Q.1:
WHAT IS AN EMPLOYEE WELFARE BENEFIT PLAN (EWBP)?
An
Employee Welfare Benefit Plan is a plan that has been established by an
employer or a group of employers. The
organization generally provides for the payment of life, sickness, accident or
other benefits to its members or their dependents or designated beneficiaries.
An EWBP is either a trust or a non-profit corporation, generally having
as its trustee a bank or trust company.
Q.2:
WHAT IS THE PURPOSE OF AN EWBP?
The
purpose of an EWBP is to provide a method by which employers may provide
certain specified health and welfare benefits to a group of its employees, as
defined by the employer. The
employer makes contributions to the EWBP to pay for the benefits selected, and
receives a deduction for all current contributions as they are paid to the
EWBP. The earnings of the EWBP
derived from its investments are generally taxable to the trust during the
period of time that the fund is accumulating.
The employee does not derive any taxable income on the contribution
made on his behalf, except for the amount of imputed income (relating to the
economic benefit of any life insurance on his life).
Q.3:
WHAT IS A MULTI-EMPLOYER TRUST (MET)?
A
MET is a welfare benefit plan which is part of a 10-or-more employer plan and
which qualifies for special treatment under I.R.C. §419A(f)(6).
In order for a MET to qualify, it
must be a plan to which at least 10 employers contribute, and to which no
single employer contributes more than 10% of the total contributions made by
all employers, and in addition is not "experience-rated".
The METs described in this Tax Guide are all assumed to be METs that
have qualified under these special rules.
Q.4:
WHAT AUTHORITY IN THE I.R.C. PERMITS FAVORABLE TAX TREATMENT
OF A MET?
(1)
§419A(f)(6): Provides the
operating rules for a MET;
(2)
§162: Allows a
deduction for the annual employer contributions into the MET.
Q.5:
IS A MET SUBJECT TO THE IRS RULES FOR QUALIFIED RETIREMENT PLANS?
No.
A MET is not a qualified retirement plan subject to the rules of I.R.C.
§401, which is the governing law for that type of plan, because it does not
fit the definition of a retirement plan.
A MET will not file a request for determination with the IRS under that
section, because it is not a retirement plan but rather is a plan that
provides current benefits. It is
therefore not subject to the voluminous body of law governing retirement
plans, and is not subject to the restrictive rules under which those plans
must operate.
For
example, MET distributions are not subject to the rules for premature
withdrawal penalties (prior to age 59½) nor are they subject to the minimum
distribution rules for late withdrawals (beginning at age 70½).
More importantly, a MET is not subject to the maximum limitation of
$35,000 under I.R.C. §415. A properly structured MET does not have to be concerned with
compliance with the pension rules, and with constant updating of plans as the
tax law continually changes in that area.
A MET is also not subject to the $170,000 salary cap for benefit
computations, nor the affiliated service company or control group rules.
Q.6:
IS A MET SUBJECT TO THE IRS RULES FOR NON-QUALIFIED DEFERRED
COMPENSATION PLANS?
No.
A MET cannot provide deferred compensation , and cannot be set up to pay
income benefits at a specific time in the future.
Nor should it only provide benefits for highly-compensated or key
employees. A MET should generally be a plan that benefits all employees, to
which current contributions made by the employer are deductible under I.R.C.
§162. This differs substantially
from a typical non-qualified deferred compensation plan, which is set up only
for key employees, under which the employer gets no current deduction, and
gets a deduction only when the funds are actually paid out to the key employee.
Q.7:
IS A MET SUBJECT TO THE RULES OF ERISA?
Yes.
A MET that receives employer contributions is subject to Title I of
ERISA (the Employee Retirement Income Security Act of 1974), in particular
those rules that apply to employee welfare benefit plans.
Under these rules, the employer must prepare a Summary Plan
Description, to be filed with the Department of Labor and distributed to the
plan participants. Additionally, the trustee must file IRS Forms 5500 annually,
to report on the financial aspects of the MET.
The trustee of the MET is subject to all of the fiduciary, disclosure
and reporting rules of ERISA.
As
long as the participants do not make any contributions to the MET, the plan is
exempt from the participation and vesting provisions of ERISA, as well as its
funding requirements, as authorized by ERISA §201(3)(A).
