7.25.9  Voluntary Employees’ Beneficiary Associations

7.25.9.1  (02-09-1999)
The Statute

  1. IRC 501(c)(9) exempts from Federal income tax voluntary employees’ beneficiary associations (VEBAs) providing for the payment of life, sick, accident, or other benefits to their members (or their dependents or designated beneficiaries) if no part of the net earnings inures (other than through such payments) to the benefit of any private shareholder or individual.

7.25.9.1.1  (02-09-1999)
History

  1. The predecessors of IRC 501(c)(9) were sections 103(16) of the Revenue Act of 1928 and 101(16) of the Internal Revenue Code of 1939.

    1. The law, prior to the Tax Reform Act of 1969, (TRA–69) required that 85 percent or more of the income of VEBAs be derived from amounts collected from members and, as added with retroactive effect by the Revenue Act of 1942, amounts contributed by employers.

    2. Also, prior to the enactment of the Tax Reform Act, old IRC 501(c)(10) (section 101(19) of the Internal Revenue Code of 1939) provided for the exemption of voluntary beneficiary associations composed exclusively of Federal officers and employees. See H.R. Rep. No. 855, 87th Cong. 1939–2 C.B. 504 at 508. The exemption requirements under old IRC 501(c)(10) were identical to IRC 501(c)(9) except there was no 85 percent test and membership was restricted to Federal officers and employees.

  2. With the imposition of the tax on unrelated business income on all VEBAs, Congress concluded that the 85 percent test was no longer necessary for tax-exempt status of IRC 501(c)(9) organizations and eliminated the requirement. See Senate Report No. 91–552, 91st Cong., 1st Sess. 69 (1969), 1969–3 C.B. 468. Recognizing that no substantive difference remained between IRC 501(c)(9) and old 501(c)(10), Congress combined the two categories of VEBAs into IRC 501(c)(9) effective January 1, 1970. Sec. 121, P.L. 91–172, 1969–3 C.B. 10, 40.

    1. Final regulations under IRC 501(c)(9) were published in the Federal Register on January 7, 1981 (T.D. 7750).

  3. In the Tax Equity and Fiscal Responsibility Act of 1982 (Public Law 97–248), Congress lowered the limits on amounts that could be contributed to qualified pension plans and limited the benefits that could be paid out of the plans.

    1. As a result of these restrictions, some tax practitioners began recommending that employers use VEBAs and other nonpension employee benefit organizations in order to obtain tax sheltering advantages similar to those that had existed with pension plans before 1982, but with fewer restrictions.

  4. Because Congress recognized that a potential for abuse existed, provisions of the Deficit Reduction Act of 1984 (Public Law 98–369) were enacted to provide restrictions upon employee welfare benefit plans, including VEBAs.

    1. In this legislation, IRC 505 established new nondiscrimination rules and mandatory filing requirements for organizations described in IRC 501(c)(9), effective for taxable years beginning after December 31, 1984.

    2. IRC 419 and IRC 419A provide for limits on deductibility of employer contributions to VEBA’s and to other welfare benefit plans, effective for contributions made after December 31, 1985.

    3. IRC 512(a)(3)(E) subjects income derived from contributions exceeding the account limit of IRC 419A to tax under IRC 511.

    4. IRC 4976 provides for an excise tax on disqualified benefits of VEBA’s and other welfare benefit plans.

    5. In the Tax Reform Act of 1986 (Public Law 99–514), Congress enacted IRC 89, which provided new eligibility and benefit requirements applicable to medical benefits and group-term life insurance benefits as well as to certain other benefits at the election of the employer. IRC 89 was retroactively repealed by section 202(a) P.L. 101–140 (1989).

7.25.9.2  (02-09-1999)
Exemption Requirements

  1. The regulations under IRC 501(c)(9) provide that for an organization to be a VEBA within the meaning of IRC 501(c)(9):

    1. the organization must be an association of employees;

    2. membership in the association must be voluntary;

    3. the organization’s purpose is to provide for the payment of life, sick, accident, or other benefits to its members or their dependents or designated beneficiaries, and substantially all of its operations are in furtherance of providing such benefits, and

    4. no part of the net earnings of the organization inures, other than by payment of the benefits referred to in (c), to the benefit of any private shareholder or individual.

7.25.9.2.1  (02-09-1999)
Nondiscrimination Requirements

  1. IRC 505(b) requires IRC 501(c)(9) and (20) organizations that are not collectively bargained to meet nondiscrimination requirements, effective for taxable years beginning after December 31, 1984.

7.25.9.2.2  (02-09-1999)
Notice Requirements

  1. IRC 505(c) provides that all IRC 501(c)(9), (17), and (20) organizations must file a notice (Form 1024) to be recognized as exempt.

    1. A full description of the benefits available to the participants must accompany the Form 1024, showing for each benefit the amount, duration, eligibility requirements, and the circumstances that will cause payment of the benefit. This information may be contained in a "plan document" , or in the creating document of the entity, such as the trust agreement or articles of incorporation.

    2. For benefits provided through policies of insurance, all such policies must be included. Where individual policies are provided to the participants, typical examples of the policies issued to participants are acceptable, provided that they adequately describe all forms of insurance available to participants.

    3. If an insurance policy has cash value, it must be owned in the name of the IRC 501(c)(9) organization.

  2. Organizations that fail to file the required notice within time limits prescribed in the regulations will not be recognized as exempt for any period prior to the filing of the notice. Reg. 1.505(c)–1T sets forth the filing requirements and time limits for organizations applying for exemption under IRC 501(c)(9), (17), and (20).

    1. IRC 501(c)(9) applicants that were organized on or before July 18, 1984, must apply before February 4, 1987. An organization organized after July 18, 1984, must apply for exemption within 15 months from the end of the month in which the organization was organized, or by February 4, 1987, whichever is later.

    2. An organization that files a timely notice and that otherwise meets the requirements of IRC 501(c)(9), will have its exemption recognized retroactively to the date it was organized. However, an organization that does not file a timely notice will not be recognized as exempt before the date on which its notice was filed.

  3. An extension of time for filing the required notice may be granted by the Area Manager if the request is submitted before the end of the applicable period and it is demonstrated that additional time is needed.

    1. An organization that files a late notice may be granted an extension of time pursuant to Reg. 301.9100–1. Rev. Proc. 92–85, 1992–2 C.B. 490, sets forth the information and representations that must be furnished by the organization and some factors that will be taken into consideration in determining whether such an extension will be granted.

  4. Although a properly completed and executed Form 1024 together with the required additional information must be submitted to satisfy the notice required by IRC 505(c), failure to file all of the information necessary to complete the notice will not alone be sufficient to deny recognition of exemption from the date of organization to the date of submission.

    1. If the notice filed by the organization within the required time is substantially complete, and the additional information requested by the Service to complete the notice is furnished within the time allowed by the Service, the original notice will be considered timely.

7.25.9.3  (02-09-1999)
Membership Requirements

  1. Generally, only employees are entitled to become members. In addition, eligibility for membership must be defined by reference to objective standards that constitute an employment-related common bond among such individuals.

    1. This “bond” can be a common employer, coverage under a collective bargaining agreement, or a labor union affiliation. In addition, employees of the VEBA and employees of the union whose members are members of the VEBA will be considered to share an employment related common bond.

7.25.9.3.1  (02-09-1999)
Multiple Employer Trusts

  1. Employees of unaffiliated employers engaged in the same line of business "in the same geographic locale" also share an employment-related common bond. Employers engaged in business in the same state, Metropolitan Statistical Area (MSA) or Consolidated Metropolitan Statistical Area (CMSA), are engaged in business "in the same geographic locale" within the meaning of Reg. 1.501(c)(9)–2(a)(1). A description of existing MSAs and CMSAs is published periodically by the Office of Management and Budget.

    1. Although the restriction of Reg. 1.501(c)(9)–2(a)(1) limiting multiple employer trusts to the same geographic locale was ruled invalid in Water Quality Employees’ Benefit Corp. v. U.S., 795 F. 2d 1303 (7th Cir. 1986), the Service believes that the holding is in error. A final resolution of this question awaits further litigation.

  2. A notice of proposed rulemaking was published in the Federal Register Vol. 57, 153 on August 7, 1992, in which Reg.1.501(c)(9)–2(a)(1) was revised by adding a paragraph (d) which further defines the term "geographic locale" .

    1. Reg. 1.501(c)(9)–2(d) of the regulations provides for a three-state safe harbor. An area is considered a single geographic locale if it does not exceed the boundaries of three contiguous states.

