Welfare-benefit trust reversion avoids excise tax and UBIT

Plain-English summary

A § 501(c)(3) charity sponsored a tax-exempt voluntary employees' beneficiary association that provided health and death benefits. After terminating the trust and making one-time payments to beneficiaries, the charity proposed receiving the remaining assets for use in its charitable activities. Employees had not contributed to the trust, and the charity represented that it had never deducted its contributions under IRC § 419. The IRS ruled that the reversion would not be a disqualified benefit subject to the 100 percent excise tax under IRC § 4976 because the contributions had not been deductible. It also ruled that the one-time return of assets was not a trade or business entered into for profit and therefore was not unrelated business taxable income under IRC §§ 511 through 514.

Ruling snapshot

• Question: Would the terminated welfare-benefit trust's residual assets trigger § 4976 excise tax or unrelated business income when returned to the sponsoring charity?
• Outcome: Approved, neither tax applies
• Key authorities: IRC §§ 419, 511-513, and 4976; Treas. Reg. §§ 1.501(c)(9)-4(d) and 1.513-1

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Release Number: 201451044 Contact Person:
Release Date: 12/19/2014
Date: September 25, 2014 Identification Number:

Uniform Issue List Telephone Number:
511.00-00
512.00-00 Taxpayer Identification Number:
4976.00-00

Legend:
Trust =
Date 1 =
Date 2 =
Date 3 =
x =

Dear

This responds to your letter, dated March 11, 2013, requesting rulings as to the federal tax
consequences of a proposed transaction under sections 4976 and 511 of the Internal Revenue
Code (“Code”).

FACTS

You represent that you are a section 501(c)(3) organization. You further represent that you
were recognized as tax-exempt under section 501(c)(3) as of the adoption date of your original
articles of incorporation on Date 1, and that you have remained tax-exempt under section
501(c)(3) organization since your inception.

Beginning Date 2, you represent that you sponsored Trust, a voluntary employees’ beneficiary
association tax-exempt under section 501(c)(9). Trust has provided health care coverage to
your active employees and eligible retirees and their dependents, and death benefits to the
designated beneficiaries of eligible retirees.

Effective Date 3, you resolved to terminate Trust. Certain Trust beneficiaries received one-time
lump sum payments in lieu of future retiree health care coverage and/or death benefits. After
these payments were made, $x remained in Trust. You further represent that, upon termination
of Trust, you propose that the residual assets of Trust will be distributed to you. You represent
that you intend to use the remaining assets in Trust upon being distributed to you to further your
charitable purposes.

Xxxxxxx Xxxxxxx Xxx

You state that your employees have neither made pre-tax nor post-tax contributions to Trust.
You also represent that you did not incur any unrelated business taxable income under sections
511 through 515 during years in which you made contributions to Trust. In addition, you state
that you have never taken any deductions under section 419 with respect to the contributions
you made to Trust.

RULINGS REQUESTED
You requested the following rulings:

1. Excise tax under section 4976 will not apply to the proposed transfer of Trust’s assets to
   you.

2. The reversion of any of Trust’s assets to you will not be taxed as unrelated business
   income to you.

LAW

Section 419(a) of the Code 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, are (subject to the limitation of section 419(b)) deductible under section 419 for the
taxable year in which paid.

Section 501(c)(9) 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.

Treas. Reg. § 1.501(c)(9)-4(d) 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 § 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 511(a)(1) provides that a tax is hereby imposed for each taxable year on the unrelated
business taxable income as defined in section 512 of every tax-exempt organization described
under section 501(c).

Section 512(a)(1) provides that except as otherwise provided in this subsection, the term
"unrelated business taxable income" means the gross income derived by any organization from
any unrelated trade or business (as defined in section 513) regularly carried on by it, less the
deductions allowed by this chapter which are directly connected with the carrying on of such
trade or business, both computed with the modifications provided in subsection 512(b).

Section 513(a) provides the term "unrelated trade or business” means, in the case of any

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organization subject to the tax imposed by section 511, any trade or business the conduct of
which is not substantially related (aside from the need of such organization for income or funds
or the use it makes of the profits derived) to the exercise or performance by such organization of
its charitable, educational, or other purpose or function constituting the basis for its exemption
under section 501.