Q.8:
WHAT TYPE OF BUSINESS SHOULD CONSIDER ADOPTING A MET?
(1) A profitable business (C Corporation, S
Corporation, partnership or LLC), that is seeking a way to reduce its tax
liabilities and to provide benefits to its employees, including
owner-employees.
(2) Companies that can no longer make contributions to
their qualified retirement plans because the plans are overfunded.
(3) Companies that have pension plans which no longer
favor the business owners, due to the $170,000 cap on compensation.
(4) Businesses and individuals who would like to
protect their assets from creditors, especially individuals who are in high
risk businesses (e.g. surgeons, real estate developers, manufacturers).
Q.9:
CAN A SOLE PROPRIETORSHIP ADOPT A MET?
No.
A MET does not have any statutory support for adoption by a sole
proprietorship, since the favorable VEBA regulations under §501(c)(9) do not
apply to a MET. Therefore, if a
sole proprietorship would like to consider the use of a MET, it should
determine to incorporate prior to adopting the MET.
A corporation that adopts a MET must have at least one participant who
qualifies as a true "employee", in addition to the owner-employee.
Q.10:
HOW IS A MET ORGANIZED?
A
MET may be organized as one of two types of legal entities, either a trust or
a non-profit corporation. Although
either entity will qualify to operate a MET, in practice the trust form is
almost always used, and in most instances a bank or trust company serves as
the trustee. In practically all
cases, the employer establishes its participation in
the MET by joining an existing MET that has been organized by a
sponsoring organization.
Q.11:
WHO CAN QUALIFY TO JOIN A MET?
Membership
must consist of individuals who become entitled to participate by reason of
their being employees. The
employer members who have adopted the MET do not require any particular
attributes, other than being corporations (C or S type) or partnerships, and
having at least two employees, including the owner-employee.
Q.12:
ARE THERE ANY GEOGRAPHIC RESTRICTIONS OF A MET?
No.
The IRS Regulations relating to VEBAs are not applicable to a MET, and
therefore there are no geographic restrictions.
Q.13:
DO ALL OF THE MEMBERS OF THE MET HAVE TO BE EMPLOYEES?
Yes.
The IRS regulations relating to VEBAs are not applicable to a MET, and
therefore those provisions that allow some VEBA participants to be
non-employees are not applicable to a MET.
Q.14:
CAN NON-EMPLOYEES BE MEMBERS OF THE MET?
No.
Q.15:
CAN RETIREES AND OTHER FORMER EMPLOYEES BE MET MEMBERS?
No.
Q.16:
CAN SPOUSES AND DEPENDENTS BE MET MEMBERS?
No.
Spouses and dependents of active employees cannot be MET members,
although they can participate in the MET's employee benefit plans.
Q.17:
IS THERE ANY REQUIREMENT THAT MET MEMBERSHIP MUST BE
VOLUNTARY?
No.
Q.18:
WHO MAY CONTROL THE MET?
A
MET must be controlled by any of the following :
(1)
its membership; or
(2)
an independent trustee, such as a bank; or
(3)
trustees, at least some of whom are designated by or on behalf of the
membership.
As
a general rule, in order to operate conservatively, an independent bank
trustee should be appointed in all cases.
The
tax requirement of control by an independent trustee is deemed satisfied if
the MET is an employee welfare benefit plan subject to ERISA.
Prior to 1990, it was assumed that as long as a MET or a VEBA was a
welfare benefit plan subject to ERISA, the employer could exercise substantial
control, as a fiduciary, over the MET. However,
a U.S. Claims Court decision in 1990 held that substantial employer control
over a VEBA could jeopardize its tax-exempt status.
It is possible that this same principle, applied to a VEBA, could also
be applicable to a MET.
Q.19:
WHO MAY NOT CONTROL THE MET?
A
MET must not be controlled by the employer under any circumstances.
Q.20:
WHAT BENEFITS MAY A MET PROVIDE?
A
MET may provide the following benefits:
(1)
Life benefits - payable on the death of a member or dependent. The death benefit should be provided through life insurance.
Pensions, annuities and similar benefits cannot be included.