    2. The three-state safe harbor includes three states which share a land or river border with at least one of the others, such as South Carolina, North Carolina, and Virginia. Also, Alaska and Hawaii are considered contiguous to California, Oregon, and Washington for purpose of these regulations.

  3. In addition, the Service has authority to recognize an area that exceeds the three-state safe harbor if:

    1. It would not be economically feasible to establish one or more VEBAs to cover employees of employers engaged in the same line of business in fewer than three states and still be able to offer VEBA membership to all employees of employers in the covered states, and

    2. Employment characteristics in that line of business, population characteristics, or other regional factors support the particular states included.

7.25.9.3.2  (02-09-1999)
Membership and Eligibility Restrictions

  1. Reg. 1.501(c)(9)–2(a)(2)(i) provides that eligibility for membership may be restricted by geographic proximity, or by objective conditions or limitations reasonably related to employment, such as a limitation to a reasonable classification of workers, a limitation based on a reasonable minimum period of service, a limitation based on maximum compensation, or a requirement that a member be employed on a full-time basis.

    1. Eligibility for benefits may be restricted by objective conditions relating to the type or amount of benefits offered. Any objective criteria used to restrict eligibility for membership or benefits may not be selected or administered in a manner that limits membership or benefits to officers, shareholders, or highly compensated employees of an employer contributing to or otherwise funding the employees’ association.

  2. Eligibility for benefits may not be subject to conditions or limitations that have the effect of entitling officers, shareholders, or highly compensated employees of an employer contributing to or otherwise funding the employees’ association to benefits that are disproportionate in relation to benefits to which other members of the association are entitled. For example:

    1. In the case of an employer-funded organization, a provision that excludes or effectively excludes certain employees, who are members of another organization or are covered by a different plan funded by the employer, to the extent that such other organization or plan offers similar benefits on comparable terms, will be considered a reasonable restriction.

    2. The provision of life benefits in amounts that are a uniform percentage of the compensation received by the individual whose life is covered will be considered a reasonable restriction. (See Regs. 1.501(c)(9) –2(a)(2)(ii) for other examples of reasonable restrictions).

  3. The regulations provide that an employer-funded VEBA may not restrict membership or eligibility for benefits to officers, shareholders, or highly compensated employees of the employer. Additional nondiscrimination rules in IRC 505(b) apply to plans that are not collectively bargained.

  4. Reg. 1.501(c)(9)–4(b) dealing with inurement and Reg. 1.501(c)(9)–2(a)(2) dealing with membership restrictions should be considered together in dealing with disproportionate benefit problems.

7.25.9.3.3  (02-09-1999)
505(b) Nondiscrimination Requirements

  1. IRC 505(b) provides certain nondiscrimination requirements for organizations described in IRC 501(c)(9) and IRC 501(c)(20) unless they are subject to the exception of IRC 505(a)(2) for collective bargaining agreements.

  2. The 505(b) nondiscrimination requirements were enacted to ensure that highly compensated employees are not favored over other employees. Under IRC 505(b) (1), a plan will meet the requirements of IRC 505(b)(1) only if:

    1. each class of benefits under the plan is provided under a classification of employees that is set forth in the plan and that does not discriminate in favor of highly compensated individuals; and

    2. the benefits do not discriminate in favor of highly compensated individuals.

  3. While Reg. 1.501(c)(9)–2(a)(2)(i) permits an employer to use its own objective criteria under 1.501(c)(9)–2(a)(2)(i) to exclude certain employees from participation, IRC 505(b) ensures that the result of these exclusions is not discriminatory in favor of highly compensated employees. In testing to determine whether a benefit is provided on a nondiscriminatory basis, IRC 505(b)(2) permits the exclusion of certain employees from consideration for purposes of the test. These employees that need not be taken into account include:

    1. employees with less than three years of service,

    2. employees under the age of 21,

    3. seasonal and less than half-time employees,

    4. employees covered by a collective bargaining agreement, and,

    5. certain nonresident alien employees.

  4. For taxable years beginning after December 31, 1987, the Tax Reform Act of 1986 provides that the determination as to whether an individual is a highly compensated individual shall be made under rules similar to those under IRC 414(q). IRC 414(q) covers a broader range of individuals than covered by the definition of highly compensated employees under prior law. For taxable years beginning before January 1, 1997, IRC 414(q) defines "highly compensated employees" to mean employees who at any time during the year (or preceding year):

    1. were five percent owners;

    2. had compensation from the employer in excess of $75,000 (adjusted for inflation);

    3. were in the top twenty percent of employees in compensation and had compensation in excess of $50,000 (adjusted for inflation); or

    4. were officers of the employer and received compensation in excess of 50 percent of the amount in effect under IRC 415(b)(1)(A) (adjusted for inflation) for the taxable year (or preceding year).

  5. For taxable years beginning after December 31, 1996, IRC 414(q) defines "highly compensated employee" to mean an employee who, during the taxable year (or preceding year):

    1. was a 5-percent owner at any time during the year or preceding year, or

    2. (i) had compensation from the employer in excess of $80,000 (adjusted for inflation); and (ii) if the employer elects the application of this clause for such preceding year, was in the top paid group of employees for such preceding year. The top-paid group consists of the top 20 percent of employees ranked on the basis of compensation paid during the year.

    3. Inflation adjustments for the above compensation levels are published annually in the Internal Revenue Bulletin. For example, see Notice 96–55, 1996–47 I.R.B. 7, for 1997 adjustments.

  6. IRC 505(b)(3) provides that if a particular benefit is subject to the nondiscrimination requirements of another Code provision, that benefit must be tested under the requirements of the other provision rather than under IRC 505(b)(1). The following benefits must be tested under the IRC provisions noted below:

    1. Group term life insurance benefits under IRC 79;

    2. Self-insured medical benefits under IRC 105;

    3. Qualified group legal service plan benefits under IRC 120;

    4. Educational assistance benefits under IRC 127; and

    5. Dependent care assistance benefits under IRC 129.

7.25.9.3.3.1  (02-09-1999)
Nondiscrimination Safe Harbor

  1. Regulations under IRC 501(c)(9) concerning the nondiscrimination requirements of IRC 505(b) have not been published. However, it is clear from the statute that discrimination is prohibited in favor of highly compensated individuals. To allow cases to be processed until regulations are published, the Service will consider a plan that falls within certain safe harbor guidelines as meeting the nondiscrimination requirements of IRC 505(b).

    1. In testing to determine whether a plan meets the safe harbor guidelines under the nondiscrimination standards of IRC 505(b), all employee welfare benefits offered by the plan are considered.

    2. A plan will come within the safe harbor guidelines only if every plan benefit meets the specific safe harbor provisions applicable to the type of benefit offered. A VEBA will not fail to qualify merely because the part of a particular benefit that the VEBA funds is discriminatory in favor of highly compensated individuals when considered alone, provided that the benefit is offered on a nondiscriminatory basis by the plan considered as a whole.

    3. A plan will not fail the safe harbor guidelines merely because it offers a benefit that is not a permissible benefit described in Reg. 1.501(c)(9)–3 for an organization described in IRC 501(c)(9). However, such a benefit may not be funded by or through the VEBA in more than a de minimis amount. Further, the benefit must comply with all legal and administrative requirements that may be applicable to the type of benefit offered, and must further comply with the nondiscrimination safe harbor requirements applicable to benefits that are not income replacement benefits unless specific nondiscrimination rules of the Internal Revenue Code are otherwise applicable to the benefit.

  2. The safe harbor guidelines permit two or more related employers to be considered a single employer.

    1. A plan that provides benefits for employees of two or more unrelated employers will only satisfy the safe harbor guidelines if the plan is nondiscriminatory with respect to the employees of each unrelated employer considered separately.

    2. The test used to determine the particular nondiscrimination standard to be applied depends upon the type of benefit offered.

    3. For benefits that are income replacement benefits (such as disability, supplemental unemployment compensation, severance, or life insurance), see IRM 7.25.9.3.2 through IRM 7.25.9.3.4 below. For the test to be applied in the case of benefits that are not income replacement benefits (such as health, dependent care, and educational benefits), see IRM 7.25.9.3.4.3 through IRM 7.25.3.4.8.

7.25.9.3.4  (02-09-1999)
Income Replacement Benefits

  1. An income replacement benefit is a benefit that is designed to protect against a contingency that interrupts or impairs earning power. Such benefits are commonly provided as a fraction or multiple of an employee’s compensation. Examples of income replacement benefits are life insurance and death benefits, disability benefits, severance benefits, and supplemental unemployment compensation benefits. A sick pay or vacation pay benefit intended to replace earnings during the absence of an employee from work is also an income replacement benefit.

