Retiree welfare trust remains collectively bargained and its set-aside income is exempt

Plain-English summary

A section 501(c)(9) voluntary employees' beneficiary association held assets for health benefits promised to union retirees under a collectively bargained plan. After the employer shut down production, the bargaining agreement ended, the employer modified and froze the benefits under authority granted by the plan, and responsibility for the plan and trust moved to independent professionals. The IRS ruled that the trust remained a welfare benefit fund maintained under a collective bargaining agreement for sections 419, 419A, and 512. Employer contributions and other trust income set aside to pay plan benefits were exempt function income under section 512(a)(3)(B). Because the collective-bargaining exception applied, the usual section 512(a)(3)(E) account-limit restriction did not make those earnings unrelated business taxable income.

Ruling snapshot

• Question: Did the retiree welfare trust remain collectively bargained, and were contributions and income set aside for benefits exempt from unrelated business income tax?
• Outcome: Approved
• Key authorities: IRC §§ 419, 419A(f)(5), 501(c)(9), 511, 512(a)(3), and 7701(a)(46); Temp. Treas. Reg. §§ 1.419A-2T, 1.512(a)-5T, and 301.7701-17T

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Contact Person:

Number: 201512006 Identification Number:

Release Date: 3/20/2015
Telephone Number:

Date: December 24, 2014 Employer Identification Number:

UIL: 419.00-00; 419A.00-00;
501.09-00; 512.00-00; 7701.00-00

Legend:

Plan =
Trust =
Company =
Union =
Date 1 =
Date 2 =
Date 3 =
Date 4 =
Year A =
N years =
$x =
$y =

FACTS

Trust has received a determination letter from the Service that it is a voluntary employees’
benefits association under section 501(c)(9) of the Internal Revenue Code (“Code”).

Trust holds assets to provide benefits provided under Plan. Plan and Trust are part of a single
employer welfare arrangement that was sponsored by Company. Plan was originally
established through negotiation of a collective bargaining agreement (“CBA”) between Company
and Union on Date 1. Plan was amended and restated on Date 3 and Date 4. Prior to the Date
3 restatement, a Joint Committee of the Union and the Company administered Plan.

Prior to its restatement, the purpose of Plan was to provide supplemental health insurance
coverage and/or reimbursement to certain former employees who were members of Union with
at least ten years of Union seniority, and who retired after Year A from employment with
Company. Plan also offered benefits to the eligible dependents of those retirees.

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Under the terms of the collectively bargained Plan, during the term of any CBA between
Company and Union, Plan could be modified, amended or terminated only through collective
bargaining. Plan terms also provided that at the conclusion of the CBA, Plan could be modified,
amended or terminated by the president of Company.

On Date 2, Company ended its production and all Union members were laid off. The CBA
between Company and Union was extinguished by agreement of the parties. A Shutdown
Agreement was negotiated between Company and Union with respect to the effects of the plant
closing on bargaining unit employees, but did not address the effects on employees who were
already retired.

On Date 3, the president of Company modified Plan in accordance with the then-existing terms
set forth in Plan. Changes to Plan include capping benefits at current levels, limitations on
movement in and out of Plan, and an eventual conversion to a Plan providing health
reimbursements only. Plan as modified also eliminates the Joint Committee. The Plan
Administrator notified Union members of the Committee of the changes to Plan and stated
Company’s position that Company is not required to continue present benefits or to provide
replacement benefits after existing assets of Trust are used up. The notification states,
however, that without additional funding, the hourly retiree benefits would end within N years,
and, therefore Company will make an additional contribution in an amount intended to provide a
medical benefit up to the time the last participant no longer needs benefits. At the same time,
Company sent detailed information about Plan changes to the retiree Plan participants, and
informed them that that in order to participate in the revised Plan the participant must sign a
Participation Agreement and a Release waiving any claims regarding Plan. Company also
informed participants that it was amending Plan with the intention of transferring Plan to an
outside provider that would oversee its management.

Union subsequently sent a letter to retirees explaining the changes to Plan, outlining Union’s
history relating to Plan, including its continuous monitoring of Plan since the plant closure, and
stating that Union would continue to do its best to protect the interest of the retirees. The letter
also reminded participants that they needed to sign the Participation Agreement and Release by
a specified date in order to receive continued benefits, and it stated that while retirees could
bring their own lawsuit the Union recommended that the retirees sign the Participation
Agreement and Release instead.