(2)
Sickness and accident benefits - these include medical benefits and
disability income benefits, whether insured or uninsured.
There can also be benefits in noncash forms, such as clinical care by
visiting nurses and medical care transportation.
(3)
Other benefits - these benefits are intended to safeguard or improve
the health of a member or his or her dependents, or to protect against a
contingency that interrupts or impairs a member's earning power. These may consist of vacation and recreational benefits,
child care facilities, severance benefits, disability benefits,
educational benefits, disaster loans and grants, and legal services
benefits. Because of the tax
risks inherent in these benefits, they are not generally recommended for most
METs.
There
are certain benefits that may not be included.
Q.21:
WHAT IS PROHIBITED INUREMENT TO A PRIVATE INDIVIDUAL?
No
part of the MET's net earnings may inure to the benefit of any private
shareholder or individual, except through benefit payments.
Prohibited inurement is defined to include the following:
(1)
Disposition of the MET's property to a person for less than adequate
consideration, or performance of services for a person for less than adequate
consideration;
(2)
Payment of unreasonable compensation to the MET trustees or employees; and
(3)
The purchase of insurance or services at more than fair market value from a company in which one or more of the MET's trustees, officers or fiduciaries
have an interest.
The
IRS has established additional rules in the VEBA Regulations as well as in
case law, dealing with the concept of "prohibited inurement".
It is possible that this VEBA case law could apply equally to a MET.
Q.22:
WHAT RESTRICTIONS APPLY TO THE DISPOSITION OF MET ASSETS UPON
TERMINATION?
The
prohibited inurement rule set forth in Q.21 above affects how MET assets may
be disbursed when the MET adopted by an individual business is
terminated. The same rule
applies to when the MET organization itself terminates.
Upon
termination of its participation in a MET by an individual business, the
prohibited inurement rule will not be violated if any assets remaining after
satisfaction of all liabilities are used to provide life, sickness, accident
or other benefits to employees, using
criteria that avoid disproportionate benefits to officers, shareholders or
highly compensated employees of the employer.
The
IRS regulations in the VEBA area are more specific, providing that the
prohibited inurement rule is not violated if, upon termination of the MET, the
assets are distributed to its members on the basis of objective and reasonable
standards which do not result in either unequal payments to similarly situated
members, or disproportionate payments to officers, shareholders or highly
compensated employees.
The
MET's governing document must provide that no assets remaining will be
returned to the employer that contributed to it; otherwise, the MET will fail
to qualify.
Q.23:
WHAT IS THE TAX STATUS OF A MET?
A
MET is not exempt from income tax, since it does not request nor does it
receive an IRS exemption letter under I.R.C. §501(c)(9).
Further, it is still subject to the deductible contribution limits
under I.R.C. §419A, unless it qualifies as a MET under I.R.C.§419A(f)(6).
Q.24:
MAY A MET DISCRIMINATE IN FAVOR OF HIGHLY-COMPENSATED EMPLOYEES?
No.
Although a MET is not subject to the restrictive non-discriminatory
rules under I.R.C. §505(b), it still should not discriminate unduly in favor
of its highly-compensated employees. This
type of discrimination, although not technically defined by the IRS, as it is
in the VEBA area, could endanger the deductibility of contributions to the
MET.
Q.25:
WHAT ARE THE NONDISCRIMINATION REQUIREMENTS FOR A MET?
There
are no rules to follow, except the use of common sense and reasonableness in
not designing an illegally discriminatory program. However, the MET should attempt to follow most of the general
guidelines in the VEBA area, as set forth in I.R.C. §505(b).This section specifically provides that life insurance, disability
benefits, severance pay and supplemental unemployment compensation benefits do
not violate the non-discriminatory requirements merely because the benefits
bear a uniform relationship to total compensation or to a basic or regular
rate of compensation.
Q.26:
CAN ANY CLASSES OF EMPLOYEES BE EXCLUDED FROM THE MET?
Yes.
In applying the nondiscrimination rules in the VEBA area, there are
several categories of employees that may be disregarded, at the option of the
employer. These are:
(1)
Employees with less than 3 years service;
(2)
Employees under age 21;
(3)
Seasonal employees;
(4)
Less than half-time employees (less than 1,000 hours per year);
(5)
Employees covered by a collective bargaining agreement; and
(6)
Nonresident aliens with no U.S.-source earned income.