    1. Life benefits, accidental death and dismemberment benefits, severance benefits, disability benefits, supplemental unemployment compensation benefits, or other income replacement benefits may be offered as a uniform percentage of total compensation, or of the basic or regular rate of compensation, of the employees covered by the plan.

  2. An income replacement benefit that is not an employer-provided group-term life insurance benefit described in IRC 79 or that is a church plan benefit will be considered to satisfy the nondiscrimination safe harbor if:

    1. the benefit offered to each highly compensated individual does not bear a larger ratio to that individual’s compensation than the average benefit offered to lower paid employees bears to their average compensation;

    2. no employee receives a benefit the amount of which is based upon a level of compensation that exceeds $150,000 (adjusted for inflation) for plan years beginning after December 31, 1993, or that exceeds $200,000 (adjusted for inflation) for plan years beginning before January 1, 1994;

    3. the terms and conditions for eligibility are nondiscriminatory; and

    4. in the case of supplemental unemployment compensation benefits, the applicable specific nondiscrimination rules are followed.

  3. In the case of an employer-provided group term life insurance benefit described in IRC 79 (other than a church plan benefit), the rules contained in IRM 7.25.9.3.4.2 are used in lieu of these guidelines.

    1. An income replacement benefit that is offered only to highly compensated individuals, or that is in any way offered upon more favorable terms to highly compensated individuals than to lower paid employees (except as provided as no more than a uniform percentage of compensation), will not meet the nondiscrimination safe harbor even if another type of benefit is offered exclusively to lower paid employees.

    2. A plan that offers a particular benefit under terms that favor employee classifications that contain a significantly greater than proportionate percentage of highly compensated individuals, when compared to the total number of participants in the plan, will not meet the nondiscrimination safe harbor.

    3. An income replacement benefit is not normally considered to be offered at a uniform percentage of compensation for purposes of the nondiscrimination safe harbor if the percentage of compensation upon which the benefit is based increases with the participant’s length of service with the employer. However, if highly compensated individuals are not disproportionately represented in the groups with the longest period(s) of service, the benefit may nevertheless be provided under a formula that takes years of service into consideration.

    4. Certain employees may be excluded from consideration for purposes of the nondiscrimination safe harbor. Those employees that may be excluded are those listed in IRM 7.25.9.3.4.4.

  4. For purposes of the nondiscrimination safe harbor, a plan need not make a particular benefit available to all employees not otherwise excluded from consideration under the above paragraph. However, if the benefit is not made available to all such employees, the ratio of highly compensated individuals eligible to receive the benefit to the total number of highly compensated individuals who are not otherwise excluded from consideration may not exceed the ratio of lower paid employees eligible to receive the benefit to the total number of lower paid employees not otherwise excluded from consideration.

    1. To illustrate this rule, the following chart sets forth an employer’s work force where a particular benefit is offered in 1997 only to managers and drivers who are over 21 years of age and who have at least one year of service with the employer.

    2. Because employees under 21 years of age and with less than 1 year of service may be excluded from consideration, the work force that must be taken into consideration in this example is comprised only of the drivers, managers, and other employees who are over 21 and have at least one year of service. In this case, the number of highly compensated individuals eligible to receive the benefit (17) when compared to the total number of highly compensated employees not excluded from consideration (18), yields a ratio of 17/18, or 94.4%. The number of eligible lower paid employees (45), when compared to the total number of lower paid employees not excluded from consideration (82), yields a ratio of 45/82 or 54.9%. Because the ratio of eligible highly compensated individuals to the total number of nonexcludable highly compensated individuals (94.4%) exceeds the comparable ratio of lower paid eligible employees to nonexcludable lower paid individuals (54.9%), the plan does not meet the nondiscrimination safe harbor with respect to the benefit.

    Highly Compensated Lower Paid
    Under 1 year service 1 21
    Under 21 1 15
    Drivers (over 21; 1 year) 10 42
    Managers (over 21; 1 year) 7 3
    Other employees (over 21; 1 year) 1 37

7.25.9.3.4.1  (02-09-1999)
Supplemental Unemployment Compensation Benefits

  1. Supplemental unemployment compensation benefits are defined in IRC 501(c)(17)(D) as benefits paid to an employee because of his involuntary separation from employment (whether or not temporary) resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and sick and accident benefits that are subordinate to such benefits.

    1. For purposes of the nondiscrimination safe harbor, subordinate sick and accident benefits are considered benefits that are not income replacement benefits and are consequently subject to the applicable rules with respect to non-income replacement benefits.

    2. A supplemental unemployment compensation benefit is considered to meet the nondiscrimination safe harbor if the benefit satisfies the nondiscrimination provisions of IRC 501(c)(17)(A) and (B) and the underlying regulations. These provisions allow a plan to make certain benefit reductions and to exclude employees who may receive supplemental unemployment compensation benefits from other sources.

    3. For taxable years beginning after December 31, 1986, discrimination is prohibited in favor of highly compensated employees defined in IRC 414(q).

    4. A plan that provides supplemental unemployment compensation benefits may exclude from consideration employees listed in IRM 7.25.9.3.4.4.

7.25.9.3.4.2  (02-09-1999)
Employer provided Group-term Life Insurance Benefits

  1. A life insurance benefit described in Reg. 1.501(c)(9)–3(b) is considered an income replacement benefit.

  2. An employer-provided group-term life insurance benefit described in IRC 79 is not considered nondiscriminatory unless one of the following conditions is met:

    1. the benefit is provided to 70 percent or more of all employees of the employer;

    2. at least 85 percent of all employees who are participants are not “key employees” defined in IRC 416(i); or

    3. the facts and circumstances show that the group term life insurance benefit is not offered under terms that favor employee classifications that contain a significantly greater than proportionate percentage of key employees, when compared to the total number of participants in the plan.

  3. Further, an employer-provided group term life insurance benefit must not in any way be offered upon more favorable terms to key employees than to other employees (except as provided as no more than a uniform percentage of compensation).

    1. For these purposes, it makes no difference whether the amount of life insurance coverage exceeds $50,000. Also for these purposes, and for the nondiscrimination safe harbor requirements generally, there may be excluded from consideration employees who have not completed 3 years of service, part-time or seasonal employees, employees not included because they are covered under a collective bargaining agreement under which group-term life insurance benefits were the subject of good faith bargaining with the employer or employers, and nonresident aliens with no United States source income from the employer (under IRC 861(a)(3)).

7.25.9.3.4.3  (02-09-1999)
Non-Income Replacement Benefits

  1. Benefits that are not income replacement benefits include any benefit that is not provided as a substitute for wages. Examples of such benefits include:

    • health and accident benefits;

    • vacation facilities;

    • childcare assistance and facilities;

    • recreational activities and facilities;

    • education and training expenses; and

    • personal legal service benefits.

7.25.9.3.4.4  (02-09-1999)
General Nondiscrimination Safe Harbor Requirements for Non-Income Replacement Benefits

  1. The nondiscrimination safe harbor requirements generally apply to benefits that are not income replacement benefits. However, some benefits are in full or in part tested under other nondiscrimination requirements. The following benefits are tested under other standards.

    • Self-insured medical benefits;

    • Group legal services benefits;

    • Educational assistance benefits; and

    • Dependent care assistance benefits.

  2. A benefit that is not an income replacement benefit satisfies the nondiscrimination safe harbor only if it is offered to participants in equal amounts under equal terms, eligibility requirements, and conditions, without regard to salary level, position, or ownership interest in the employer.

    1. A benefit that is not an income replacement benefit does not meet the nondiscrimination safe harbor if the terms or operation of the plan in any way provides a greater benefit for highly compensated individuals than for lower paid employees. Thus a vacation facility that is provided on a preferential basis to participants with a certain minimum period of service under the employer (except as may be excluded from consideration under paragraph (d)) will not satisfy the nondiscrimination safe harbor if highly compensated individuals are disproportionately represented in the group with the longer period of service.

  3. For purposes of the nondiscrimination safe harbor, a plan need not make a particular benefit available to all employees not otherwise excluded from consideration. However, if the benefit is not made available to all such employees, the ratio of highly compensated individuals eligible to receive the benefit to the total number of highly compensated individuals (who are not otherwise excluded from consideration) may not exceed the ratio of lower paid employees eligible to receive the benefit to the total number of lower paid employees (who are not otherwise excluded from consideration).

