IRS approves a VEBA trust merger and excess asset transfer

Plain-English summary

A corporate employer proposed merging two voluntary employees' beneficiary association trusts into a third VEBA trust and making a one-time transfer from an overfunded collectively bargained retiree medical trust. The merged trust would keep separate subtrusts and records, and no subtrust's assets could pay another subtrust's benefits or revert to the employer. The employer agreed to include its previously deducted contributions to the transferring trust in income under the tax benefit rule, with no section 111 exclusion. The IRS ruled that neither the merger nor the transfer would create a disqualified benefit or a section 4976 excise tax because no assets would revert to the employer. It also ruled that the merger would not create gross income and that the transfer would not create section 61 income beyond the amount already included under the tax benefit rule.

Ruling snapshot

• Question: What federal tax consequences arise when an employer merges VEBA trusts and transfers excess assets from an overfunded retiree medical trust into the merged trust?
• Outcome: Approved
• Key authorities: IRC §§ 61, 111, 419, 419A, 4976, and 501(c)(9); Hillsboro National Bank v. Commissioner; Rev. Rul. 73-599; Rev. Rul. 77-92

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201625019
Release Date: 6/17/2016
Index Number: 4976.00-00, 4976.01-00,
61.44-00, 111.00-00

Third Party Communication: None
Date of Communication: Not Applicable

Person To Contact:
, ID No.

Telephone Number:

Refer Reply To:
CC:TEGE:EB:HW

PLR-T-103511-15
Date: March 11, 2016

Legend:
Taxpayer =
Trust A =
Trust B =
Trust C =
Trust D =
Plan =
V =
$W =
$X =
$Y =
$Z =

Dear

PLR-T-103511-15 2

This responds to your letter dated October 29, 2014, and subsequent correspondence,
requesting a ruling as to the federal tax consequences under section 4976 and section
61 of the Internal Revenue Code (Code) with respect to the merger of Trust A and Trust
B into Trust C, and the transfer of assets from Trust D to Trust C.

FACTS

Taxpayer is a corporation that was formed through multiple business combinations.
Taxpayer represents that Trust A, Trust B, Trust C, and Trust D are each maintained as
a voluntary employees’ beneficiary association under section 501(c)(9).

Taxpayer maintains Trust A, which currently provides medical benefits under Plan to
eligible employees, eligible retirees, and their eligible dependents. Taxpayer represents
that the contributions and related deductions for Trust A were calculated in accordance
with the requirements of the Code, including sections 419A(c)(1) and 419A(c)(2).

Taxpayer maintains Trust B, which currently provides life insurance benefits under Plan
to eligible employees, eligible retirees and their eligible dependents. Taxpayer
represents that it has taken deductions for all employer contributions made to Trust B in
accordance with the requirements of the Code, including section 419A(c)(2)(B).

Taxpayer maintains Trust C, which currently provides medical and long term disability
benefits under Plan to eligible employees. Taxpayer represents that the contributions
and related deductions for Trust C were calculated in accordance with the requirements
of the Code, including section 419A(c)(1).

Taxpayer maintains Trust D, which currently provides medical benefits under Plan to
certain eligible retirees and their eligible dependents. Taxpayer represents that Trust D
has at all times qualified as a trust maintained pursuant to a collective bargaining
agreement under § 1.419A-2T of the Income Tax Regulations.

MERGER OF TRUST A AND TRUST B INTO TRUST C

Trust A and Trust B will be merged into Trust C by no later than December 31, 2016.
Trust C will be amended to provide that Trust C may be permitted to fund benefits for
certain non-union retirees. Trust C will be renamed and new Trust C will contain three
separate subtrusts including: a subtrust consisting of current Trust A, a subtrust
consisting of current Trust B, and a subtrust consisting of current Trust C. Taxpayer
represents that the assets of each subtrust will be used to provide medical and welfare
benefits to eligible employees and retirees of Taxpayer and certain of its affiliates in the
same manner as prior to the merger of the trusts. Taxpayer represents that each

PLR-T-103511-15 3

subtrust will continue to maintain separate books and records. Taxpayer represents
that Trust C will provide that none of the assets in a subtrust in Trust C can be used as
assets for any other subtrust and none of the assets in a subtrust in Trust C are
available to pay any of the other subtrusts’ benefits.