All participants who could be located (more than 99 percent of total plan participants) have
signed releases.

Plan was modified again effective Date 4 to make certain clarifications and other administrative
changes.

Company, which is in the process of dissolving as a corporation, recently further funded Trust
with approximately $x. Trust now holds approximately $y in assets, and Company has
transferred the responsibility for sponsoring Plan and Trust to a professional firm acting as an
independent fiduciary for the Plan and Plan Administrator. Together with a professional third-
party administrator, the successor entities will oversee and administer Plan and Trust for the life

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of Trust. At the end of Trust’s existence, remaining funds in Trust will be distributed to the
remaining participants and beneficiaries for incurred and payable benefits as provided for under
Trust provisions. If funds exist beyond the life of all participants and beneficiaries, surplus Trust
assets that remain will be distributed as provided under Trust provisions. You further represent
that in no event will Trust assets revert to or inure to the benefit of Company, its shareholders,
Union, any trustee or named fiduciary, or any other party responsible for maintaining Plan and
Trust after Company’s dissolution.

RULINGS REQUESTED

1. Trust is maintained pursuant to a collective bargaining agreement for purposes of
   section 419A(f)(5) of the Code.

2. Any investment income, employer contributions and other income received by Trust and
   set aside to pay Plan benefits is exempt function income within the meaning of section
   512(a)(3)(B), and therefore, Trust’s earnings shall not constitute unrelated business
   taxable income within the meaning of section 512.

LAW

Section 419A(a) provides that for purposes of sections 419, 419A and 512 the term “qualified
asset account” means any account consisting of assets set aside to provide for the payment of
disability benefits, medical benefits, SUB or severance pay benefits, or life insurance benefits.

Section 419A(c)(1) provides that, in general, the account limit for any qualified asset account for
any taxable year is the amount reasonably and actuarially necessary to fund (A) claims incurred
but unpaid (as of the close of such taxable year) for benefits referred to in subsection (a), and
(B) administrative costs with respect to such claims.

Section 419A(c)(2) provides that the account limit for any taxable year may include a reserve
funded over the working lives of the covered employees and actuarially determined on a level
basis (using assumptions that are reasonable in the aggregate) as necessary for (A) post-
retirement medical benefits to be provided to covered employees (determined on the basis of
current medical costs), or (B) post-retirement life insurance benefits to be provided to covered
employees.

Section 419A(f)(5)(A) provides that no account limits shall apply in the case of any qualified
asset account under a separate welfare benefit fund under a collective bargaining agreement.

Section 501(a) provides that an organization described in section 501(c) (including a VEBA
described in section 501(c)(9)) shall be exempt from taxation unless the exemption is denied
under section 502 or 503.

Section 511 imposes tax on the unrelated business taxable income (as described in section

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512) of organizations described in section 501(c).

Section 512(a)(3)(A) 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 allowable deductions that are directly connected with the production
of gross income (excluding exempt function income), both computed with specified
modifications.

Section 512(a)(3)(B) provides that the term “exempt function income” means, for a section
501(c)(9) organization, the gross income from dues, fees, charges, or similar amounts paid by
members of the organization as consideration for providing the members or their dependents or
guests goods, facilities, or services in furtherance of the organization to which such income is
paid. Such term also means all income (other than an amount equal to the gross income
derived from any unrelated trade or business regularly carried on by the organization) which is
set aside to provide for the payment of life, sick, accident, or other benefits, including
reasonable costs of administration directly connected with the provision of such benefits.

Section 512(a)(3)(B) further provides that, if during the taxable year, an amount that is
attributable to income so set aside is used for a purpose other than to provide for the payment
of life, sick, accident or other benefits, or for purposes specified in section 170(c)(4), such
amount shall be included, under subparagraph (A), in the unrelated business taxable income for
the taxable year.

Section 512(a)(3)(E) provides that the set-aside described in section 512(a)(3)(B) for a section
501(c)(9) organization 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 for the taxable year (not taking into account
any reserve described in section 419A(c)(2)(A) for post-retirement medical benefits).