7.25.9.3.4.5  (02-09-1999)
Health and Accident Benefits

  1. The nondiscrimination safe harbor rules for non-income replacement benefits are applicable to all health and accident benefits except self-insured medical reimbursement benefits.

  2. A plan that includes a self-insured medical reimbursement benefit must meet one of the following eligibility requirements as set forth in Reg. 1.105–11(c)(2):

    1. the plan must actually cover at least 70 percent of all employees;

    2. at least 70 percent of employees must be eligible for coverage of which at least 80 percent must actually be covered; or

    3. the classification test of Reg. 1.105–11(c)(2)(ii) is satisfied. Generally, this requires an analysis under 1.410(b)–4.

  3. A self-insured medical reimbursement plan must meet the nondiscriminatory benefits requirements of Reg. 1.105–11(c)(3). These requirements will not be met unless all benefits provided for participants who are highly compensated (or their dependents) are provided for all other participants (or their dependents) on the same basis.

    1. There may be excluded from consideration employees described in Reg. 1.105–11(c)(2)(iii). The term “highly compensated individuals” is defined in Reg. 1.105–11(d).

7.25.9.3.4.6  (02-09-1999)
Group Legal Services Benefits

  1. Group legal services benefits are tested for nondiscrimination under the rules of IRC 120 for years beginning before July 1, 1992. IRC 120 does not apply to taxable years beginning after June 30, 1992. Group legal services benefits provided as a result of collective bargaining are not subject to the nondiscrimination rules of IRC 505 (b)(1). See also, IRM 7.25.19 (Qualified Group Legal Services Plans).

7.25.9.3.4.7  (02-09-1999)
Educational Assistance Benefits

  1. Educational assistance benefits are tested for nondiscrimination under IRC 127. In the past, this provision was under frequent threat of termination. Under Pub. L. No. 107-16, IRC 127 is under no threat of termination until taxable years beginning after December 31, 2010.

    1. Standards for determining discrimination requirements for purposes of the nondiscrimination safe harbor before June 1, 1997, are provided in Reg. 1.127–2(e).

    2. Discrimination is prohibited in favor of highly compensated employees described in IRC 414(q).

    3. No more than 5 percent of the amounts paid or incurred by the employer for educational assistance during the year may be provided for the class of individuals who are shareholders or owners (or their spouses or dependents), each of whom on any day of the year owns more than 5 percent of the stock or profits interest in the employer.

    4. IRC 127 excludes post-graduate educational assistance. Post-graduate educational assistance is treated as a benefit to which the nondiscrimination rules of IRC 505(b) apply.

7.25.9.3.4.8  (02-09-1999)
Dependent Care Assistance Benefits

  1. Dependent care assistance benefits are tested for nondiscrimination as to eligibility requirements under the provisions of IRC 129(d). Rules similar to those in effect applicable to educational assistance benefits under IRC 127 are used to determine whether the nondiscrimination requirements of IRC 129(d) are met. IRC 129 has no termination provision. Consequently, the nondiscrimination standards of IRC 505(b)(1) and the nondiscrimination safe harbor for non-income replacement benefits will not be applicable to dependent care assistance benefits.

    1. The rules and definitions applicable to the class of persons against which discrimination is prohibited, and the employees that may be excluded from consideration, are the same as those applicable to educational assistance benefits described in IRC 127.

7.25.9.4  (02-09-1999)
Employee Defined

  1. Reg. 1.501(c)(9)–2(b)(1)) defines the term "employee" broadly. A person is considered to be an employee if that person first becomes entitled to participate in the association by reason of being an employee. Thus, a person and the dependents of a person may receive benefits even though the person is on a leave of absence, working temporarily for another employer or as an independent contractor, or terminated from employment by reason of retirement, disability, or layoff.

    1. Further, because it is consistent with exemption for a plan to provide benefits to retired employees, an organization will not be disqualified from exemption merely because it provides benefits only to retirees, if such benefits are merely a continuation of benefits that have been provided to those employees while they were actively employed.

    2. It is permissible to have non-employee members if at least 90% of the total membership of the association on one day of each quarter of the association’s taxable year consists of employees, and the non-employee members share an employment related bond with the employee members. Such individuals may include, for example, the proprietor of a business whose employees are members of the association.

    3. The surviving spouse and dependents of an employee are "employees" if they are considered to be members of the association. Thus, if the surviving spouse and dependents meet this condition they will not be subject to the 10% limitation on non-employees.

7.25.9.5  (02-09-1999)
Voluntary Defined

  1. The regulations require that the VEBA must be an entity having an existence independent of the member-employees or their employer(s), and that it be controlled by either its membership, by independent trustees, or by trustees or other fiduciaries some of whom are designated by the membership.

    1. A financial intermediary such as a bank, acting in a fiduciary capacity, generally will be considered to be an independent trustee.

    2. A VEBA will also be considered to be controlled by independent trustees if it is an “employee welfare benefit plan” as defined in section 3(1) of the Employee Retirement Income Security Act of 1974 (ERISA) and, as such, is subject to the requirements of Parts 1 and 4 of Subtitle B, Title 1 of ERISA.

  2. Under section 3(1) of ERISA the term “employee welfare benefit plan” means any plan established or maintained by an employer or by an employee organization, or by both, for the purpose of providing for its participants or their beneficiaries, through the purchase of insurance or otherwise:

    1. medical, surgical, or hospital care or benefits, or benefits in the event of sickness, disability, death or unemployment, or vacation benefits, apprenticeship or other training programs, or day care centers, scholarship funds, or prepaid legal services, or;

    2. any benefit described in section 302(c) of the Labor Management Relations Act of 1947 (other than pensions on retirement or death, and insurance to provide such pensions).

  3. Section 302(c) of the Labor Management Relations Act of 1947 does not apply to any employee welfare benefit plan if:

    1. such plan is a governmental plan (as defined in section 3(32) of ERISA);

    2. such plan is a church plan (as defined in section 3(33)) with respect to which no election has been made under IRC 410(d);

    3. such plan is maintained solely for the purpose of complying with applicable workmen’s compensation laws or unemployment compensation or disability insurance laws;

    4. such plan is maintained outside of the United States primarily for the benefit of persons substantially all of whom are nonresident aliens; or

    5. such plan is an excess benefit plan (as defined in section 3(36) of ERISA and is unfunded.

  4. Thus, the vast majority of employee welfare benefit plans would meet the control requirement by coming under section (3)1 of ERISA. However, in Lima Surgical Associates v. U.S., 20 Ct.Cl. 674, 90-1 USTC ¶ 50329 (1990), affirmed on other grounds, 944 F.2d 885 (Fed. Cir. 1991), the court found that an organization was neither independently controlled nor an employee welfare benefit plan under section (3)1 of ERISA. Because the organization paid a benefit upon retirement it was considered to be a pension plan rather than an employee welfare benefit plan.

  5. An association will be considered to be controlled by its membership if it is controlled by one or more trustees designated pursuant to a collective bargaining agreement (whether or not the bargaining agent of the represented employees bargained for and obtained the right to participate in selecting the trustees). (See Reg. 1.501(c)(9)–8 for the effective date of these provisions).

7.25.9.6  (02-09-1999)
Permissible Benefits

  1. IRC 501(c)(9) organizations can provide life, sick, accident, and other benefits to members, their dependents, and designated beneficiaries. Dependents include a member’s spouse, his or her minor children, children who are students, other minor children living with the member. Dependents also include any other individual who an association, relying on information furnished to it by a member, in good faith believes is a person described in IRC 152(a).

    1. The regulations provide that substantially all of an IRC 501(c)(9) organization’s operations must be in furtherance of providing permissible benefits. This means that while an organization may provide some nonqualifying benefits, it will not qualify for exemption if it systematically and knowingly provides nonqualifying benefits of more than a de minimis amount.

7.25.9.6.1  (02-09-1999)
Life Insurance Benefits

  1. Life benefits are benefits payable on the lives of a member or a member’s dependents. The regulations permit the payment of benefits that are either furnished pursuant to a contract of insurance with a life insurance company or paid directly by the VEBA.

  2. The regulations require that "life benefits" consist of current protection only, and generally do not permit various forms of "permanent" life insurance contracts. There are three exceptions to this general rule.

    1. A VEBA may provide to a participant in a group life insurance contract a certificate of eligibility for individual coverage without evidence of insurability on termination of the member’s relationship with the association.

    2. "Life benefits" generally include any "permanent benefit" provided in the manner prescribed in the regulations under IRC 79. This is relevant to employer-funded organizations and permits, to the extent provided in the regulations under IRC 79, the provision of permanent benefits, the cost of which is required to be included currently in the gross income of the employee.