Further,
since the general rules in §505(b) do not apply to a MET, then it is possible
to include only certain groups of employees as participants in the MET,
provided that any such classification does not result in a program that unduly
favors the owner group without including a general cross-section of rank and
file employees.
Q.27:
WHAT IS THE MAXIMUM COMPENSATION THAT MAY BE USED AS A BASE FOR MET
BENEFITS?
There
is no compensation limit, such as the $170,000 restriction in a VEBA, since
the rules of §505(b) are not applicable to a MET.
This means that all compensation can be used as a base for benefits in
a MET, without the need to limit compensation to $170,000 or any other figure.
Q.28:
CAN A MET SECURE AN IRS APPROVAL LETTER OF TAX-EXEMPT STATUS?
No.
A MET is not a tax-exempt organization, and is therefore not entitled to
receive a determination letter of tax exempt status from the IRS.
This means that all income earned by the assets in the MET are subject
to current income tax.
Q.29:
MAY THE CONTRIBUTIONS TO A MET BE VARIED FROM YEAR TO YEAR?
Yes.
Although a MET is intended to be a permanent welfare benefit plan for
the employees, there is no fixed obligation to make a certain payment each
year. The MET must be actuarially
sound when installed, and the initial contribution level will be selected by
the employer. However, the
contributions can be varied each year, and the employer specifically retains
the privilege of reducing or discontinuing contributions, and to amend the
plan. The plan may also be
terminated, although the employer must have the intention to continue the plan
in the future (at the time of inception of the plan) in order to meet IRS
requirements.
To
the extent that the MET owns insurance policies on the lives of the
participants as investments, care must be taken to have enough funds in the
MET to carry that insurance without the danger of lapsing.
However, so long as there is enough funding to maintain the insurance
contracts, then the annual contributions may be varied.
Q.30:
WHAT IS THE LATEST DATE FOR AN ANNUAL MET CONTRIBUTION TO BE MADE SO THAT IT IS TAX DEDUCTIBLE?
A
MET contribution that is made by the last day of the calendar year, or the
last day of the employer's fiscal year if other than the calendar year, is
deductible in that year. This
result assumes that the employer reports its income on the cash basis. In the event that the employer reports on the accrual basis,
the contribution is deductible provided all necessary documentation is
completed by the last day of the year, and the MET contribution is made no
later than 75 days after the end of the fiscal year.
In order to secure the deduction in either case, the adoption agreement
and all other ancillary documents must be completed, executed and forwarded to
the MET trustee by the last day of the employer's year.
Q.31:
DO THE PARTICIPANTS IN A MET REALIZE CURRENT TAXABLE INCOME?
Yes.
Although the employer contributions to the MET do not constitute
taxable income to the participants, there is an amount of taxable income
arising from the economic benefit attributable to the life insurance on the
participant's life. This is
computed by the IRS under the tables for "P.S.58 cost".
If the published "yearly renewable term rate" of the insurer
is lower than the P.S.58 cost, then that lower amount can be reported by the
participant. IRS Notice 2001-10
replaces the P.S.58 table with lower rates.
Q.32:
WHAT ARE THE START-UP COSTS FOR INSTALLING A MET?
The
expenses to initiate a MET fall into several categories, with the estimated
amounts indicated:
(1) Adoption fee, to join an existing MET trust,
covering initial setup and documentation, generally about $500 (paid to the
MET sponsor);
(2) Initial annual administration fee, for completing
the actuarial work as well as the record-keeping for the first year, estimated
at $1,000 plus a nominal fee for each plan participant (paid to the plan
administrator); and
(3) Trustee fee, usually $750 (paid to the independent
bank trustee).
The
total first year costs are generally in the area of $2,250, plus the
appropriate per participant charges. These
fees are deductible as ordinary and necessary business expenses when paid by
the employer. Other fees may
depend on the legal and other expenses that the MET may incur in any year.
Q.33:
WHAT ARE THE CONTINUING COSTS FOR MAINTAINING A MET?
The
annual costs for maintaining the MET are all the fees set forth in Q.32 above,
except for (1), the adoption fee, which is a one-time expense.