Section 513(a)(2) provides that unrelated business taxable transaction does not include
transaction, which is carried on, in the case of an organization described in section 501(c)(3)
primarily for the convenience of its members, students, patients, officers, or employees.

Section 512(a)(1) provides that the term "unrelated business taxable income" means the gross
income derived by any organization from any unrelated trade or business (as defined in
section 513) regularly carried on by it, less the deductions allowed by this chapter which are
directly connected with the carrying on of such trade or business, both computed with the
modifications provided in section 512(b).

Section 4976(a) imposes a 100 percent 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) defines "disqualified benefit" to include any portion of a welfare benefit
fund reverting to the benefit of the employer.

Section 4976(b)(3) 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.

Treas. Reg. § 1.513-1(a) provides that a gain or income derived from an activity is an unrelated
business taxable income, if the activity (1) is a trade or business; (2) is regularly carried on; and
(3) is not substantially related to the tax-exempt organization's exercise or performance of its
tax-exempt functions or purpose.

Treas. Reg. § 1.513-1(b) provides that for purposes of section 513 the term "trade or business"
has the same meaning it has in section 162 and generally includes any activity carried on for the
production of income from the sale of goods or performance of services.

United States v. American Bar Endowment, 477 U.S. 105 (1986) held that the standard test for
the existence of a "trade or business" under section 513 is whether the provision of goods or
services is entered into with the dominant hope and intent of realizing a profit.

ANALYSIS AND CONCLUSION
RULING REQUEST 1:
You represent that you have been a section 501(c)(3) organization since your inception. As a

tax-exempt entity under section 501(c)(3), the contributions you made to Trust generally would
not have been allowable as a deduction under section 419. Under section 4976(b)(3), section

Xxxxxxx Xxxxxxx Xxx

4976(b)(1)(C) does not apply to amount attributable to contribution to a fund that were not
allowable as a deduction under section 419. Consequently, the transfer of Trust assets to you
upon Trust’s termination will not result in any “disqualified benefit” within the meaning of
section 4976(b)(1)(C), and will not, in and of itself, cause you to be liable for the excise tax
imposed by section 4976.

RULING REQUEST 2:

You represent that upon termination of Trust, residual assets of Trust will be distributed to you.
You state that this is a one-time transaction.

Under § 1.513-1(a), an income derived from an activity is an unrelated business taxable income,
if the activity (1) is a trade or business; (2) is regularly carried on and; (3) is not substantially
related to the tax-exempt organization’s exercise or performance of its tax-exempt functions or
purpose. Thus, the first test under § 1.513-1(a) is whether the transfer of the residual assets of
the Trust to you is a trade or business. Section 513(c) defines a trade or business as any
activity carried on for the production of income from the sale of goods or the performance of
services. Under § 1.513-1(b), any activity carried on for the production of income from the sale
of goods or the performance of services, is a trade or business.

You did not enter into a transaction with Trust to produce income. Rather, Trust upon
dissolution and after paying expenses associated with operating Trust, is returning back to you
contributions you made to Trust which Trust used to fund section 501(c)(9) benefits. You state
that you have never taken any deductions under section 419 with respect to the contributions
you made to Trust.

Because the reversion of Trust’s assets back to you is not a trade or business, the Trust's
assets that will revert back to you is not taxable under sections 511 through 514. Your intent
and hope as a result of this transaction was not to make a profit. See United States v. American
Bar Endowment, 477 U.S. 105 (1986).

RULING:

Based on the information submitted, representations made, and the authorities cited above, we
conclude that:

1. The transfer of Trust assets to you upon Trust’s termination will not result in any
   “disqualified benefit” within the meaning of section 4976(b)(1)(C), and will not, in and of
   itself, cause you to be liable for the excise tax imposed by section 4976.

2. The reversion of any Trust’s assets to you will not be taxed as unrelated business
   income to you.

This ruling will be made available for public inspection under section 6110 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

Xxxxxxx Xxxxxxx Xxx

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) 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.

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.

Sincerely,

Michael Seto
Manager, EO Technical

Enclosure
Notice 437