    3. A VEBA that is funded with employee, rather than employer, contributions generally may offer "life benefits" that involve permanent protection. Where permanent benefits are allowed, cash surrender and policy loan benefits are permitted as these are commonly provided in permanent life insurance contracts.

  3. The regulations permit settlement of a life insurance policy in the form of an annuity where the treatment of the annuity is the same as if the annuity had been taken in lieu of a lump sum, that is, where the interest element in the periodic annuity payment is includable in the recipient’s gross income.

  4. The Joint Committee on Taxation Explanation to the Deficit Reduction Act of 1984 indicates that life insurance benefits may not be integrated with social security benefits for purposes of meeting nondiscrimination requirements.

7.25.9.6.2  (02-09-1999)
Sick and Accident Benefits

  1. The term "sick and accident benefits" means amounts furnished to or on behalf of a member or a member’s dependents in the event of illness or personal injury. These benefits may be provided through reimbursement for amounts paid by a member or through the payment of premiums to a medical benefit or health insurance program. (See Reg. 1.501(c)(9)–3(c)).

7.25.9.6.3  (02-09-1999)
Other Benefits Defined

  1. The regulations provide that "other benefits" are those that are similar to life, sick, and accident benefits. A benefit is similar if:

    1. It is intended to safeguard or improve the health of a member or a member’s dependents, or

    2. It protects against a contingency that interrupts or impairs a member’s earning power.

7.25.9.6.4  (02-09-1999)
Specific Other Benefits

  1. In addition to the benefits described in the paragraphs below, examples of other benefits include vacation pay and facilities, child care payments and facilities and subsidizing recreational activities.

    1. The regulations permit benefits in the form of temporary living expense loans at times of disaster, such as fire or flood, but do not allow such organizations to provide loans to members in the ordinary course of a banking or financing business.

    2. The regulations provide that job readjustment allowances may be paid as an example of a benefit provided to protect against a contingency which interrupts earning power, as it allows a worker to bridge the period between jobs without the loss of income.

    3. Supplemental unemployment compensation benefits are permitted and are defined in IRC 501(c)(17)(D)(i).

    4. Permissible severance benefits are defined by reference to 29 CFR 2510.3–2(b), a regulatory labor provision which distinguishes a severance pay plan from a pension plan for purposes of Title I of ERISA. General guidelines include a maximum amount of payment not to exceed twice the employee’s most recent annual compensation, payment being completed within two years after the termination of employment, and payments not directly or indirectly contingent upon retirement.

7.25.9.6.5  (02-09-1999)
Benefits under the Labor Management Relations Act (LMRA)

  1. Reg. 1.501(c)(9)–3(e) provides that for collectively bargained trusts, other benefits also include any benefit provided in the manner permitted by paragraph (5) et. seq. of section 302(c) of the LMRA. In applying this portion of the regulations the following points should be kept in mind:

    1. The regulations permit these benefits "except to the extent otherwise provided" in the regulations. This resolves the apparent inconsistency of pension benefits that are allowed under section 302(c)(5) but which are expressly prohibited in Reg. 1.501(c)(9)–3.

    2. The benefits must be provided "in the manner permitted" by section 302. This includes the establishment of a trust by the employees representative (i.e. labor union), the existence of a written collective bargaining agreement, employer-representation in the administration of the organization, etc.

    3. Significant benefits allowed are the provision of educational benefits to members’ dependents and personal legal service benefits.

7.25.9.6.6  (02-09-1999)
Legal Benefits

  1. Personal legal service benefits are permitted in the case of collectively bargained trusts because they are specifically enumerated under section 302(c)(8) of the LMRA. However, trusts that do not participate in the collective bargaining process are restricted to personal legal service benefits which consist of payments or credits to one or more organizations or trusts described in IRC 501(c)(20). IRC 501(c)(20) is not effective for tax years beginning after June 30, 1992. See IRM 7.25.19 (concerning qualified group legal services plans).

    1. A trust formed as part of a qualified group legal services plan or plans cannot be exempt under IRC 501(c)(20) for taxable years beginning after June 30, 1992. An existing 501(c)(20) organization would be taxable unless it can qualify for recognition of exemption under IRC 501(c)(9). An organization that has already received a determination or ruling letter from the Service recognizing its exemption under IRC 501(c)(20) is not subject to the 15 month notification required by IRC 505(c). An organization, or trust, that has previously notified the Service of its claim to exemption by filing Form 1024, is not required under section 505(c) to renotify the Service. Accordingly, an organization that is exempt under IRC 501(c)(20) can, if it otherwise qualifies, request a ruling or determination modifying its exemption from IRC 501(c)(20) to IRC 501(c)(9) effective July 1, 1992.

7.25.9.6.7  (02-09-1999)
Educational Benefits

  1. Education or training benefits or courses such as apprenticeship training programs for members are permissible other benefits. In addition, because collectively bargained trusts may provide the benefits described in section 302(c) of the LMRA, these organizations can provide educational benefits, such as scholarships, to dependents of members.

7.25.9.6.8  (02-09-1999)
Non-Qualifying Benefits

  1. The following categories of benefits are impermissible:

    1. Benefits similar to those provided by a pension, stock bonus or profit-sharing plan; see Lima Surgical Associates v. U.S., 944 F.2d 885 (Fed. Cir. 1991);

    2. Deferred compensation benefits, defined as being payable by reason of passage of time rather than as the result of an unanticipated event;

    3. Property and malpractice insurance;

    4. Loans (other than loans at times of disaster);

    5. Savings plans (See Example (2) of Regs. 1.501(c)(9)–3(g)); and

    6. Commuting expenses.

7.25.9.7  (02-09-1999)
Inurement of Earnings

  1. No part of the net earnings of an IRC 501(c)(9) organization may inure to the benefit of any private shareholder or individual other than through the payment of permitted benefits. "Private shareholder or individual" refers to persons having a personal or private interest in the activities of the organization and includes the members, officers, trustees, employees and fiduciaries of the organization and contributing employers.

    1. The payment of disproportionate benefits to members who are officers, shareholders or highly compensated employees of a contributing employer constitutes inurement. Reg. 1.501(c)(9)–4(b) dealing with inurement, and Reg. 1.501(c)(9)–2(a)(2) dealing with membership restrictions should be considered together in considering problems involving disproportionate benefits.

    2. Generally, the payment of unreasonable compensation to the trustees or employees of the association, or the purchase of insurance or services for amounts in excess of their fair market value from a company in which one or more of the association’s trustees, officers or fiduciaries has an interest, will constitute prohibited inurement.

  2. Inurement can also consist of the disposition of property to, or the performance of services for, a person for less than the greater of fair market value or cost to the association. Acts of inurement may also constitute violations of the fiduciary responsibility rules of ERISA.

  3. Experience-rated insurance rebates to employers are allowed. An insurance policy that has a continuing residual cash value must be owned in the name of the IRC 501(c)(9) organization.

  4. On dissolution, assets may be distributed to members, or used for benefits until depleted, but may not be returned to the contributing employers. In addition, administrative adjustments can be made if an employer erroneously makes excessive contributions. The excessive amounts can be returned to the employer during the same tax year in which they were made.

7.25.9.8  (02-09-1999)
Records and Taxation of Benefits

  1. Every IRC 501(c)(9) organization must maintain records indicating the amount contributed by each member and contributing employer, and the amount and type of benefits paid by the organization to or on behalf of each member.

  2. Cash and noncash benefits realized by a person on account of the activities of an IRC 501(c)(9) organization must be included in the gross income of the recipient to the extent provided in the Code.

  3. Many of the benefits received by members of IRC 501(c)(9) organizations are excluded from the gross income of the recipient. For example, the following benefits are excluded if they meet the statutory requirements the sections provided:

    • health and accident plans under IRC 105,

    • compensation for injuries under IRC 104,

    • certain death benefits under IRC 101,

    • employer contributions to accident and health plans under IRC 106, and

    • certain educational assistance under IRC 127.

  4. The above statutes govern the taxability of benefits to the individual. It is irrelevant:

    1. whether an individual is eligible for membership in the IRC 501(c)(9) organization,

    2. whether the benefit paid is permissible, or

    3. whether the organization is in fact tax-exempt.

  5. For example, if a benefit is paid by an employer-funded IRC 501(c)(9) organization to a member who is not an "employee" , a statutory exclusion from gross income that is available only for "employees" would be unavailable in the case of a benefit paid to such individual.

