revenue
Code (“Code”), and an organization described in section 501(c)(9) as a Voluntary Employees'
Beneficiary Association (“VEBA”). You represent that you received a favorable tax-exempt
status under section 501(c)(9) of the Code on June 29, 1989.

You provide medical, life, dental, and sickness benefits to employees of your participating
members/employers (individually as the “Employer” and collectively as the “Employers”). The
Employers are in the A industry, located in the northern part of State Z. Your participating
Employers are members of the sponsoring trade association known as B.

You represent that in the summer of 2006, B sent you notice that it plans to end its sponsorship.
B also required the Employers to seek alternate insurance arrangements, and as of December
2006, all of the Employers had arranged alternative healthcare coverage for their employees.
As a result, there are no remaining Employers in the VEBA. You now plan to wind up and
terminate the VEBA. Pursuant to Article IX, Section 2(d) of your trust document (“Trust”), upon
the VEBA’s termination, the trustee shall “Apply any remaining assets toward keeping in force

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the plan, policy or policies held at termination for such a period as the contributions shall serve,
or toward such other purposes as, in the opinion of the trustees, shall be consistent with the
purpose of this Trust”. You represent that the Trust assets (the “Fund Balance”) that you will
transfer to the Employers upon your termination were derived from exempt function income.

You represent that you do not plan to distribute to the Employers any of the Fund Balance
remaining after payment of administrative expenses. Rather, you will require each Employer to
enter into a written agreement (“Agreement”). Under the Agreement, you will determine how
much of the Fund Balance is allocable to each Employer. The Agreement will stipulate that
Employers shall use any portion of the Fund Balance allocable to them to provide VEBA
benefits as provided under section 501(c)(9) of the Code.

You submitted a copy of the Agreement. Pursuant to the Agreement:

a. Each Employer understands that after you terminate the VEBA and pay expenses
resulting thereof, you are permitted solely to use Fund Balance to continue to provide
their employees with section 501(c)(9) of the Code benefits until the Fund Balance is
exhausted. The Employers have no legal right to a reversion of assets under the Code
or the Agreement.

b. You will use the Fund Balance to pre-pay employee benefits permitted under section
501(c)(9). Each Employer must represent that it has in place a plan that will provide its
employees with the benefits permitted within the perimeters of section 501(c)(9) of the
Code and section 1.501(c)(9)-3 of the Income Tax Regulations (“regulations”). Each
Employer must submit proof of such plan. Each Employer must also consent that
either you or the Internal Revenue Service (“Service”) may require such Employer to
produce copies of such plan.

c. To enable you to pre-pay the group plans the Employers will set up, each Employer
must submit information about the group plan and the cost of the group plan. Upon
your receipt and verification of the group plan’s information, you will draw a check in
the name of the group plan and mail the check to the Employer who will then forward
the check to the group plan.

d. Each Employer shall not administer benefit(s) payment arrangements that will bestow
disproportionate benefit(s) to officers, shareholders, or other highly paid employees of
the Employer.

e. If an Employer's contribution to the VEBA included contributions by an Employer's
employees, the Employer agrees that during the successor coverage period
represented by your distribution, no further contribution shall be required of the
employees. The Employer may also reimburse the employees any amount(s)
attributable to employee premium payments as far as the Employer still has records
reasonably accounting for such employee contributions and the employee
expenditures for medical benefits described in section 213 of the Code, if possible.

f. Each Employer understands that the Service can audit any Employer to make certain
that the Employer applied its share of the Fund Balance to pay benefit(s) consistent

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with the terms and provisions of the Agreement, the Internal Revenue Code, and this
Private Letter Ruling.

Each Employer understands that you plan to terminate and wind up by December 31,
2010, and if any Employer fails to comply with the Agreement, such an Employer will
forfeit any claim to the Fund Balance.

You represent that you plan to use an objective method to determine the amount of the Fund
Balance allocable to each Employer. Pursuant to this objective method, you shall:

a.

b.