Trust C might provide other benefits under Plan which are permissible under section
501(c)(9). Taxpayer represents that any such benefits will be provided through a
separate subtrust and assets of the three subtrusts described above will not be used to
pay for those benefits.

TRANSFER OF ASSETS FROM TRUST D TO TRUST C

Trust D will be amended to allow for a one-time transfer of (i) the Trust D balance on the
date of the transfer less (ii) $Y. $Y is approximately (i) V% of the projected amount
required to fund the $Z of annual benefits and claims of the Trust D and (ii) 15 times the

projected retiree contributions to Trust D. The amendment will require the
transferred amount to be transferred no earlier than January 1, , and be completed
by December 31, , so that the transfer of the entire transferred amount will be

completed in one taxable year of Taxpayer.

The transferred amount will be held in the general account of Trust C until able to fund
each of the subtrusts. At such point, the funds held in the general account of Trust C
will be transferred and allocated to each subtrust to be used during a year for the
payment of health and welfare claims and expenses. None of the transferred amount
will be used to fund benefits directly. Any portion of the transferred amount in excess of
the amount needed to pay claims for that year will remain in the general account of
Trust C and be used in subsequent years to provide benefits payable through the
subtrusts.

Taxpayer represents that the contributions and related deductions for Trust D were
calculated in accordance with the requirements of the Code, including section
419A(f)(5)(A). From the effective date of Trust D through the tax year ending December
31, , the total amount of contributions to Trust D that had been deducted was $W.
Trust D had a balance of $X in assets as of December 31, . Taxpayer made no
nondeductible contributions to Trust D, and there will be no amounts deducted after
December 31, , and before the one-time transfer. The amount of the one-time
transfer exceeds the total amount of previously deducted contributions to Trust D. The
projected balance of Trust D, after the transfer of assets from Trust D to Trust C, will be
$Y. Retiree contributions are less than the annual benefits payable by Trust D and are
used to pay benefits in the year in which they are placed into Trust D.

Taxpayer represents that Trust D has become overfunded due to declining headcount,
increased cost shifting to participants, the inability of Taxpayer to pay certain


PLR-T-103511-15 4

prescription drug expenses from Trust D, and limits on benefits that may be paid from
Trust D.

Taxpayer represents that Trust A, Trust B, Trust C and Trust D each individually have
specific provisions that prohibit the trust from distributing any portion of the trust to
Taxpayer. Each trust has a specific provision to provide that: (i) the assets of the trust
allocable to any plan shall be held for the exclusive purposes of providing benefits to
participants of the plan and their beneficiaries and defraying the reasonable expenses
of administering the plan and the trust; (ii) that trust assets may only be returned to
Taxpayer if a contribution (less losses) was made by Taxpayer due to a mistake of fact,
and (iii) upon the termination of the plan, the assets of the trust shall be used to provide
benefits described in section 501(c)(9) to plan participants and their beneficiaries (or
used as provided in § 1.501(c)(9)-4(d) of the Income Tax Regulations), except as
otherwise provided in regulations of the Department of Labor promulgated under section
403(d)(2) of the Employee Retirement Income Security Act of 1974 (ERISA).

Taxpayer represents that in the context of this merger, Taxpayer will not divert or direct
any Trust A, Trust B, Trust C, or Trust D assets to Taxpayer.

Taxpayer represents that it does not have any current or future legal obligations to
provide benefits through Trust C, including without limitation, specifically (i) the benefits
to be provided to certain non-union retirees under Trust C or (ii) any other benefits
under Plan which are permissible under section 501(c)(9) of the Code.

Taxpayer represents that it will take the total amount of previously deducted
contributions to Trust D ($W) into gross income under the tax benefit rule in the year of
the one-time transfer, and no portion of that amount is excludable under section 111.

RULINGS REQUESTED
Taxpayer requests rulings that:

(1) The proposed merger of Trust A and Trust B into Trust C, and the transfer from
Trust D to Trust C, will not result in a reversion of assets to Taxpayer and
therefore will not result in an excise tax under section 4976 due to a reversion of
assets to Taxpayer.

(2) The proposed merger of Trust A and Trust B into Trust C will not cause Taxpayer
to include any amount in gross income under section 61, including the
inclusionary part of the tax benefit rule.

(3) The proposed one-time transfer from Trust D to Trust C will not cause Taxpayer
to include any amount in gross income under section 61 in excess of the amount
included pursuant to the tax benefit rule.

