PLR 1249018: IRS approves deductions for welfare benefit fund note payments

Plain-English summary

The IRS ruled on the tax treatment of a company's prepayment of a note contributed to a welfare benefit trust and the later transfer of that note to a third party. It concluded that qualifying prepayments and cash proceeds received by the trust could be deductible as contributions in the year of payment, subject to the unfunded present value of promised benefits and any applicable capitalization rules. The IRS also treated a note transferred to a third party as new indebtedness issued by the company with terms matching the remaining note and an issue price equal to the transfer proceeds. The ruling supplemented an earlier ruling and did not address capitalization under section 263A or other unruled tax consequences.

Ruling snapshot

• Question: How would prepayment or transfer of a note contributed to a welfare benefit trust affect the company's deductions and debt treatment?
• Outcome: Approved
• Key authorities: IRC §§ 162, 212, 263A, 419, 419A, and 6110; Treas. Reg. §§ 1.162-10T, 1.419-1T, and 1.419A

Full text (IRS public release)

201249018

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION DEC 28 2011

UIL: 419.00-00; 419.05-00; 419A.00-00

TIER. LA. FQ

LEGEND
Company =

Note =

Trust =
Amount A =
AmountB =

Amount C

Entity 1 =
Date A =
Loan Terms A=
Loan Terms B =
Loan Terms C =

Loan Terms D =

201249018

Loan Terms E =

Dear

This is in response to a request submitted on your behalf by your authorized

representatives dated as supplemented by additional correspondence
dated , in which you requested a private letter ruling to
supplement (the Prior Ruling), which was previously

issued to you.

As described in more detail below, the Prior Ruling addressed, among other things, the
tax treatment of the contribution of Note to Trust. Your ruling request
concerns the tax treatment of prepayment of Note, and the tax treatment of a transfer of
Note by Trust to a third party.

FACTS
The background facts are set forth in the Prior Ruling.

The following facts and representations have been submitted under penalty of perjury in
support of the ruling requested:

Pursuant to a settlement agreement, Company became obligated to contribute Note to
Trust to provide for Trust’s payments of employees’ post-retirement medical benefits.
On Date A, Company contributed Note to Trust with a principal amount of Amount A,
and an implied Amount B interest rate payable in Amount C Loan Terms A installments
Loan Terms B. The interest rate payable on Note was greater than the long-term
applicable Federal rate in effect for Date A. The Note indenture provides that Note is
Loan Terms C and prepayable at any time. Company has a right of first offer (ROFO) in
the event that Trust wishes to dispose of all or a portion of Note to a third party for cash.
The holder of Note may demand that Company Loan Terms D.

The Loan Terms E.

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The Prior Ruling addresses, among other things, the tax treatment of Company's
contribution of Note to Trust. The Prior Ruling concluded that “each annual installment
on Note paid to Trust is a contribution to Trust,” and “[e]Jach such contribution is
deductible by Company, subject to any capitalization requirement generally applicable
to such contributions under section 263A of the Code or otherwise, pursuant to sections
419 and 419A of the Code for the taxable year in which the installment payment is
made to Trust.” The Prior Ruling further states that each such contribution was only
deductible “to the extent that, as of the date of the contribution, the amount of the
contribution does not exceed the unfunded present value of benefits to be provided
through Trust”. The Prior Ruling does not address the consequences of a prepayment
or transfer of Note to a third party. You represent that events subsequent to the Prior
Ruling have increased the likelihood that Note will be transferred or prepaid. You have
asked us to assume, and we are so assuming, that any transfer would be solely for
cash.

RULINGS REQUESTED

1) Upon prepayment of Note (or portions thereof) in cash by Company pursuant to
the Note indenture and/or repurchase of Note by Company pursuant to the right
of first offer, such prepayment is deductible by Company in the taxable year in
which it is made, subject to any capitalization requirement otherwise applicable to
Note, and provided that the amount of the prepayment does not exceed the
unfunded present value of benefits to be provided through the Trust as of the
date of prepayment.

2) The cash proceeds received by Trust from a transfer constitute a contribution by
Company to Trust, and such contribution (in the amount of such transfer
proceeds) is deductible by Company in the taxable year in which the transfer is
made, subject to any capitalization requirement otherwise applicable to Note, and
provided that the amount of cash proceeds does not exceed the unfunded
present value of benefits to be provided through Trust as of the date of transfer.

3) Upon the sale of Note by Trust (other than pursuant to the right of first offer),
Company is considered to have issued a debt instrument to the transferee of
Note with terms identical to those remaining on Note as of the transfer date and
with an issue price equal to the amount of the transfer proceeds.

LAW

Section 162(a) of the Internal Revenue Code provides for a deduction for all ordinary
and necessary expenses paid or incurred during the taxable year in carrying on a trade
or business. Section 1.162-10T, Q&A-2 of the Income Tax Regulations provides that
section 419 governs the deduction of contributions paid or accrued by an employer with
respect to a “welfare benefit fund” within the meaning of section 419(e).