  6. The fact that educational benefits constitute "other benefits" does not necessarily mean that such benefits are eligible for the exclusion under either IRC 117 or IRC 127.

7.25.9.8.1  (02-09-1999)
Taxable Benefits

  1. Benefits realized by an employee may constitute taxable income to the employee to the extent provided in the Code including, but not limited to, IRC 61, 72, 101, 104, and 105. See also other appropriate sections of the Code such as IRC 79, 106, 120, and 127. Benefits may be taxable when the employer makes a contribution to the trust or when the trust pays the benefit. Benefits are generally subject to tax at the time a benefit is "realized" .

  2. Benefits will generally be considered "realized" when the employer makes contributions to the trust if they are definable and nonforfeitable at that time. In these cases, the employer must report the contributions as wages paid to the employee unless excludable under IRC 106 or other applicable Code section. If benefits are forfeitable, that is, contingent on some event not within the employee’s control, such as involuntary unemployment, income will not be realized until payments are made by the IRC 501(c)(9) trust.

    1. In Rev. Rul. 67–351, 1967–2 C.B. 86, a vacation plan was established for employees pursuant to a collective bargaining agreement. The employer funded the plan and each employee’s interest in the plan was fully vested and nonforfeitable from the time the money was paid by the employer. The amounts were required to be paid to employees 16 months after the end of the fiscal year in which they were paid to the trust. The revenue ruling held that the employer contributions were realized by the employee when paid by the employer.

    2. However, in Rev. Rul. 57–316, 1957–2 C.B. 626, vacation plan contributions by an employer were held not to be realized by the employee at the time the money was paid by the employer where the trustees of the IRC 501(c)(9) organization had "control" of the payment of the vacation benefit under IRC 3401(d). In this case the IRC 501(c)(9) organization is responsible for withholding at the time of payment to the employee.

    3. In Rev. Rul. 77–347, 1977–2 C.B. 363, supplemental unemployment compensation benefits were "realized" by employees in the year of receipt. Employees did not receive the benefits until employment was terminated because of permanent discontinuance of the company’s business, acquisition by another company, etc. See also Rev. Rul. 70–51, 1970–1 C.B. 192.

  3. If a benefit is taxable it will either be wages (subject to income tax withholding, FICA and FUTA and reporting on Forms W–2 or W–3), or it will be subject to the information return requirements of IRC 6041. Generally, payments, other than wages, in excess of $600 must be reported on Forms 1096 and 1099. Wages or benefits that are treated as wages are reported on Forms W–2 and W–3.

    1. Generally, vacation benefits constitute wages under Regs. 31.3401(a)–1(b)(3), except as noted above, as do supplemental unemployment compensation payments.

    2. Dismissal or severance payments generally constitute wages (Regs. 31.3401(a)–1(b)(4)). If a benefit is taxable when the employer pays it, and the benefit is in the form of wages, the employer is responsible for withholding, FICA and FUTA. If the benefit is taxable when the IRC 501(c)(9) organization pays it, the organization is responsible for the reporting and any other requirements.

    3. However, an IRC 501(c)(9) organization may be responsible for income tax withholding, while the employer is directly responsible for FICA and FUTA taxes. (See Rev. Rul. 57–316, 1957–2 C.B. 625.) Under Reg. 31.3504–1 the IRC 501(c)(9) organization may receive authorization to pay over FICA and FUTA taxes on behalf of the employer. (See Rev. Rul. 70–51, 1970–1, C.B. 192, and Rev. Proc. 68–21, 1968–1 C.B. 817.)

  4. Cases indicating that an employer is not properly withholding or paying employment taxes should be referred to EO Examinations under existing procedures. For example, an employer may be treating payments to an IRC 501(c)(9) organization as being made solely to an accident and health plan under IRC 106, when in reality these payments are also payments for a severance benefits plan. The employer must instead make an allocation between the two plans as the employer is required to withhold on the portion allocable to the severance plan. Under such circumstances the information should be referred to EO Examinations.

    1. Exempt Organizations specialists are responsible for determining whether IRC 501(c)(9) organizations are meeting their responsibilities with respect to income tax withholding, FICA and FUTA, and reporting on W–2s and W–3s in the case of wages, and the reporting requirements of IRC 6041 in the case of other taxable benefits.

7.25.9.9  (02-09-1999)
Relation of IRC 501(c)(17) to IRC 501(c)(9)

  1. A supplemental unemployment benefit (SUB) plan can, at its option, qualify for exemption under IRC 501(c)(9) or IRC 501(c)(17). See Reg. 1.501(c)(17)–3(b). However, there are differences in the treatment of these organizations that could affect such a decision.

    1. IRC 501(c)(17) organizations are subject to the prohibited transaction rules of IRC 503 while IRC 501(c)(9) organizations are not.

    2. An IRC 501(c)(17) organization can provide only SUB benefits and subordinate sick and accident benefits, while a VEBA can provide a much broader range of benefits.

    3. A VEBA is tested under the nondiscrimination requirements of IRC 505(b), while an IRC 501(c)(17) organization is tested under the nondiscrimination rules of the IRC 501(c)(17) statute and its underlying regulations.

7.25.9.10  (02-09-1999)
Unrelated Business Taxable Income of VEBAs

  1. IRC 512(a)(3) provides special rules for determining the unrelated business taxable income of IRC 501(c)(7) and IRC 501(c)(9) organizations. For income earned after December 31, 1985, the provisions of IRC 512(a)(3) also apply to IRC 501(c)(17) and IRC 501(c)(20) organizations.

  2. Generally, all income of an IRC 501(c)(9) organization is taxable unless it constitutes exempt function income under IRC 512(a)(3)(B). Contributions by employers are not income, but are considered to be contributions to capital for this purpose.

    1. Exempt function income generally includes all fees paid by members of a VEBA. In addition, it includes investment income which is set aside under IRC 512(a)(3)(B)(ii) for the payment of life, sick, accident, or other benefits.

    2. Income from an unrelated trade or business (under the general rule of IRC 512(a)(1)) cannot be set aside. Thus, a VEBA is taxed on income from an unrelated trade or business under IRC 513 or 514 in the same manner as other exempt organizations.

  3. The legislative history of IRC 512(a)(3)(B) indicates that investment income is an integral part of the exempt insurance function of an organization exempt from Federal income tax under IRC 501(c)(9). IRC 512(a)(3)(B) serves to remove from the unrelated business income tax an organization’s investment income where that income is committed to provide for the payment of life, sick, accident, or other benefits permitted by IRC 501(c)(9). See S. Rep. No. 91–552, 91st Cong., 1st Sess. 72 (1969), 1969–3 C.B. 470.

    1. Generally, income that is to be set aside for the purposes specified in IRC 512(a)(3)(B) must be specifically earmarked as such or placed in a separate account or fund.

    2. However, a 501(c)(9) organization which, by the terms of its governing instrument, must use its net investment income for life, sick, accident, or other benefits, the income and assets of the organization can be considered as committed to purposes within IRC 512(a)(3)(B) without any additional action by the organization’s governing body. Likewise, no additional designation is necessary for IRC 501(c)(17) and IRC 501(c)(20) organizations.

  4. The Deficit Reduction Act of 1984 (Public Law 98–369) set limits on the levels to which certain benefits of employee welfare benefit plans may be funded.

    1. To the extent the funding for disability, medical, supplemental unemployment, severance, or life benefits exceeds the account limit of IRC 419A(c) at the of the taxable year, IRC 512(a)(3)(E) provides that the amounts in excess of the account limit will not be considered to be amounts set aside for life, sick, accident, or other benefits under IRC 512(a) (3)(B)(ii).

    2. However, under IRC 512(a)(3)(E)(iii)(II) the limitations shall not apply to income derived from reserves for post-retirement medical or post-retirement life benefits that were in existence prior to the enactment of Public Law 98–369.

    3. Further, pursuant to IRC 512(a)(3)(E)(i), any reserve for post-retirement medical benefits is not included in the account limit under section 419A.

    4. The provisions of IRC 512(a)(3)(E) are applicable for income earned after December 31, 1985. IRC 512(a)(3)(E) does not apply to organizations that receive substantially all of their contributions from organizations that have been tax-exempt organizations throughout a five-year period ending with the taxable year in which contributions are made.

  5. For income received before December 31, 1985, and for income received by and for collectively bargained plans at any date prior to the issuance of final regulations under IRC 419A, set-aside income may be accumulated if the accumulation is reasonable in amount and duration and is for the purposes set forth in IRC 512(a)(3)(B)(ii).