Section 7701(a)(46) and Treas. Reg. section 301.7701-17T provide that in determining whether
there is a collective bargaining agreement between employee representatives and one or more
employers, the term “employee representatives” shall not include any organization more than
one-half of the members of which are employees who are owners, officers, or executives of the
employer. An agreement shall not be treated as a collective bargaining agreement unless it is a
bona fide agreement between bone fide employee representatives and one or more employers.
Additionally, the Internal Revenue Service shall make the determination for purposes of the
Code as to whether there is a collective bargaining agreement between employee
representatives and one or more employees. Further, specific Code provisions may require
other conditions than those in section 7701(a)(46) to be satisfied in order for a plan to be
considered to be collectively-bargained.

Section 1.419A-2T, Q&A-1 provides that contributions to welfare benefit funds that are
maintained pursuant to one or more collective bargaining agreements and the reserves of such
a fund generally are subject to the rules of sections 419, 419A, and 512. However, neither
contributions to nor reserves of such a collectively bargained welfare benefit fund shall be
treated as exceeding the otherwise applicable limits of section 419(b), 419A(b), or 512(a)(3)(E)

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until the earlier of: the date on which the last collective bargaining agreement relating to the fund
in effect on, or ratified on or before, the date of issuance of final regulations concerning such
limits for collectively bargained welfare benefit funds terminates, or (ii) the date three years after
the issuance of such final regulations.

Section 1.419A-2T, Q&A-2 provides that for purposes of Q&A-1, a collectively bargained welfare
benefit fund is a welfare benefit fund that is maintained pursuant to agreement that the
Secretary of Labor determines to be a collective bargaining agreement. In addition, the benefits
provided through the fund must have been the subject of arms-length negotiations between
employee representatives and one or more employers, and the agreement between the
employee representatives and the employer(s) satisfies section 7701(a)(46). Moreover, the
circumstances surrounding a collective bargaining agreement must evidence good faith
bargaining between adverse parties over the welfare benefits to be provided through the fund.
Finally, a welfare benefit fund is not considered to be maintained pursuant to a collective
bargaining agreement unless at least 50 percent of the employees eligible to receive benefits
under the fund are covered by the collective bargaining agreement (90 percent for a welfare
benefit fund that was not in existence on July 1, 1985).

Section 1.512(a)-5T, Q&A-1 explains that section 512(a)(3) restricts the amount of income that
may be set aside by a section 501(c)(9) organization for exempt purposes.

Section 1.512(a)-5T, Q&A-3(a) provides that the amounts set aside in a section 501(c)(9) VEBA
as of the close of the taxable year of the VEBA to provide for the payment of life, sick, accident,
or other benefits may not be taken into account for purposes of determining “exempt function
income” to the extent that such amounts exceed the qualified asset account limit, determined
under sections 419A(c) and 419A(f)(7), for such taxable year. (Section 419A(f)(7) involves a
special rule for tax years not applicable to this ruling request.) In calculating the qualified asset
account limit for this purpose, a reserve for post-retirement medical benefits under section
419A(c)(2)(A) is not to be taken into account.

Section 1.512(a)-5T, Q&A-3(b) provides that the exempt function income of a VEBA for a
taxable year of the VEBA includes: (1) certain amounts paid by members of the VEBA
(“member contributions”); and (2) other income of the VEBA (including earnings on member
contributions) that is set aside for the payment of life, sick, accident, or other benefits to the
extent that the total amount set aside in the VEBA as of the close of the taxable year for any
purpose (including member contributions and other income set aside in the VEBA as of the
close of the taxable year) does exceed the qualified asset account limit for such taxable year of
the organization. For purposes of section 512(a)(3)(B), member contributions include both
employee contributions and employer contributions to the VEBA. In calculating the total amount
set aside as of the close of the taxable year, certain assets with useful lives extending
substantially beyond the end of the taxable year (e.g., buildings and licenses) are not to be
taken into account to the extent they are used in the provision of life, sickness, accident, or
other benefits. Accordingly, the unrelated business taxable income of a VEBA for the taxable
year of the organization generally will equal the lesser of two amounts: the income of the VEBA
for the taxable year (excluding member contributions); or, the excess of the total amount set
aside as of the close of the taxable year (including member contributions, and excluding certain

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assets with a useful life extending substantially beyond the end of the taxable year to the extent
they are used in the provision of welfare benefits) over the qualified asset account limit
(calculated without regard to the otherwise permissible reserve for post-retirement medical
benefits) for the taxable year. See Treas. Reg. section 1.419A-2T for special rules relating to
collectively bargained welfare benefit funds.

