Charitable transfer avoids the disqualified-benefit excise tax

Plain-English summary

A business trust planned to terminate a voluntary employees’ beneficiary association after all plan benefits and liabilities had been satisfied. The remaining trust assets, all derived from previously deducted employer contributions, would be transferred to unrelated charitable organizations. The taxpayer represented that it would include the assets’ fair market value in income under the tax benefit rule, exclude no portion under section 111, and claim no charitable deduction. The IRS concluded that a transfer to unrelated charities would not cause any part of the welfare benefit fund to revert to the employer. It therefore ruled that the transfer would not create a disqualified benefit or, by itself, trigger the 100 percent excise tax under section 4976.

Ruling snapshot

• Question: Would transferring the terminating welfare benefit trust’s remaining assets to unrelated charities create a disqualified benefit under section 4976?
• Outcome: Approved
• Key authorities: IRC §§ 111, 419, 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: 201545026
Release Date: 11/6/2015
Index Number: 4976.01-00, 111.00-00

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact:
Telephone Number:
Refer Reply To:
CC:TEGE:EB:HW
PLR-T-103512-15
Date: June 15, 2015

Legend:

Taxpayer =

Company A =

Company B =

Company C =

Trust =

Bankruptcy Court =

Plan =

Year 1 =

Year 2 =

Year 3 =

$X =

Dear :

This responds to your letter dated May 9, 2014, and subsequent correspondence,
requesting a ruling under section 4976 of the Internal Revenue Code (Code) regarding

the termination of Trust and the transfer of Trust assets to various charitable
organizations.

PLR-T-103512-15 2

FACTS

Taxpayer is a business trust established pursuant to an order of the Bankruptcy Court in
connection with the insolvency of Company A. Company A was formed after its former
parent company, Company B, went bankrupt in Year 1. Company A and its affiliates,
including Company C, filed for Chapter 11 protection in Bankruptcy Court in Year 2. In
Year 3, Taxpayer took over the Company A bankruptcy estate.

Company B provided welfare benefits to its employees through Plan, including medical
benefits, group term life insurance benefits, severance benefits, and disability benefits
(“Plan Benefits”). Company B established Trust to hold and invest the contributions it
made and to pay or provide Plan Benefits to employees. Taxpayer is the successor in
interest and assignee of certain assets and obligations of Company A, including those
relating to Plan.

Trust intends to terminate and transfer all remaining Trust assets, after payment of
administrative expenses related to the termination, to various unrelated charitable
organizations.

Taxpayer represents as follows:

1. Trust is a voluntary employees’ beneficiary association under section 501(c)(9) of the
   Code.

2. There are no remaining participants in Plan, all benefits owed under Plan have been
   paid, and there are no outstanding benefit claims or liabilities.

3. All of the remaining assets in Trust are derived from contributions made after
   December 31, 1985.

4. All contributions to Trust were deducted by Company A, Company B, or Company C.

5. The total amount of the previously deducted contributions exceeds the amount of the
   remaining assets in Trust as of December 31, 2014.

6. The amount of remaining assets in Trust as of December 31, 2014, is approximately
   $X.

7. Taxpayer acknowledges that the transfer of the remaining assets in Trust to the
   charitable organizations will be subject to the tax benefit rule.

PLR-T-103512-15 3

8. Taxpayer will take the fair market value of the remaining assets in Trust that are
   transferred to the charitable organizations into income under the tax benefit rule, and no
   portion of that amount is excludable under section 111.

9. Taxpayer will not take a charitable deduction for the amount transferred to the
   charitable organizations.

RULING REQUESTED

Taxpayer has requested a ruling that the termination of Trust and the transfer of the
remaining assets in Trust to various charitable organizations 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 the 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 such 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.

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

PLR-T-103512-15 4

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 511 of the Code imposes a tax on the unrelated business taxable income of
exempt organizations, including organizations described in section 501(c)(9).

Section 512(a)(1) provides, generally, 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 Chapter 1 which are directly connected with the carrying on of such trade or
business, both computed with the modifications provided in section 512(b).

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 deductions allowed by Chapter 1
which are directly connected with the production of the gross income (excluding exempt
function income), both computed with modifications.

Section 512(a)(3)(B) provides that the term “exempt function income” means 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 purposes constituting the basis for the
exemption of the organization to which such income is paid. The 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 such organization computed as if the
organization were subject to paragraph (1)), which is set aside—

PLR-T-103512-15 5

(i) for a purpose specified in section 170(c)(4), or

(ii) in the case of an organization described in paragraph (9), (17), or (20) of
section 501(c), to provide for the payment of life, sick, accident, or other benefits,

including reasonable costs of administration directly connected with a purpose
described in clause (i) or (ii). If during the taxable year, an amount which is attributable
to income so set aside is used for a purpose other than that described in clause (i) or
(ii), such amount shall be included, under subparagraph (A), in unrelated business
taxable income for the taxable year.

Section 512(a)(3)(E) limits amounts set aside to provide benefits described in section
512(a)(3)(B)(ii) that can be treated as exempt function income.

Section 170(c)(4) provides that the term “charitable contribution" includes a contribution
or gift by an individual to or for the use of a domestic fraternal society, order, or
association, operating under the lodge system, but only if such contribution or gift is to
be used exclusively for religious, charitable, scientific, literary, or educational purposes,
or for the prevention of cruelty to children or animals.

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 proposed transfer of the remaining assets in Trust to charitable organizations will
allow amounts attributable to contributions made for the purpose of providing Plan
Benefits to be transferred and used for charitable purposes. Thus, the transfer will
implicate the tax benefit rule because Taxpayer deducted the amount of the
contributions for Plan Benefits in a prior year, but now plans to transfer the assets to
charitable organizations, which is fundamentally inconsistent with the premise of the
deduction. Taxpayer has therefore represented that it will include the fair market value
of the assets in income under the tax benefit rule.

PLR-T-103512-15 6

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. Furthermore,
section 512(a)(3)(B)(i) contemplates that a voluntary employees’ beneficiary association
may make a contribution to a charitable organization. Based on the information
submitted by Taxpayer, it does not appear that the transfer of assets to the unrelated
charitable organizations will result in any portion of Trust reverting to the benefit of
Taxpayer. Thus, the termination of Trust and the transfer of Trust assets to charitable
organizations will not result in a “disqualified benefit” within the meaning of section
4976(b)(1)(C), and 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. Specifically, this ruling does not
address the tax consequences to Trust.

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,
/S/

Janet A. Laufer

Senior Technician Reviewer

Health & Welfare Branch

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