    1. Accumulations that are reasonably necessary for the purpose of providing permissible benefits are considered reasonable even though such accumulations may be quite large and the time between the date of receipt by the organization of such amounts and the date of payment of the benefits is quite long.

    2. If an accumulation has become unreasonable in amount or duration through continual additions to it over a period of years, it would no longer be reasonably necessary to set aside additional amounts to be added to the accumulated reserve. Whether or not an accumulation of funds is unreasonable is a question requiring consideration of the detailed facts and circumstances of a particular case.

  6. Until final regulations are published under IRC 419A, the provisions of IRC 419A(C) and IRC 512(a)(3)(E) are not applicable to collectively bargained plans under IRC 419A(f)(5). See Reg. 1.419A–2T for a definition of collectively bargained plans.

7.25.9.11  (02-09-1999)
Deductibility of Employer Contributions

  1. Before the Deficit Reduction Act of 1984, an employer could deduct under IRC 162 ordinary and necessary expenses for employee welfare benefits as long as they were not deferred compensation-type benefits. In general, employer deductions were not limited to amounts includible in the employee’s gross income.

  2. Congress enacted IRC 419 and IRC 419A in Public Law 98–369 in order to provide limits on the deductibility of employer contributions. Generally, the new rules were intended to permit employers to obtain current deductions only for amounts that are includible in an employee’s gross income in the same year (or that would be includible in the same year but for a provision of the Code).

    1. However, the new rules also allow deductions for amounts used to fund accounts set aside for certain benefits up to limits specified in IRC 419A(c). The rules also prevent overfunding and sheltering abuses by imposing unrelated business income tax on income derived from amounts that exceed the limits of IRC 419A(c).

    2. The rules of IRC 419 and IRC 419A apply to IRC 501(c)(7), IRC 501(c)(9), IRC 501(c)(17), and IRC 501(c)(20) organizations, as well as to certain nonexempt funds. However, under IRC 419A(f)(6), these rules do not apply to certain plans to which ten or more employers contribute.

    3. IRC 419 and 419A are effective for contributions made after December 31, 1985.

7.25.9.11.1  (02-09-1999)
IRC 419

  1. IRC 419 provides that ordinary and necessary employer contributions to welfare benefits funds, to the extent the requirements of section 162 and 212 are satisfied, are deductible under IRC 419 and not under IRC 162 or IRC 212. The amount of the deduction is limited to the employer’s qualified cost for the taxable year, reduced by the fund’s after-tax income.

    1. The term "welfare benefit fund" is defined in IRC 419(e) to include plans through which an employer provides benefits (other than pension and other deferred compensation benefits described in IRC 419(e)(2)) to employees. Welfare benefit funds include employer-funded organizations described in IRC 501(c)(7), IRC 501(c)(9), IRC 501(c)(17) and IRC 501(c)(20), in addition to nonexempt employer-funded organizations.

  2. The employer’s "qualified cost" is defined in IRC 419(c) to mean the sum of the amounts in (a) and (b) below:

    1. The employer’s qualified direct cost for the taxable year. The employer’s qualified direct cost is the aggregate amount (including administrative expenses) that would have been allowable as a deduction to a cash-basis employer directly providing benefits to employees. For these purposes, a benefit is treated as provided only in the year the benefit is includible in the gross income of the employee (or would be includible but for a provision of the Code.)

    2. The employer’s additions to qualified asset accounts described in IRC 419A (as limited by IRC 419A(b)) for the taxable year.

    3. In establishing the allowable deduction under IRC 419, the employer’s qualified cost is reduced by the fund’s "after tax income." "After tax income" is the fund’s gross income, reduced by any income taxes paid and by expenses directly connected with the production of gross income. Gross income does not include employer contributions, but does include employee contributions. The effect of these rules is to reduce otherwise allowable employer deductions by the amount of net investment income of the fund and by the amount of employee contributions to the fund.

    4. Employer contributions in excess of the IRC 419 deductibility limits are carried forward to succeeding taxable years.

7.25.9.12  (02-09-1999)
IRC 419A

  1. IRC 419A defines "qualified asset account" for purposes of the limitation on allowable deductions for employer contributions under IRC 419. Qualified asset accounts are accounts set aside to provide for disability, medical, life, supplemental unemployment, or severance benefits. Deductions under IRC 419 are limited to contributions that do not cause the account limit of IRC 419A(c) to be exceeded.

    1. IRC 419A(c)(1) provides that the account limit for any qualified asset account is the amount reasonably and actuarially necessary to fund claims incurred but unpaid as of the close of the taxable year, and administrative costs for such claims. However, IRC 419A(c)(2) through (5) provide other limits for particular benefits.

    2. An additional reserve is allowed for post-retirement medical and life insurance benefits, but only if the plan meets the nondiscrimination requirements of IRC 505(b). For these purposes, certain taxable life insurance benefits need not be taken into account.

    3. A separate account must be maintained for each key employee for whom a post-retirement medical or life insurance benefit is provided.

7.25.9.13  (02-09-1999)
IRC 4976 Excise Tax on Disqualified Benefits

  1. IRC 4976(a) imposes a 100% excise tax on the employer for disqualified benefits provided by an employer-maintained welfare benefit fund. Such funds include organizations described in IRC 501(c)(7), IRC 501(c)(9), IRC 501(c)(17), or IRC 501(c)(20) through which employers provide benefits to employees.

    1. IRC 4976 is effective for distributions made after December 31, 1985.

  2. Disqualified benefits are defined in IRC 4976(b) as:

    1. Post-retirement and life insurance benefits for key employees other than from a separate account under IRC 419A(d);

    2. Post-retirement medical and life insurance benefits to highly compensated individuals under non-collectively bargained plans that are discriminatory under IRC 505(b)(1), whether or not IRC 505(b)(1) provisions apply to the plan; or

    3. Amounts for which a deduction is allowable under IRC 419 that later revert from the fund to the benefit of the employer.

7.25.9.14  (02-09-1999)
VEBA Funded Cafeteria Plan Benefits

  1. The provision of IRC 125 benefits, such as health insurance, disability, life insurance, child care through a VEBA trust is not necessarily inconsistent with exempt status under IRC 501(c)(9).

    1. IRC 505(b)(3) provides that if a benefit is subject to nondiscrimination rules under some other section of the Internal Revenue Code, those rules must be satisfied and not the nondiscrimination requirements of IRC 505(b)(1).

  2. Benefits that are provided through a VEBA and a related cafeteria plan can be viewed as meeting the nondiscrimination requirements of IRC 501(c)(9) if the following standards are met:

    1. The nondiscrimination rules applicable to a specific benefit must be met so that the specific benefit is treated as nontaxable. For example, a dependent care assistance program must meet the rules in IRC 129(d), a self-insured medical expense reimbursement plan must meet the rules in IRC 105(h), and group-term life insurance must meet the rules in IRC 79(d).

    2. In addition to the nondiscrimination rules which determine whether specific benefits are nontaxable, the cafeteria plan itself must also meet the nondiscrimination requirements set forth in IRC 125(b).

  3. Because the Service will not rule on the qualification of IRC 125 plans, the following caveat should be used in these situations:

    1. We are not making a determination directly or indirectly, on whether the arrangement which you describe as a "cafeteria plan" meets the requirements of IRC 125 and other related sections of the Internal Revenue Code. Further, this determination is not to be construed by inference or otherwise as approving, for purposes of exemption under IRC 501(c)(9), any other arrangement which purports to be a "cafeteria plan" .

  4. Since cash or deferred savings arrangements can be provided through a cafeteria plan, but are not permissible benefits under IRC 501(c)(9), any exemption ruling or determination under IRC 501(c)(9) should clearly only cover permissible IRC 501(c)(9) benefits.

7.25.9.15  (02-09-1999)
Digests of Published Rulings and Procedures

  1. Medicare payment reimbursed.—An organization which is exempt from Federal income tax under IRC 501(c)(9) may reimburse its members for premiums paid under the medical benefits program (medicare) provided under the Social Security Amendments of 1965, Public Law 89–97, 1965–2 C.B. 601. Rev. Rul. 66–212, 1966–2 C.B. 230.

  2. Employment taxes; collection and payment.—An organization established by a collective bargaining agreement between an association of manufacturers and a labor union to collect Federal and State employment taxes which the manufacturers are required to deduct from the wages of their employees who are members of the union, and pay over the amounts so collected to the appropriate tax authorities, does not qualify for exemption under IRC 105(c)(4), 501(c)(5), 501(c)(6), or 501(c)(9). Rev. Rul. 66–354, 1966–2 C.B. 207.

