IRS denies VEBA status to an insurance trust

Plain-English summary

The IRS denied an insurance trust's request for recognition as a voluntary employees' beneficiary association under IRC § 501(c)(9). The trust made insurance coverage available to employees of businesses belonging to chambers of commerce and associations, but the IRS found no sufficient employment-related common bond among the participants. The IRS also found that the trust did not maintain adequate records to show that it avoided discrimination in favor of highly compensated employees under IRC §§ 505(b) and 105(h). The letter explains the organization's protest and appeal rights, including a 30-day deadline.

Ruling snapshot

• Question: Did the insurance trust qualify for exemption as a VEBA under IRC § 501(c)(9)?
• Outcome: Denied, exemption not recognized
• Key authorities: IRC §§ 501(c)(9), 505(b), 105(a), and 105(h); Treas. Reg. §§ 1.501(c)(9)-1 and 1.501(c)(9)-2(a)(1); Harding Hospital, Inc. v. United States, 505 F.2d 1068 (1974)

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224
TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 201224037
Contact Person:

Release Date: 6/15/2012
Identification Number:

Date: March 23, 2012
Contact Number:
FAX Number:

Employer Identification Number:

Legend: UIL #’s:
501.09-00

N = Bank
501.09-04

O = Date #1

Q = Date #2

S = Date #3

T = State

Dear [illegible]:

We have considered your application for recognition of exemption from federal income
tax under Internal Revenue Code (Code) section 501(a). Based on the information
provided, we have concluded that you do not qualify for exemption under Code
subsection 501(c)(9) or under any other subsection of 501(a). The basis for our
conclusion is set forth below.

Issue(s):

Are you an association of employees which qualifies for exemption from tax under the
provisions of § 501(c)(9) of the Code? You are not for the reasons stated below.

Facts:

You were formed on O as an insurance trust pursuant to an Agreement and Declaration
of Trust (Declaration) entered into between N, a bank, and unspecified Employers. The
Declaration was later amended and restated.

According to the Declaration, your purpose is to obtain, maintain, renew, and hold
insurance policies through which participating employers can provide health and other
insurance benefits under employee benefit plans maintained by participating employers
for their participants and beneficiaries.

The members of your Board of Trustees must be employees of employers participating
in the trust, or employees or members of a chamber of commerce endorsing the trust.

An employer is entitled to participate in the trust and to provide its eligible employees
with benefits if the employer satisfies the following requirements:

a. The employer agrees to participate in the trust for the purpose of providing
benefits to its employees and their dependents;

b. The employer is accepted for participation in the trust pursuant to any
underwriting rules established by providers or underwriters of insurance
policies;

c. The employer makes any and all contributions required by the trust and
premium contributions due under the insurance policies; and

d. The employer is a member in good standing of an association or chamber of
commerce that is endorsing the trust.

You represent that the trust operated as a dry trust, without income, without expenses
and without reserves until Q.

Your stated objective is to enable small companies to join together in order to obtain
insurance protection through mass purchasing. Your insurance plans are available to
sponsoring chambers of commerce and associations through brokers and agents.

You also confirmed that the trust was not established pursuant to a collective
bargaining agreement and no contributions are received arising out of a collective
bargaining agreement.

You currently offer plans and coverage which provide medical, dental, vision, and life
and disability insurance through a program specifically created for sponsoring chambers
of commerce. Each participating group must be a member of one of over 100 chambers
and associations in the T and have a group size between 2 and 99 enrolled employees.

You do not compile or maintain records of the compensation of the employees,
including those who are highly compensated. There are no separate categories for

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participation based on compensation. You do not request or maintain records
concerning the number of each group participant's employees not covered by the plan.

Brokers and agents must be affiliated with you and also appointed by your carrier prior
to receiving quotes or writing business. Brokers and agents are paid 5% commission
on groups of 5-99 employees and 2% on groups of 2-4 employees.

Your website outlines the following participation and contribution requirements:

• The employer must contribute a minimum of 75% toward the employee premium
  unless the group is in a restricted industry. Restricted industry employers must
  contribute 100% toward the employee premium.

• At least 75% of eligible employees must enroll. If the group is in a restricted
  industry, 90% participation is required.

Active, full-time employees of participating employers are eligible for coverage.

Law:

A Voluntary Employees’ Beneficiary Association (VEBA) is a mutual association of
employees providing certain specified benefits to its members or their designated
beneficiaries. It may be funded by the employees or their employer. The VEBA has
existed in the tax law since the Revenue Act of 1928 when it was given exempt status
under section 101(16) of the Act. Exemption for this type of entity was re-enacted by
the Revenue Acts of 1932, 1934, 1936 and 1938. Provisions for continued recognition
of VEBA arrangements was incorporated into the 1939 Code as section 101(16) and
subsequently into the 1954 Code, as amended to date, as section 501(c)(9).

Section 501(c)(9) of the Code exempts from federal income tax the 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) if no part of the net earnings inures (other than through such payments) to
the benefit of any private shareholder or individual.

