EP Abusive Tax Transactions - Collectively Bargained Welfare Benefit Funds under Section 419A(f)(5)

Notice 2003-24 discusses tax problems raised by certain trust arrangements seeking to qualify for exception for collectively bargained welfare benefit funds under IRC section 419A(f)(5). In general, contributions to a welfare benefit fund are deductible when paid, but only if they qualify as ordinary and necessary business expenses of the taxpayer and only to the extent allowable under IRC sections 419 and 419A. These sections impose strict limits on the deduction for contributions in excess of current costs. An exception to some of the limits is provided under IRC section 419A(f)(5) for contributions to a separate welfare benefit fund under a collective bargaining agreement. This exception is based, in part, on the premise that deductions in such a setting will not be excessive because of the arms’ length negotiations between adversary parties inherent in the collective bargaining process.  

Promoters have approached business owners about arrangements that purportedly allow the business to take a current tax deduction for all contributions to a welfare benefit fund. Prior to this contact, these businesses typically have not had involvement with labor organizations or other aspects of the collective bargaining process. These arrangements usually require large employer contributions relative to the amount actually needed to provide the current coverage for the welfare benefits under the arrangement.

Typically, benefits that are provided or expected to be provided to employees who are also owners are more favorable than the benefits provided to employees who are not owners. In some arrangements, participants can access funds by obtaining a loan from the trust. The promoters of these arrangements rely on IRC section 419A(f)(5), claiming that the benefits are provided under a collective bargaining agreement.

In general, these arrangements and other similar arrangements do not satisfy the requirements of IRC section 419A(f)(5) and do not provide the tax deductions claimed by their promoters.