These continuing costs are similarly deductible as ordinary and
necessary business expenses at the time they are paid.
Q.34:
HOW ARE THE PARTICIPANTS TAXED UPON THE RECEIPT OF THEIR MET BENEFITS?
When
the participants receive their MET benefits from the plan, ordinary income tax
is due in the year of receipt, if the benefit is of the type to be included in
ordinary income. Since most
participants are on the cash basis of accounting, this tax would be
attributable to the year in which the benefits are received.
Q.35:
WHAT IS THE FUNDING METHOD FOR THE DEATH BENEFIT?
The
death benefit is generally funded by permanent or ordinary life insurance. The type of insurance contract that is used is flexible, and it may
consist of a fixed, variable, universal or any other type of insurance.
IRS requires that the policies must be owned by the MET, and of course
all cash value and other ownership attributes belong to the MET.
The policies may have cash value only if they are individual policies
or are part of a plan of group-permanent life insurance.
A
VEBA is a tax-exempt organization that receives a favorable determination
letter from the IRS, in which the IRS determines that the organization is
exempt from current income tax under I.R.C. §501(c)(9).
A MET does not fall within this exemption of the Code, and therefore
does not request a §501(c)(9) exemption letter.
The
following are the differences between the two plans, other than the tax
treatment of income within the trust.
(1)
A VEBA is subject to the $170,000 compensation limit, for the computation of
multiple of compensation benefits; a MET has no limitation on compensation
that can be utilized in computing that multiple.
(2)
A VEBA must comply with the employment-related affiliation rules and the
geographic limitation rules (3-state safe harbor); a MET can be installed for
any type of business located in any geographic area, with no particular
relationships.
(3)
A VEBA is subject to the controlled group rules and affiliated service group
rules, and must cover all employees of all such related groups; a MET must
cover only employees of its own business entity, and need not cover controlled
groups of affiliated service groups.
(4)
A VEBA may cover corporations (C and S type) as well as LLCs, sole
proprietorships and partnerships; a MET may only cover C corporations, S
corporations, LLCs and partnerships.
(5)
A VEBA is subject to the non-discriminatory rules of §505; a MET is subject
only to the test of reasonableness in developing a rational method of
excluding certain categories of employees, so long as that method is based
upon some logical business purpose.
Other
than the above distinctions, both the VEBA and the MET are of the same generic
derivation, both being employee welfare benefit plans, both established for
the purpose of providing lifetime benefits to employees and both having
similar operating rules and regulations under §419 and §419A of the Code.
Q.47:
IN SUMMARY, WHAT ARE THE TAX AND ECONOMIC ADVANTAGES OF ADOPTING A MET?
(1)
Tax Advantages:
(a) The employer obtains a current income tax
deduction for the contributions made to the MET to provide for the costs of
furnishing the benefits for its employees who are participants;
(b) The earnings of the funds in the MET which is a
Death Benefit Only Plan are subject to income tax.
However, there is no current taxation on investments in life insurance
policies.
(c) The
participants are required to pay current income tax only on the economic benefit or P.S.58 table costs, which are usually lower than the total
life insurance
premiums paid by the employer;
(d) The payment of income taxes on the accumulated MET funds is
deferred until such time as the MET program is terminated;
(e) The benefits of the MET may be structured by appropriate estate
planning so as to escape estate taxation at the death of the participant
(2) Economic benefits:
(a) The benefits of the MET should be exempt from creditors of both the
employer
and the participants, since they do not
possess title or ownership interests in the funds;
(b) The employer can provide for the life insurance needs of the participants;
(c) There is no vesting in the funds for employees who terminate prematurely;
(d) Contributions are flexible as to amount on an annual basis;
(e) The investments of the MET can be limited to policies issued by major
insurance companies that are highly rated
(f) There are no restrictive rules regarding early distributions or late
distributions, since no distributions are
intended;
(g) There are no specific limits on the amount of contribution, other than
those limitations provided by
sound and conservative actuarial concepts;
(h) The plan prohibits any reversion of assets to the employer, since all funds
must be utilized for the
benefit of employees;
(i) Upon termination of the MET, assets may be distributed based on
non-discriminatory criteria.