Determine the Fund Balance after payment of administrative expenses,

Allocate the Fund Balance by line of coverage (i.e., medical, life, dental, sickness and
accident) using the 2002-6 total contributions to VEBA as the denominator, and the
2002-6 contributions by line of coverage as the numerator and;

Determine the Employers’ share of the Fund Balance per line of coverage using total
2002-6 contributions as the denominator and the Employers’ respective 2002-6
contributions as the numerator.

Finally, in a draft letter that you plan to send to the Employers, you stated to the Employers “the
Trust cannot make payment to your company directly. However, the letter ruling obtained by
the Trust allows the Trust to pre-pay your insurance/plan obligations for up to the amount of the
identified rebate amount.”

You represent that if you are unable to locate an Employer or an Employer fails to respond or
timely agree to the Agreement, you reserve the right to allocate the share of the Fund Balance
allocable to a nonresponsive Employer to the other Employers.

RULINGS REQUESTED:

1. The proposed transactions will not adversely affect your tax-exempt status as an
   organization described under section 501(c)(9) of the Code.

2. The proposed transactions will not result in the imposition of tax on the Employers under
   section 4976 of the Code.

3. Transfers will not result in your incurring unrelated business taxable income under
   section 511 of the Code.

LAW:

Section 501(c)(9) of the Code provides for the exemption from federal income tax of voluntary
employees’ beneficiary associations providing 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.

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Section 1.501(c)(9)-1 of the regulations provides that for an organization to be described in
section 501(c)(9) of the Code, it must be an employees' association; membership in the
association must be voluntary; the organization must provide for the payment of life, sick,
accident, or other benefits to its members; and there can be no inurement (other than by
payment of permitted benefits) to the benefit of any private shareholder or individual.

Section 1.501(c)(9)-4(a) of the regulations provides, generally, 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 benefits permitted by section 1.501(c)(9)-3.

Section 1.501(c)(9)-4(d) of the regulations provides that it will not constitute prohibited
inurement if, on termination of a plan established by an employer and funded through an
association described in section 501(c)(9), any assets remaining in the association, after
satisfaction of all liabilities to existing beneficiaries of the plan, are applied to provide, either
directly or through the purchase of insurance, life, sick, accident or other benefits within the
meaning of section 1.501(c)(9)-3 pursuant to criteria that do not provide for disproportionate
benefits to officers, shareholders, or highly compensated employees of the employer.

Section 4976(a) of the Code imposes a 100% excise tax if an employer maintains a welfare
benefit fund, and there is a disqualified benefit provided during any taxable year.

Section 4976(b)(1)(C) of the Code provides that for purposes of subsection (a), the term
"disqualified benefit" means any portion of a welfare benefit fund reverting to the benefit of the
employer.

Section 511 of the Code imposes a tax on the unrelated business taxable income of
organizations described in section 501(c)(9).

Section 512(a)(3)(A) of the Code provides that, in the case of 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 by this chapter which are
directly connected with the production of the gross income (excluding exempt function income),
both computed with modifications.

Section 512(a)(3)(B)(ii) of the Code provides that in the case of an organization described in
paragraph (9), (17) or (20) of section 501(c), "exempt function income" includes all income
(other than an amount equal to the gross income derived from any unrelated trade or business
regularly carried on by such organization computed as if the organization were subject to
section 512(a)(1)), which is set-aside to provide for the payment of life, sick, accident, or other
benefits, including reasonable costs of administration directly connected with its exempt
purpose.

Section 512(a)(3)(E) of the Code provides that, generally, for organizations described in
paragraph (9), (17) or (20) of section 501(c), a set-aside 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 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
section 419A(c)(2)(A) for post-retirement medical benefits).