ANALYSIS AND CONCLUSION

Under the facts of this ruling request, benefits originally provided by Plan were part of a bona
fide agreement between employer (Company) and employee representatives meeting the
requirements of section 7701(a)(46) (Union), and the Plan benefits were the subject of arms-
length negotiations between those parties. One of the terms negotiated as part of the Plan was
that, at the conclusion of the CBA, Plan could be modified, amended or terminated by the
president of Company. On Date 2, the CBA between Company and Union was extinguished by
agreement of the parties when all Union members were laid off, and subsequently the president
of Company modified Plan in accordance with the terms set forth in the collectively bargained
Plan. Those modifications and the additional funds contributed by Company essentially resulted
in the freezing of the benefits previously negotiated by Company and Union. Plan and Trust are
currently being maintained pursuant to those modifications.

Section 511 imposes income tax on the unrelated business taxable income (UBTI) of certain
tax-exempt organizations, including VEBAs. Under section 512(a)(3)(A), the UBTI of a VEBA is
the VEBA’s gross income (excluding exempt function income), less certain specified deductions,
both computed with certain specified modifications.

Under Treas. Reg. section 1.512(a)-5T, Q&A-3(b), in the case of a VEBA, exempt function
income includes employer contributions to the VEBA.

Under section 512(a)(3)(B), in the case of a VEBA, exempt function income generally means all
income set aside to provide for the payment of life, sick, accident, or other benefits, including
certain specified reasonable costs of administration. However, if an amount so set aside is
used for another purpose, that amount is included in the VEBA’s UBTI for the year so used.

Further, section 512(a)(3)(E)(i) places limitations on the amount that is set aside to provide for
the payment of life, sick, accident, or other benefits that may be treated as exempt function
income. Under these limitations, a set-aside for any purpose specified in section 512(a)(3)(B)(ii)
may be taken into account as exempt function income only to the extent that it does not result in
an amount of assets that exceeds the account limit determined under section 419A for the
taxable year (not taking into account any reserve described in section 419A(c)(2)(A) for post-
retirement medical benefits).

However, funds maintained pursuant to collective bargaining agreements come within a special
rule for collectively bargained plans under section 419A(f)(5) and Temp. Treas. Reg.
section 1.419A-2T. Pending the adoption of final regulations, Treas. Reg. section 1.419A-2T,
Q&A 1 provides that amounts held in welfare benefit funds that are maintained pursuant to a

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collective bargaining agreement will not be treated as exceeding the otherwise applicable limits
of sections 419(b), 419A(b), or 512(a)(3)(E).

In this case, we conclude that contributions to Trust by Company are exempt function income
within the meaning of section 512(a)(3)(B), and so are not subject to tax on unrelated business
income under section 511. Moreover, under the particular facts presented here, we conclude
that for purposes sections 419, 419A, and 512, Trust is a welfare benefit fund maintained
pursuant to a collective bargaining agreement. We further conclude under the facts presented
here that because Trust is a welfare benefit fund maintained pursuant to a collective bargaining
agreement, the limitation otherwise imposed by section 512(a)(3)(E) on the amounts set-aside
to provide welfare benefits that can be treated as exempt function income does not apply.
Finally, we conclude that income received by Trust and set aside to pay Plan benefits is exempt
function income within the meaning of section 512(a)(3)(B) of the Code.

RULINGS

1. Trust is maintained pursuant to a collective bargaining agreement for purposes of
   section 419A(f)(5) of the Code.

2. Employer contributions and any income received by the Trust and set aside to pay Plan
   benefits is exempt function income within the meaning of section 512(a)(3)(B) of the
   Code and, therefore, Trust’s earnings will not constitute unrelated business taxable
   income within the meaning of section 512.

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
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.

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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.

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,

Mary Jo Salins
Acting Manager, EO Technical

Enclosure
Notice 437