Retiree health trust may fund active-employee benefits without reversion tax

Plain-English summary

An employer maintained a voluntary employees' beneficiary association trust holding assets for retiree health benefits. It proposed amending the trust to segregate a redacted amount and use it exclusively for health benefits for active employees. Because the employer had previously deducted contributions as a reserve for post-retirement medical benefits, it represented that it would include the transferred amount in income under the tax benefit rule. The IRS ruled that using the trust assets for active-employee health benefits would not cause any portion of the welfare benefit fund to revert to the employer. The amendment therefore would not, by itself, create a disqualified benefit or trigger the 100 percent excise tax under section 4976.

Ruling snapshot

• Question: Would amending the welfare-benefit trust to fund active-employee health benefits cause a taxable reversion to the employer under section 4976?
• Outcome: Approved, no employer reversion or section 4976 excise tax would result from the amendment itself
• Key authorities: IRC §§ 61, 111, 419, 419A, and 4976; Hillsboro National Bank v. Commissioner, 460 U.S. 370 (1983)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Washington, DC 20224
Number: 201530022 Third Party Communication: None
Release Date: 7/24/2015 Date of Communication: Not Applicable

Index Number: 4976.01-00, 111.00-00

Person To Contact:
Telephone Number:
Refer Reply To:

CC:TEGE:EB:HW
PLR-T-103508-15

Date:

April 08, 2015
Legend:
Taxpayer =

Trust =
Plan =

Date X =
$X =
$Y =
$Z =
Dear

This responds to your letter dated April 25, 2014, and subsequent correspondence,
requesting a ruling regarding the tax consequences of an amendment to Trust, which
you represent is a voluntary employees’ beneficiary association under section 501(c)(9)
of the Internal Revenue Code (Code). The amendment would permit some of
Taxpayer's assets, now dedicated to post-retirement health benefits, to be used to
provide health benefits to active employees.

FACTS

Taxpayer sponsors Trust, which holds assets used to provide post-retirement health
benefits under Plan to eligible employees who retire from Taxpayer. Trust and Plan
were established on Date X. Section 2.3 of Trust provides that “[n]o benefits shall be

PLR-T-103508-15 2

paid out of [Trust] which would cause [Taxpayer] to be subject to tax for the payment of
disqualified benefits under Section 4976 of the Code.” Section 2.3(c) of Trust
specifically prohibits “any portion of [Trust] reverting to the benefit of [Taxpayer].”
Taxpayer has contributed a total of $X to Trust, and Trust had $Y in assets as of
December 31, 2014. Taxpayer represents that it deducted contributions to Trust in
accordance with section 419A(c)(2) of the Code.

Taxpayer intends to amend Trust to include active employees of Taxpayer as an
additional class of participants entitled to receive health benefits under Plan. The
amendment will provide that $Z of Trust to be used to provide health benefits to active
employees will be segregated in a separate subpart of Trust and used exclusively for
such benefits. Taxpayer further represents that it will recognize $Z in income under the
tax benefit rule.

RULING REQUESTED

Taxpayer has requested a ruling that the amendment of Trust and the use of Trust
assets to provide health benefits to active employees will not result in a reversion to
Taxpayer within the meaning of section 4976(b)(1)(C), and, therefore, will not cause
Taxpayer to be subject to excise tax under section 4976.

LAW

Section 61(a) of the Code provides that, unless otherwise excepted, gross income
includes all income from whatever source derived.

Section 111(a) of the Code provides that gross income does not include income
attributable to the recovery during the taxable year of any amount deducted in any prior
taxable year to the extent the amount did not reduce the amount of tax imposed by
Chapter 1 of the Code.

Generally, the tax benefit rule requires a taxpayer who received a tax benefit from a
deduction in an earlier year to recognize income in a later year if an event occurs that is
fundamentally inconsistent with the premise on which the deduction was initially based.
Hillsboro National Bank v. Commissioner, 460 U.S. 370 (1983); see also Hughes &
Luce, LLP v. Commissioner, 70 F.3d 16 (5th Cir. 1995), cert. denied, 517 U.S. 1208
(1996). The term “tax benefit rule” encompasses two concepts, an inclusionary part and
an exclusionary part. Frederick v. Commissioner, 101 T.C. 35, 40-41 (1993). The

inclusionary part has been developed in the courts and requires a taxpayer to include a
previously deducted amount in the current year’s income when a fundamentally
inconsistent event has occurred. The exclusionary part is partially codified at

section 111(a) and permits a taxpayer to exclude an amount that did not previously
provide a tax benefit when it was deducted; the exclusionary part cannot apply unless
the inclusionary part applies.