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ANALYSIS:

You have requested a ruling on whether the proposed transactions will adversely affect your
tax-exempt status as an organization described under section 501(c)(9) of the Code. Pursuant
to section 1.501(c)(9)-4(d) of the regulations, it will not constitute prohibited inurement if, on
termination of a plan established by an employer and funded through an association described
in section 501(c)(9), any assets remaining in the association, after satisfaction of all liabilities to
existing beneficiaries of the plan, are applied to provide, either directly or through the purchase
of insurance, life, sick, accident or other benefits within the meaning of section 1.501(c)(9)-3
pursuant to criteria that do not provide for disproportionate benefits to officers, shareholders, or
highly compensated employees of the employer.

You represent that after you terminate the VEBA and pay administrative expenses and
liabilities, the remaining Fund Balance of the VEBA will be used to pre-pay group plans that will
benefit the employees. Each Employer must provide to you information about the group plan it
has secured for its employees and the group plan’s costs. Upon your receipt and verification of
the information regarding an Employer’s group plan and its cost, you will draw a check in the
group plan's name, not that of the Employer, and mail the check to the Employer. The
Employer upon receipt of the check will forward the check to the group plan.

In order for an Employer to receive an allocable share of the Fund Balance, it must enter into
the Agreement with you. The Agreement provides that no assets of the VEBA will revert back to
any Employer, and each Employer must make certain that the group plan can only provide
benefits permitted under section 501(c)(9) of the Code and section 1.501(c)(9)-3 of the
regulations. Each Employer must also agree that there will be no disproportionate benefits to
officers, shareholders, or other highly compensated employees of the Employers. Thus,
because you will use the Fund Balance to pre-pay the group plans the Employers secured to
provide VEBA benefits permitted under section 501(c)(9) of the Code with no disproportionate
benefit inuring to any person, and because none of the VEBA’s assets will revert back to any
Employer, we conclude that this transaction will not adversely jeopardize your tax-exempt status
under section 501(c)(9).

Second, you have requested a ruling on whether the proposed transactions will result in the
imposition of tax on the Employers under section 4976 of the Code. Pursuant to section
4976(a) of the Code, a 100% excise tax shall be imposed if an employer maintains a welfare
benefit fund, and there is a disqualified benefit provided during any taxable year. Further,
section 4976(b)(1)(C) of the Code provides that for purposes of subsection (a), the term
"disqualified benefit" means any portion of a welfare benefit fund reverting to the benefit of the
employer.

You represent that each Employer must obtain a group plan that will provide solely benefits
permitted under section 501(c)(9) of the Code. The Employers will submit information including
costs of maintaining the group plans to you. After your verification of the group plans’
information and costs, you will draw checks in the name of the group plans, not the Employers,
to cover the costs of the group plans. You will mail the checks to the Employers and the
Employers will forward the checks to the group plans. You will follow this procedure until the
Fund Balance allocable to each Employer is exhausted. You represent that as a result of this
procedure, you will pay no money directly to the Employers. You further represent that no

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assets will revert to any Employer. Thus, because no Employer will receive a disqualified
benefit, the proposed transactions will not result in the imposition of tax on the Employers under
section 4976.

Finally, you have requested a ruling on whether the transfers will result in your incurring
unrelated business taxable income under section 511 of the Code. You represent that the Fund
Balance, after payment of administrative expenses, is exempt function income and does not
constitute unrelated trade or business income. Pursuant to section 512(a)(3)(A) of the Code, in
the case of an organization described in section 501(c)(9), unrelated business taxable income
does not include any exempt function income, computed with modifications. Because the Fund
Balance is exempt function income and not unrelated business taxable income under section
512(a)(3)(A) of the Code, it would not be subject to unrelated business income taxation under
section 511.

RULINGS:
Based on the information submitted, we rule as follows:

1. The proposed transactions will not adversely affect your tax-exempt status as an
   organization described under section 501(c)(9) of the Code.

2. The proposed transactions will not result in the imposition of tax on the Employers under
   section 4976 of the Code.

3. Transfers will not result in your incurring unrelated business taxable income under
   section 511 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 resolved questions concerning your federal income tax status,
this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and
telephone number are shown in the heading of this letter.

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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.

Sincerely,

Theodore R. Lieber
Manager, Exempt Organizations
Technical Group 3

Enclosure
Notice 437