PLR-T-103511-15 5

LAW

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

Section 111(a) 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.

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.

PLR-T-103511-15 6

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

Section 1.419-1T, Q&A-2(a) of the Income Tax Regulations, provides that section 419
of the Code generally applies to contributions paid or accrued with respect to a welfare
benefit fund after December 31, 1985, in taxable years of employers ending after that
date.

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.


PLR-T-103511-15 7

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

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.

In Revenue Ruling 73-599, 1973-2 C.B. 40, modified by Rev. Rul. 77-92, 1977-1 C.B.
41, the issue was whether the balance in a retired lives reserve had to be included in
the gross income of the employer in the taxable year in which the employer terminated
the insurance contract. At the time it terminated the insurance contract, the employer
directed that the insurance carrier should transfer the balance in the retired lives reserve
to a trust qualified as a VEBA under section 501(c)(9). The employer had deducted the
premiums paid into a retired lives reserve during the years when it was maintaining the
insurance contract for the benefit of its employees. The insurance contract provided
that, upon cancellation or other termination of the contract, any balance in the retired
lives reserve could be distributed to the employer as a dividend or, at the employer's
option, transferred to a trust qualified under section 501(c)(9) for the purpose of
providing insurance coverage for retired employees. Under these facts, the ruling holds
that the balance in the retired lives reserve was includable in the employer's gross
income under section 61(a) in the year of the transfer. The ruling states that, because

PLR-T-103511-15 8

the insurance contract gave the employer a fixed right to receive the balance in the
retired lives reserve in the year in which it terminated its coverage under the policy, that
balance was includable in the employer's gross income for the year of the termination,
notwithstanding the fact that the employer directed the insurance company to transfer
the money to a section 501(c)(9) trust. The ruling also holds that, in those cases in
which the tax benefit rule under section 111 applies, the rule applies only to that part of
the balance that was accumulated out of premiums; it does not apply to that part of the
accumulated balance that is the interest increments.

Similarly, in Revenue Ruling 77-92, a corporate employer with a group term insurance
program that included a retired lives reserve had the option to discontinue the insurance
coverage and to direct the insurance carrier to use the amount in the retired lives
reserve either to pay premiums for insurance on the lives of retired employees or to pay
a dividend to the employer. The employer terminated the insurance contract and
directed the insurance carrier to transfer the balance in the retired lives reserve to
another insurance company to purchase insurance for retired employees. The ruling
states that the facts presented are in substance the same as those contained in Rev.
Rul. 73-599, except that the right reserved to the employer in Rev. Rul. 77-92 to transfer
the funds remaining in the retired lives reserve consisted of the right to direct payment
to those funds to another insurance company rather than to a trust that qualified for
exemption under section 501(c)(9) of the Code. However, this difference was not
considered material because the taxpayer's right of control over the retired lives reserve
was substantially the same in both cases. Accordingly, the ruling concludes that the
same basic federal income tax rules apply to the transfers in the two cases. The ruling
also states that the portion of the transferred reserve accumulated out of premiums paid
or incurred in taxable years ending after June 17, 1969, is not includible in the
employer's income because such premiums were not deducted since the employer
retained the right of recapture.

ANALYSIS AND CONCLUSIONS
MERGER OF TRUST A AND TRUST B INTO TRUST C

Taxpayer represents that following the merger of Trust A and Trust B into Trust C, the
assets of each subtrust will be used to provide medical and welfare benefits to eligible
employees and retirees of Taxpayer and certain of its affiliates in the same manner as
prior to merger. Each subtrust will continue to maintain separate books and records,
and Trust C will provide that none of the assets in a subtrust in Trust C can be used as
assets for any other subtrust and none of the assets in a subtrust are available to pay
any of the other subtrusts’ benefits.

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

PLR-T-103511-15 9

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. We
conclude that the merger of Trust A and Trust B into Trust C is not fundamentally
inconsistent with the premise on which the deductions for contributions to Trust A and
Trust B were based, and, therefore, the tax benefit rule does not require Taxpayer to
include any amount in income as a result of that merger.