Section 1.501(c)(9)-1 of the Income Tax Regulations provides that for an organization to
be described in section 501(c)(9) of the Code an organization must meet all the
following requirements:

(a) The organization must be an association of employees;
(b) Membership in the association must be voluntary;

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(c) The organization's purpose is to provide for the payment of life, sick, accident,
or other benefits to its members or their dependents or designated
beneficiaries, and substantially all of its operations are in furtherance of
providing such benefits, and

(d) No part of the net earnings of the organization inures, other than by payment
of the benefits referred to in (c), to the benefit of any private shareholder or
individual.

Section 1.501(c)(9)-2(a)(1) of the regulations states membership of an organization
described in section 501(c)(9) must consist of individuals who become entitled to
participate by reason of their being employees and whose eligibility for membership is
defined by reference to objective standards that constitute an employment-related
common bond among such individuals.

Typically, those eligible for membership in an organization described in section
501(c)(9) of the Code are defined by reference to:

• A common employer (or affiliated employers),

• Coverage under one or more collective bargaining agreements (with respect to
  benefits provided by reason of such agreement(s),

• Membership in a labor union, or

• Membership in one or more locals of a national or international labor union.

For example, membership in an association might be open to all employees of a
particular employer, or to employees in specified job classifications working for certain
employers at specified locations and who are entitled to benefits by reason of one or
more collective bargaining agreements. In addition, employees of one or more
employers engaged in the same line of business in the same geographic locale will be
considered to share an employment-related bond for purposes of an organization
through which their employers provide benefits. Employees of a labor union also will be
considered to share an employment-related common bond with members of the union,
and employees of an association will be considered to share an employment-related
common bond with members of the association.

Section 505(b) of the Code contains certain requirements for organizations described in
sections 501(c)(9) and 501(c)(20) unless they are subject to the exception of section
505(a)(2) for collective bargaining agreements. Under 505(b)(1), a plan will meet the
requirements of section 505(b)(1) only if,

(1) each class of benefits under the plan is provided under a classification of
employees which is set forth in the plan and that does not discriminate in favor of
employees who are highly compensated individuals, and

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(2) In the case of each class of benefits, such benefits do not discriminate in favor
of employees who are highly compensated individuals. A life insurance, disability,
severance pay, or supplemental unemployment compensation benefit shall not be
considered to fail to meet the requirements of subparagraph (B) merely because the
benefits available bear a uniform relationship to the total compensation, or the
basic or regular rate of compensation, of employees covered by the plan.

Under section 105(a), amounts received by an employee through a self-insured medical
reimbursement plan which are attributable to contributions of the employer, or are paid
by the employer, are included in the employee’s gross income unless such amounts are
excludable under section 105(b). For amounts reimbursed to a highly compensated
individual to be fully excludable from such individual’s gross income under section
105(b), the plan must satisfy the requirements of section 105(h). Section 105(h) is not
satisfied if the plan discriminates in favor of highly compensated individuals as to
eligibility to participate or benefits. All or a portion of the reimbursements or payments
on behalf of such individuals under a discriminatory plan are not excludable from gross
income under section 105(b). A self-insured medical reimbursement plan is a separate
written plan for the benefit of employees which provides for reimbursement of employee
medical expenses under section 105(b). A plan or arrangement is self-insured unless
reimbursement is provided under an individual or group policy of accident or health
issued by a licensed insurance company or under an arrangement in the nature of a
prepaid health care plan that is regulated under federal or state law in a manner similar
to the regulation of insurance companies.

Section 105(h)(2) of the Code provides that a plan satisfies the requirements of section
105(h) only if it does not discriminate in either eligibility or benefits in favor of highly-
compensated individuals. Section 105(h)(5) of the Code provides, in part, that a highly-
compensated individual is an individual who owns more than 10% in value of the stock
of the employer and is among the highest paid 25% of all employees (other than those
employees described in section 105(h)(3)(B) who are not participants.

In Harding Hospital, Inc. v. United States, 505 F.2d 1068 (1974), the court held that an
organization seeking a ruling as to recognition of its exempt status has the burden of
proving that it satisfies the requirements of the particular exemption statute.

Application of the Law:

Section 501(c)(9) of the Code, in conjunction with section 501(a), exempts from federal
income tax a voluntary employees’ beneficiary association (VEBA) providing for the
payment of life, sick, accident, or other benefit to its members or their dependents, or
designated beneficiaries, if no part of the “net earnings” of the association inures (other
than through such payments) to the benefit of any private shareholder or individual. A

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VEBA functions primarily as a cooperative device for pooling funds and distributing risks
over and benefits to a defined group of employees sharing an employment-related
common bond.

You are not as defined in section 501(c)(9) of the Code and sections 1.501(c)(9)-1 or
1.501(c)(9)-2(a)(1) of the regulations, because you are not an association of employees
whose eligibility for membership is defined by reference to objective standards that
constitute an employment-related common bond among such individuals. Employees of
any small business that is a member of one of over 100 chambers of commerce in the T
may become a member of your plan. Therefore, membership is not defined by
reference to a common employer, affiliated employers, coverage under a collective
bargaining agreement, or membership in a labor union. Additionally, there is no
evidence that the eligible employers are engaged in the same line of business in the
same geographic locale.