  3. Workmen’s compensation benefits, collection and payment. —An association formed by a corporation to provide workmen’s compensation benefits that the corporation was already obligated to pay under State law does not qualify for exemption under IRC 501(c)(9). Rev. Rul. 74–18, 1974–1 C.B. 139.

  4. Organization with only one member.—An organization that has as its purpose the provision of life, sick and accident benefits to all employees of a specified professional corporation does not qualify for exemption under IRC 501(c)(9) when the professional corporation has only one employee. Rev. Rul. 85–199, 1985–2 C.B. 163.

    1. For taxable years beginning after December 31, 1987, the Tax Reform Act of 1986 provides that the determination as to whether an individual is a highly compensated individual shall be made under rules similar to those under IRC 414(q). IRC 414(q) covers a broader range of individuals than covered by the definition of highly compensated employees under prior law. Specifically covered under IRC 414(q) are employees who at any time during the year (or preceding year):

Exhibit 7.25.9-1  (02-09-1999)
Preamble to Final Regulations T.D. 7750

SUPPLEMENTARY INFORMATION:


Background

 On July 17, 1980, the Federal Register published proposed amendments to the Income Tax Regulations (26 CFR Part 1) under section 501(c)(9) of the Internal Revenue Code of 1954 (45 FR 47871), as amended by section 121 of the Tax Reform Act of 1969 (83 Stat. 541), concerning voluntary employees’ beneficiary associations. Approximately 240 comments were received; a public hearing was held on October 14, 1980. After consideration of all comments regarding the proposed regulations those regulations are adopted as revised by this Treasury decision.


Control by Employees


 Almost all comments requested deletion or modification of the provision of the proposed regulations which required that an association be controlled by its membership, or by independent trustee(s), or by trustees or other fiduciaries at least some of whom are designated by, or on behalf of the membership. In response to these comments, many of which pointed out that section 501(c)(9) organizations are generally subject to the provisions of Title I of the Employee Retirement Income Security Act of 1974 (ERISA), the proposed regulations have been amended to provide that employee welfare benefit plans within the scope of section 3(1) of ERISA and subject to Parts 1 and 4 of Title I of ERISA will be considered to be controlled by independent trustees. The reporting and disclosure requirements of Part 1 of Title I of ERISA are so designed as to ensure that employees are informed of the status of the association’s benefit plan. The fiduciary standards set out in Part 4 of Title I of ERISA protect the interests of participants by establishing standards of conduct for plan fiduciaries.


 The proposed regulations also are revised to indicate more clearly that where the designation of the trustee(s) of a collectively bargained plan is the result of the collective bargaining process, the plan is deemed to meet the control requirement of the regulations. Where a plan is negotiated through collective bargaining, but the employees’ bargaining agent has not bargained for the right to participate in selection of the trustee and the trustee therefore is designated by the employer, the control requirement also will be considered satisfied. In addition, a financial intermediary such as a bank, acting in a fiduciary capacity, generally will be considered to be an independent trustee.


Disproportionate Benefits


 A number of comments suggested that the rule against discrimination in the provision of benefits has no basis in the statutory language of or legislative history to section 501(c)(9) and requested deletion or modification of that rule. However, substantially the same provision appeared in the 1969 version of the proposed regulations, published in the Federal Register on January 23, 1969. That provision, when proposed in 1969, attracted little adverse comment from the public. In addition, the Tax Reform Act of 1969, enacted nearly one year after the 1969 notice was published, amended section 501(c)(9) and related provisions in several respects. Despite these revisions to section 501(c)(9), Congress, in the Tax Reform Act of 1969, neither changed nor commented on this aspect of the proposed regulations.


 The antidiscrimination provision is retained but clarified. First, the regulations recognize that, in determining whether a plan discriminates in eligibility for membership (or for a particular benefit), the failure to cover employees represented by a collective bargaining agent who in the collective bargaining process has eschewed membership (or a particular benefit) need not be taken into account. In addition, the regulations indicate that while an employer-funded organization may not restrict membership or eligibility for benefits to officers, shareholders, or highly compensated employees of the employer, section 510(c)(9) organizations need not comply with antidiscrimination rules as stringent as those that apply to qualified pension trusts described in section 401 of the Code. The final regulations provide, however, that section 501(c)(9) organizations that are employer-funded may not provide disproportionate benefits to officers, shareholders, or highly compensated employees of the funding employer. This rule is the same as that contained in the 1969 proposed regulations. On the other hand, these final regulations indicate a variety of circumstances under which benefits will not be considered disproportionate. In particular, they indicate that for certain kinds of benefits, such as life insurance or disability benefits, the provision of benefits in amounts that are a uniform percentage of compensation of covered employees will not be considered disproportionate.


 In response to several comments, the final regulations have been revised to indicate that, where a plan does not discriminate in eligibility for benefits, the fortuitous payment during any year of disproportionate benefits to officers, shareholders, or highly compensated employees, because, for example, such individuals as a group suffered more adverse experience during the year, will not be considered disproportionate.


Membership


 Several comments requested deletion of the provision that restricts membership in voluntary employees’ beneficiary associations in the multiple employer context (so-called "multi-employer trusts" ) to those engaged on the same line of business in the same geographic locale. This provision is retained. First, section 501(c)(9) provides for the exemption of associations of employees who enjoy some employment related bond. Allowing section 501(c)(9) to be used as a tax-exempt vehicle for offering insurance products to unrelated individuals scattered throughout the country would undermine those provisions of the Internal Revenue Code that prescribe the income tax treatment of insurance companies. Second, it is the position of the Internal Revenue Service that where an organization such as a national trade association or business league exempt from taxation under section 501(c)(9) operates a group insurance program for its members, the organization is engaged in an unrelated trade or business. See Rev. Rul. 66–151, 1966–1 C.B. 152; Rev. Rul. 73–386, 1973–2 C.B. 191; Rev. Rul. 78–52, 1978–1 C.B. 166. To allow trade associations to provide insurance benefits through a trust exempt under section 501(c)(9) would simply facilitate circumvention of the unrelated trade or business income tax otherwise applicable to such organizations.


 A number of comments suggested that the regulations as proposed would prohibit the qualification of plans that cover only retired employees. The regulations as adopted are clarified to indicate that retired members are considered to be employees if the retired member was at one time an active employee.


Life, Sick, Accident, or Other Benefits


 The regulations are clarified to provide that the definition of a dependent for purposes of the provision of benefits under section 501(c)(9) is not necessarily identical to the definition of a dependent under section 152(a). Qualified benefits may be provided to a minor or student child of a member or member’s spouse, or to any other minor child residing with the member, even if the support test of section 152(a) is not met.


 Because of uncertainty on the point, it is specifically noted that the regulations as proposed and as adopted by this Treasury decision permit a section 501(c)(9) organization that receives employer funding to use insurance policies involving cash values only where the policies are part of a plan of so-called "group-permanent" life insurance subject to section 79 and the regulations thereunder. In addition, the revised regulations indicate that collectively bargained trusts may provide, by reason of section 302(c)(5) of the Labor Management Relations Act of 1947, legal service benefits and scholarships to dependents. Such trusts may not, although permitted to do so by section 302(c)(5), provide any benefit that is similar to a pension or other retirement income benefit except as specifically permitted by the final regulations.


 Several comments requested that a provision be added to state that death benefits paid by a self-funded plan are eligible for exclusion from the gross income of the beneficiary under section 101(a) of the Code. This issue is not addressed in these regulations, which are intended to clarify the provisions of section 501(c)(9) and not to resolve income tax or other issues that may arise under other sections of the Code.


 Finally, several comments suggested that the regulations should be revised to allow the proceeds of life insurance policies provided through a section 510(c)(9) organization to be settled in the form of an annuity to the beneficiary, even where the beneficiary does not have the option to take the policy proceeds in lump sum. The regulations are revised to permit settlement of a life insurance policy in the form of an annuity where the treatment of the annuity is the same as if the annuity had been taken in lieu of a lump sum, that is, where the interest element in the periodic annuity payment is includable in the recipient’s gross income.


Effective Date


 Several comments requested a delay in the effective date of final regulations, particularly because of difficulties in meeting the "employee control" and "discrimination" tests discussed above. The "employee control" test, however, has been modified in the fashion requested by most commenters. The discrimination rules have been revised to reflect the concept of "disproportionate benefits" contained in the 1969 proposed regulations and the concept "disproportionate" itself has been clarified in a way requested by many commenters. Consequently, the effective date of the final regulations has not been changed.


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