Furthermore, based on the information provided by Taxpayer, the merger of Trust A and
Trust B into Trust C will not be an accession to wealth for Taxpayer and, therefore, does
not result in gross income under section 61. In this case, with regard to the merger of
Trust A and Trust B into Trust C, there are provisions requiring the assets of Trust A
and Trust B to be used for providing benefits and prohibiting those trusts from
distributing any portion to Taxpayer. The provisions precluding Taxpayer from receiving
a reversion distinguishes this case from the situations considered in Rev. Ruls. 73-599
and 77-92. Moreover, Taxpayer has no right to any sort of reversion of Trust C’s assets
and has no current or future obligations to provide benefits through Trust C. Therefore,
Taxpayer will not realize any income under section 61 due to the merger of Trust A and
Trust B into Trust C.

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 provided by Taxpayer, it does not appear that the merger of Trust A and
Trust B into Trust C will result in any portion of Trust A, Trust B or Trust C reverting to
the benefit of Taxpayer. Thus, the merger will not result in a "disqualified benefit" within
the meaning of section 4976(b)(1)(C), and the merger will not, in and of itself, cause
Taxpayer to be liable for the excise tax imposed by section 4976.

TRANSFER OF ASSETS FROM TRUST D TO TRUST C

The amendment of Trust D, a separate welfare benefit fund under a collective
bargaining agreement within the meaning of section 419A(f)(5)(A), will allow amounts
that were originally set aside to provide retiree health benefits for union retirees to be
transferred to Trust C and used to provide health and other welfare benefits to
Taxpayer's active employees and other retirees. Therefore, the amendment of Trust D
will implicate the tax benefit rule because Taxpayer deducted its contributions to Trust D
in accordance with section 419A(f)(5)(A) in prior years, but after the amendment the
amount of the one-time transfer will be available to provide benefits under Trust C,
which is not a separate welfare benefit fund under a collective bargaining agreement as
described in section 419A(f)(5)(A). Thus, the amendment is fundamentally inconsistent
with the premise of the prior deductions. Taxpayer has therefore represented that it will
take the total amount of previously deducted contributions to Trust D ($W) into gross


PLR-T-103511-15 10

income under the tax benefit rule in the year of the amendment and one-time transfer,
and no portion of that amount is excludable under section 111.

Because the amount of the one-time transfer exceeds the total amount of previously
deducted contributions to Trust D, it is necessary to consider whether Taxpayer will
have an accession to wealth under section 61. In this case, with regard to the transfer
of assets from Trust D to Trust C, there are provisions requiring the assets of Trust D to
be used for providing benefits and prohibiting Trust D from distributing any portion of
Trust D to Taxpayer. Although Trust D is being amended to allow the transfer of assets
to Trust C, Trust D provisions prohibit Trust D assets from reverting to Taxpayer. The
provisions precluding Taxpayer from receiving a reversion distinguishes this case from
the situations considered in Rev. Ruls. 73-599 and 77-92. Moreover, Taxpayer has no
right to any sort of reversion of Trust C’s assets. Furthermore, Taxpayer has
represented that it does not have any current or future legal obligations to provide
benefits through Trust C. Therefore, because Taxpayer does not have any right to a
reversion of Trust D assets or a relief from a liability, it will not realize any income under
section 61 of the Code on the amount transferred from Trust D to Trust C that exceeds
the $W to be included in Taxpayer's income under the tax benefit rule.

Based on the information submitted by Taxpayer, it does not appear that the transfer of
Trust D assets to Trust C will result in any portion of Trust D reverting to the benefit of
Taxpayer. Thus, the transfer from Trust D to Trust C 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.

We assume, without expressing an opinion, for purposes of this ruling, that Taxpayer
has the authority to complete the transactions described and that these transactions can
otherwise be effectuated and do not fail to meet the requirements of other applicable
federal and state law.

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. Specifically, no opinion is expressed regarding the amount of any deductions
under sections 419 and 419A. We note, however, that Taxpayer will not be considered
to have contributed to Trust C any amount transferred from Trust D to Trust C that
exceeds the amount that Taxpayer is taking into income under the tax benefit rule as
described above. Accordingly, the total amount deductible by Taxpayer under sections
419 and 419A with respect to any amounts transferred from Trust D to Trust C cannot
exceed $W.

This ruling is directed only to the taxpayer requesting it. Specifically, no opinion is
expressed regarding the tax consequences of the described transactions to Trust A,
Trust B, Trust C, or Trust D, nor is any opinion expressed regarding the status under

PLR-T-103511-15 11
section 501(c)(9) of any trust (including any subtrust). Section 6110(k)(3) 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 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 Laufer

Senior Technician Reviewer

Health & Welfare Branch

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