PLR-T-103508-15 3

The tax benefit rule allays some of the inflexibilities of the annual accounting system
under specific circumstances. Hillsboro National Bank, 460 U.S. at 377. The general
purpose of the tax benefit rule is to approximate the results produced by a tax system
based on transactional rather than annual accounting. Id. at 381. The tax benefit rule
will “cancel out” an earlier deduction when a later event is “fundamentally inconsistent”
with the premise on which the deduction was initially based, even in situations where
there is no actual recovery of funds. Id. at 381-383. One must consider the facts and
circumstances of each case in light of the purpose and function of the provisions
granting the deductions. Id. at 385. Although it is usually helpful to determine whether
the later event would have foreclosed the deduction if it had occurred within the same
tax year, that inquiry is not an exclusive test. See American Mutual Life Insurance Co.
v. United States, 267 F.3d 1344, 1350 (Fed. Cir. 2001).

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

Section 419(b) limits the employer's deduction under section 419(a) to a welfare benefit
fund’s qualified cost for the taxable year. The qualified cost of a welfare benefit fund for
a taxable year is defined in section 419(c)(1) as the sum of the qualified direct cost for
the taxable year and, subject to the limitation of section 419A(b), any addition to a
qualified asset account for the taxable year. Under section 419(c)(2), the qualified cost
for any taxable year is reduced by the welfare benefit fund’s after-tax income for the
taxable year.

Section 419(c)(3)(A) provides that the term “qualified direct cost” means, with respect to
any taxable year, the aggregate amount (including administrative expenses) that would
have been allowable as a deduction to the employer with respect to the benefits
provided during the taxable year, if those benefits were provided directly by the
employer and the employer used the cash receipts and disbursements method of
accounting.

Section 419(c)(3)(B) provides that, for purposes of section 419(c)(3)(A), a benefit is
treated as provided when that benefit would be includible in the gross income of the
employee if provided directly by the employer (or would be so includible but for any
provision of Chapter 1 of the Code excluding that benefit from gross income).
Section 419A(a) defines the term “qualified asset account” to include any account
consisting of assets set aside to provide for the payment of medical or life insurance
benefits.

Section 419(e)(1) defines the term “welfare benefit fund” to include any fund through
which the employer provides welfare benefits to employees or their beneficiaries. The

PLR-T-103508-15 4

term “fund” is defined in section 419(e)(3) to include an organization described in
section 501(c)(9).

Section 419A(a) provides that the term “qualified asset account” means any account
consisting of assets set aside to provide for the payment of (1) disability benefits, (2)
medical benefits, (3) SUB or severance pay benefits, or (4) life insurance benefits.

Section 419A(b) provides that no addition to any qualified asset account may be taken
into account under section 419(c)(1)(B) to the extent the addition results in the amount
of the account exceeding the account limit.

Section 419A(c)(1) provides that, except as otherwise provided in this subsection, 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 the taxable year) for benefits referred to in subsection (a), and (B)
administrative costs with respect to the 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 4976(a) of the Code 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.

ANALYSIS AND CONCLUSION

As explained above, the tax benefit rule is implicated when a taxpayer has taken a
deduction in a prior year, and in a subsequent year an event occurs that is
fundamentally inconsistent with the premise of the deduction. The facts and
circumstances of each case must be considered “in light of the purpose and function of
the provisions granting the deductions.” Hillsboro National Bank, 460 U.S. at 385.

The amendment of Trust will allow amounts that were originally set aside to provide
retiree health benefits to be used to provide health benefits for active employees. The
contributions made by Taxpayer were originally deducted as part of a reserve for post-
retirement medical benefits under section 419A(c)(2). Thus, the amendment of Trust
will implicate the tax benefit rule because Taxpayer deducted the contributions for

PLR-T-103508-15 5

retiree health benefits in a prior year, but after the amendment the amounts attributable
to the contributions will be available to provide benefits for active employees, which is
fundamentally inconsistent with the premise of the deduction. Taxpayer has therefore
represented that it will include in income $Z, which is the amount that will be available
under the Trust amendment for the payment of health benefits for active employees.

As explained above, 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. A “disqualified benefit” is defined in section 4976(b)(1)(C) to include any
portion of a welfare benefit fund reverting to the benefit of the employer. Based on the
information submitted by Taxpayer, it does not appear that the amendment of Trust or
use of Trust assets to provide health benefits for active employees will result in any
portion of Trust reverting to the benefit of Taxpayer. Thus, the amendment of Trust and
the use of Trust assets to provide health benefits to active employees will not result in a
“disqualified benefit” within the meaning of section 4976(b)(1)(C), and the transaction
will not, in and of itself, cause Taxpayer to be liable for the excise tax imposed by
section 4976.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

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

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

Sincerely,

Janet A. Laufer

Senior Technician Reviewer

Health & Welfare Branch

Office of Associate Chief Counsel
(Tax Exempt & Government Entities)