You have also failed to meet the requirements under sections 505(b) and 105(h)
because you do not maintain adequate records to demonstrate that you do not
discriminate in favor of highly compensated individuals.

Therefore, you have not met the burden of proving that you are organized and
operating as a VEBA described by section 501(c)(9) of the Code.

Applicant’s Position:

You represent that the employment-related common bond that exists between your
members is their employment relationship with employer members of chambers of
commerce and business associations within the T endorsing the trust. You admit that
the employment-related common bond is not identical to any of the deemed
employment-related common bonds or the examples given as guidance in the facts-
and-circumstances test. However, you claim the facts and circumstances, together with
the structure and administration of the trust satisfies the employment-related common
bond requirement established in the Regulations.

You represent you are similar to a legitimately formed VEBA and are unlike a
commercial insurance program. You make the following claims:

• You have an employer-employee relationship while an insurance program identifies
  an insurance company-customer relationship. You claim the employees receiving
  benefits under the trust do not purchase insurance directly from the insurance
  companies, and the insurance companies do not directly solicit the employees to
  purchase insurance through the trust. You represent that no insurance company-

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customer relationship exists between the trust and the employees receiving
benefits under the trust or their employers.

• You are unlike an insurance program and similar to a VEBA because you are non-
  commercial in nature and lack a profit motive.

• You are unlike an insurance program and similar to a VEBA because you do not
  market or advertise the availability of benefits to the general public. Knowledge of
  the benefits of the plan is made available to the employer members of endorsing
  chambers of commerce and business associations within T through brokers,
  endorsing chambers of commerce and business associations, and your website.

• You are unlike an insurance program and similar to a VEBA because membership
  is restricted to employees within a geographic local. You claim this is adequate to
  minimize the possibility that it could be used as a vehicle to sell insurance to
  individuals.

• You represent that the trust exists independent of the member-employees or their
  employers, the trust is controlled by independent trustees, and membership in the
  trust is voluntary. You state the trust is an employee welfare plan as defined in ERISA
  section 3(1), and complies with ERISA’s reporting, disclosure and fiduciary
  responsibility provisions.

Service’s Response to Applicant’s Position:

The fact that all of your members are employees of employers who are themselves
members of one of over 100 chambers of commerce or business associations in the T
is not sufficient to demonstrate an employer-related common bond as required by the
Regulations.

Although you state that you are unlike a commercial insurance provider, you admit that
your objective is to enable small companies to join together in order to obtain insurance
protection through mass purchasing. Your insurance plans are available to sponsoring
chambers of commerce and associations through brokers and agents who are paid on
commission. You do not maintain information regarding highly compensated
employees or the number of employees who are not covered by the plan. These are all
characteristics of commercial insurance providers.

You did not provide any relevant information that would result in a favorable
determination. As in Harding Hospital, Inc. v. United States, 505 F.2d 1068 (1974), you
have the burden of proving that you satisfy the requirements for tax exemption. You
have failed to provide enough information to prove to us that members share an

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employment-related common bond and that you are not operating in a manner similar to
a commercial insurance provider.

Conclusion:

You have not demonstrated employment-related common bond as required under
section 1.501(c)(9)-2(a)(1) of the regulations. And you have not satisfied the non-
discriminatory requirements imposed under sections 105(a) and 505(b).

Therefore, you do not qualify for exemption under Code subsection 501(c)(9) as a
voluntary employees' beneficiary association (VEBA).

Your Appeal Rights:

You have the right to file a protest if you believe this determination is incorrect. To
protest, you must submit a statement of your views and fully explain your reasoning.
You must submit the statement, signed by one of your officers, within 30 days from the
date of this letter.

We will consider your statement and decide if that information affects our determination.
If your statement does not provide a basis to reconsider our determination, we will
forward your case to our Appeals Office. You can find more information about the role
of the Appeals Office in Publication 892, Exempt Organization Appeal Procedures for
Unagreed Issues.

An attorney, certified public accountant, or an individual enrolled to practice before the
Internal Revenue Service may represent you during the appeal process. To be
represented during the appeal process, you must file a proper power of attorney, Form
2848, Power of Attorney and Declaration of Representative, if you have not already
done so. For more information about representation, see Publication 947, Practice
Before the IRS and Power of Attorney. All forms and publications mentioned in this
letter can be found at www.irs.gov, Forms and Publications.

If you do not intend to protest this determination, you do not need to take any further
action. If we do not hear from you within 30 days, we will issue a final adverse
determination letter to you. That letter will provide information about filing tax returns
and other matters.

Please send your protest statement, Form 2848 and any supporting documents to the
applicable address:

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Mail to: Deliver to:
Internal Revenue Service Internal Revenue Service
EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008
P.O. Box 2508 Cincinnati, OH 45202.

Cincinnati, OH 45201

You may also fax your statement using the fax number shown in the heading of this
letter. If you fax your statement, please call the person identified in the heading of this
letter to confirm that he or she received your fax.

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

Sincerely,

Lois G. Lerner
Director, Exempt Organizations
Rulings & Agreements

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Enclosure: Publication 892