New Vehicle Dealership Audit Technique Guide 2004 - Chapter 13 - Voluntary Employees' Benefit Associations (12-2004)
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Chapter 13 - Table of Contents
In the 1980’s, the tax treatment of contributions to funded welfare benefit plans changed with the enactment of IRC sections 419 and 419A. This change is important since larger automobile dealerships tend to use such funding to purchase vehicles. If a dealership has an employee welfare benefit plan that is funded through either a Voluntary Employees’ Beneficiary Association (VEBA) trust or a taxable trust, you will want to verify that payments to the trust comply with the rules of sections 419 and 419A, as well as certain other sections.
This chapter is included in this Guide for agent awareness only. In 1993, the former Industry Specialization Program created an Issue Specialist position for audit issues involving sections 419 and 419A and VEBAs. As a result of the reorganization, ISP’s were placed in the Pre-Filing and Technical Guidance section of the Large and Mid-Size Business division. The ISP position was renamed to that of “Technical Advisor.”
What is a VEBA?
VEBA is an acronym for "voluntary employees' beneficiary association." They are trusts that are exempt from tax under the provisions of IRC section 501(c)(9). A VEBA is a "welfare benefit fund" to which sections 419 and 419A will apply if it is part of a plan of an employer through which the employer provides welfare benefits to employees and their beneficiaries. While welfare benefit funds can also be taxable trusts, most welfare benefit funds apply for exempt status as VEBAs in order to reduce or eliminate income taxes at the trust level. VEBA’s file Form 990, whereas taxable trusts file Form 1041.
A "welfare benefit" is an employee benefit other than those to which IRC sections 83(h), 404, and 404A apply. The most common types of welfare benefits are medical, dental, disability, severance and life insurance benefits. It is important to remember that an examination of an employer’s deduction for its contribution to a welfare benefit fund is not an examination of the trust itself. The actual examination of a VEBA trust itself must be handled by an agent from the Tax Exempt and Government Entities division.
What do I need to do?
In order to determine if there are potential examination issues in this area, first ask the taxpayer (or their representative) about (1) the nature of the employee benefit plan, (2) the types of benefits provided, (3) whether the benefits are paid through a welfare benefit trust, (4) whether the plan or the benefits provided under the plan purport to be the subject of a collective bargaining agreement and (5) whether the trust purports to be a 10-or-more employer plan. Experience has shown that the proper examination of issues involving sections 419 and 419A is very fact intensive and involves extensive legal and actuarial analysis. Case development generally involves the issuance of third-party summonses to obtain relevant information.
If there are potential audit issues in your case, you should obtain copies of all documents relating to the creation or adoption of the plan and trust. This should include copies of all promotional material (including any cost-benefit proposals and legal opinions) and details on all contributions made to the fund and payments made from the fund. If the plan involves benefits that are provided through either individual or group insurance products, obtain copies of the policies and/or certificates of insurance and details on all premiums paid and policy values. You should also obtain a listing of the participants in the plan and the type and amount of benefits being provided to each participant. Secure copies of the Forms 5500 filed by the plan and the Forms 990 or Forms 1041 filed by the trust. You should also determine the names and addresses of all third parties involved in the plan (e.g., benefit consultants/ promoters, insurance salespersons, trustees, insurance companies, etc.).
There are many closely-held businesses claiming deductions for contributions to welfare benefit funds that claim to be exempted from the deduction limitations of sections 419 and 419A because they meet the requirements of sections 419A(f)(5) (for separate funds under collective bargaining agreements) or 419A(f)(6) (for 10-or-more employer plans). In 1995, the Service issued Notice 95-34 warning taxpayers about potential problems with promoter claims regarding 10-or-more employer plans. In 2000, the Service issued Notice 2000-15 classifying such arrangements as abusive corporate tax shelters. Treasury issued Proposed Regulations covering 10-or-more employer plans on July 11, 2002. The most recent Tax Court case involving such plans, Neonatology Associates, P.A., et al., v. Commissioner, 115 T.C 43 (2000) aff’d 299 F. 3d 221 (3rd Cir. 2002), found that the majority of the contributions to one such plan were actually constructive dividends and thus nondeductible to the corporation and currently includible in the shareholder’s income. The Court upheld the Service’s imposition of penalties on both the corporate and individual entities.
Since promoters of these arrangements tend to promise business owners current deductions for benefits to be received in the future, we expect that the popularity of these products will increase if Congress enacts tax legislation prospectively reducing the individual federal income tax rates. For more information on the types of plans being marketed, you can go to any Internet search engine and search under the terms: “welfare benefit funds,” “VEBA,” “Section 419A(f)(6)” or “Section 419A(f)(5).”
In general, sections 419 and 419A limit an employer’s deduction for contributions to a welfare benefit fund to the amount of the benefits actually paid during the year by the fund (determined using the cash-basis method of accounting) plus a limited allowance for reserves for incurred but unpaid claims and post-retirement medical and life insurance benefits. Section 419A(c)(1) allows a limited reserve for incurred but unpaid claims for disability, medical, SUB or severance pay and life insurance benefits.
If the fund qualifies as a separate fund under a collective bargaining agreement, in general, section 419A(f)(5) provides that there is no “account limit” for such reserves. Section 419A(f)(6) provides, in general, that the deduction limitations under sections 419 and 419A do not apply if the fund qualifies as a 10-or-more employer plan. In order to qualify, the plan must not maintain “experience-rating arrangements” with respect to individual employers, nor can any employer normally contribute more than 10% of the total contributions made by all employers.
Sections 419 and 419A are not applicable if the benefits provided by the plan are determined to be deferred compensation. In these situations IRC section 404 controls. In general, section 404(a)(5) provides that an employer’s deduction takes place in the year in which the amount attributable to the contribution is includible in the employees’ gross income. However, if more than one employee participates in the plan, an employer can only take a deduction if separate accounts are maintained for each employee.
In all situations, sections 419 and 419A comes into play only if the contributions to the fund are otherwise deductible under the Code. For example, if the contribution was determined to be a constructive dividend, and thus not otherwise deductible, then sections 419 and 419A would not be applicable. (See, e.g, Neonatology Associates, supra.)