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Section 419(a) provides that contributions paid or accrued by an employer to a welfare
benefit fund are not deductible under Chapter 1 , but if they would otherwise be
deductible shall (subject to the limitation in section 419(b)) be deductible under section
419 for the taxable year when paid.

Section 1.419-1T, Q&A-10(a) states in part that contributions paid or accrued with
respect to a welfare benefit fund are deductible only to the extent that the contributions
satisfy the requirements of section 162 or 212. '

Section 1.419-1T, Q&A-10(d) provides that in determining the extent to which
contributions paid or accrued with respect to a welfare benefit fund are deductible under
section 419 , the rules of sections 263, 446(b), and 461(a) will be treated as having
been satisfied to the extent the contributions satisfy the otherwise applicable rules of
section 419 . Thus, for example, contributions to a welfare benefit fund will not fail to be
deductible under section 419 merely because they create an asset with a useful life
extending substantially beyond the close of the taxable year if such contributions satisfy
the otherwise applicable requirements of section 419.

ANALYSIS

Ruling Request #1

The Prior Ruling held that each annual installment payment on Note was deductible by
Company as a contribution to Trust, under sections 419 and 419A, in the taxable year in
which made (subject to the limitations stated above). The same analysis applies to a
prepayment of Note as would apply to each annual installment. Making payments in
advance, pursuant to a prepayment provision in the Note indenture or a right of first
offer, does not adversely affect the deductibility of the payment.

Accordingly, upon prepayment of Note (or portions thereof) in cash by Company
pursuant to the Note indenture, and/or the repurchase of Note by Company pursuant to
the right of first offer, such prepayment is deductible by Company in the taxable year in
which it is made, subject to any capitalization requirement otherwise applicable to Note,
and only to the extent that the amount of the prepayment does not exceed the unfunded
present value of benefits to be provided through Trust as of the date of prepayment.

Ruling Request #2

Section 419(a) provides that “contributions paid or accrued by an employer’ (emphasis
added) are deductible for the taxable year when paid, subject to the other limitations of
section 419. If Trust transfers Note to a third party, the third party will pay Trust for Note,
and thereafter Company will pay annual installments to the third party. For purposes of
section 419, “payment” by Company is considered to occur when Trust receives the
payment from the third party.

‘The Regulations refer to deductibility under sections 162 and 212 (rather than “otherwise” deductibility)
because they were published before technical corrections of section 419(a) were enacted.

5 201249018

This approach is consistent with the policy of Don E. Williams v. Comm’r, 429 U.S. 569
(1977), which interpreted the analogous “payment” requirement in section 404. The
Supreme Court explained that the policy behind the payment requirement is to “insure
the integrity of the employees’ plan and insure the full advantage of any contribution
which entitles the employer to a tax benefit.” Id. at 579. Here, when Note is transferred
to a third party, and the third party pays proceeds to Trust, Trust will get the full
advantage of the contribution that entitles Company to a tax benefit.

Accordingly, any cash proceeds received by Trust from a transfer of Note to a third
party constitute a contribution by Company to Trust, and such contribution (in the
amount of such transfer proceeds) is deductible by Company in the taxable year in
which the transfer is made, subject to any capitalization requirement otherwise
applicable on Note, and only to the extent that the amount of the cash proceeds does
not exceed the unfunded present value of benefits to be provided through Trust as of
the date of transfer.

Ruling Request #3

Because the contribution of Note to Trust does not by itself represent a paying out or
reduction of Company’s assets under Williams, the contribution of Note by Company to
Trust is not a transfer of property. However, this special treatment of Note is no longer
applicable when Note is transferred to a third party because the policy of Williams would
no longer apply to a transferee that is not a welfare benefit fund or similar entity. Under
the second ruling above, Company, in effect, is treated as receiving the cash proceeds
from the third party in exchange for a new note and then contributing the cash proceeds
to Trust as a prepayment on Note. Therefore, upon a transfer of Note to a third party,
Company is treated for federal income tax purposes as incurring new indebtedness in
respect of the third party transferee (that is, as if Company issued a new Note to the
transferee third party with an issue price equal to the transfer proceeds and with terms
identical to those remaining on Note as of the transfer date).

Except as specifically ruled above, no opinion is expressed as to the federal tax
consequences of the transaction described above under any other provision of the
Internal Revenue Code or as to the consequences under Title I of ERISA. Specifically,
no opinion is expressed regarding whether part or all of the contributions to Trust must
be capitalized under section 263A.

Pursuant to a power of attorney on file with this office, a copy of this letter ruling is being
sent to your authorized representatives.

This letter is directed only to the taxpayer who requested it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.

Please contact at with any questions about this letter.

6

291249018

Sincerely yours,

Donzell H. Littlejohn, Manager
Employee Plans Technical Group 2

Enclosures:
Deleted copy of letter ruling
Notice of Intention to Disclose