Educational Outline

Abusive WBPs and VEBAs used, covering such benefits as vacation homes, yachts, travel, educational, medical, life and severance benefits - deductions virtually unlimited.

1984

DEFRA added §419 and §419A (limitations) and discrimination rules under §505. DEFRA trimmed the benefits primarily enjoyed by highly-compensated employees (key employees, owners) by adding requirements that welfare plans must be subject to actuarial advice, and benefits must be spread over the lifetime of the employees.

DEFRA exception for multi-employer WBP: §419A(f)(6), 10-or-more employer plan which does not maintain experience-rating arrangements with respect to individual employers, and no employer normally contributes more than 10% of the total contributions. This exception has unlocked a great potential for welfare benefit plans. If the WBP plan qualifies, the constraints and limitations of §419 and §419A will not apply.

TODAY

More than 5,000 WBPs in existence (Source: IRS).

WBP plan must not be discriminatory, and must not be "abusive". IRS has identified 4 issues that must be properly addressed:

(1) plan must not be a retirement plan or compensation;

(2) no experience rating;

(3) no separate accounting; and

(4) not prepaid expenses.

II. WHY CONSIDER A WBP?

- Employer contributions are tax deductible

- Assets accumulate and compound on a tax-deferred basis, if invested solely in life insurance or if the WBP qualifies as a tax-exempt VEBA

- Benefits tax-free to employees (other than P.S.58 costs)

- Assets protected from all creditors - no reversion to employer

- Large percentage of contributions are used to fund benefits for owner-employees

- No need to comply with complicated pension rules (pre-59S and post-70S penalties, $30,000 annual limitation, overfunding limitations, distribution rules)

- Survivor benefits are income tax free, and if properly structured, can be free of estate taxes

- Employer can provide for life insurance needs of the participants

- No vesting in the funds for employees who terminate prematurely

- No limits on the amount of contribution, other than that which is reasonable, and computed by the use of conservative actuarial concepts

III. WHO SHOULDER CONSIDER A WBP?

- Profitable businesses (C-Corp.; S-Corp.; LLC; LLP; Partnership) or professional practices desiring a method of reducing tax liability

- Companies that can no longer make contributions to their qualified retirements because of either: (1) those plans are overfunded, or (2) plans no longer favor the business owner

- Business owners who have estate tax problems and wish to reduce or eliminate estate and inheritance taxes

- Individuals who would like to protect a portion of their assets from creditors, especially persons who are in a high risk business

IV. STATUTORY FRAMEWORK FOR VEBAs (predecessor of WBPs)

1. §501(c)(9): Tax-exemption (VEBA only)

Provides exemption from income tax for the VEBA, providing for the payment of life, sick, accident, or other benefits to the members, if no part of the net earnings inures to the benefit of any private shareholder or individual. First enacted in 1928 as §103(16) of the Revenue Act of 1928.

2. §505(b): Non-discriminatory requirements (VEBA only)

(1) General. Each class of benefits provided under a classification of employees must not be discriminatory in favor of the highly compensated, and each of such benefits is not to discriminate in favor of the highly compensated. A life insurance, disability, severance pay or supplemental unemployment compensation benefit shall bear a uniform relationship to total compensation or basic or regular rate of compensation.

(2) Exclusion of Certain Employees. The following employees may be excluded from consideration:

(A) Employees with less than 3 years service;

(B) Employees who have not attained age 21;

(C) Seasonal employees or less than half-time employees;

(D) Employees covered by a collective bargaining agreement; and

(E) Employees who are nonresident aliens and who receive no earned income from the employer which constitutes United States income.

(3) Other Non-discrimination Rules. In the case of any benefit for which other sections proved non-discrimination rules, paragraph (1) shall not apply, but the non-discrimination rules so provided in such section must be satisfied.

(4) Aggregation Rules. At the election of the employer, 2 or more plans of such employer may be treated as 1 plan for purposes of this section.

(5) Highly Compensated Individual. The determination as to whether an individual is a highly compensated individual shall be made under rules similar to those in §414(q).

(6) Compensation Limit. Compensation must be limited to $150,000, as adjusted.

3. §419: WBP limitations

Provides limitations for contributions to welfare benefit funds. A fund is defined in §419(e)(3) to mean any organization described in §501(c)(9).

4. §419A(f)(6): Multi-employer plan exception

Exception for 10-or-more employer plans (multi-employer plans). The limitations and restrictions of §419 and §419A do not apply to any welfare benefit fund which is part of a 10-or-more employer plan, so long as the plan does not maintain experience-rating arrangements with respect to individual employers. No employer may normally contribute more than 10% of the total contributions by all employers.

5. §162(a): Deduction for WBP contributions

Deduction is allowed for ordinary and necessary trade or business expense, provided the expense is reasonable in amount. Employee benefits, specifically welfare or similar benefit plan, is allowed by Regs. §1.162-10(a), provided these are not benefits similar to a retirement plan or other deferred compensation plan.

6. §4976: 100% Excise Tax

100% excise tax on a WBP providing a disqualified benefit. Definition of disqualified benefit is (1) any post-retirement life insurance benefit, if a separate account is required to be established for any key employee and such payment is not from such account; (2) any post-retirement life insurance benefit provided with respect to highly-compensated or key employees, unless the requirements of §505(b) are met; and (3) any portion of a welfare benefit fund reverting to the benefit of the employer.

7. §6662: Accuracy-related penalty

Accuracy-related penalty of 20% for understatement of income tax. Relief under §6662(d)(2)(B) to the extent that the taxpayer had substantial authority for the position taken in tax return. Substantial authority can be satisfied by reasonable reliance on a qualified advisor. §6664(c) provides reasonable cause by reliance on an independent professional advisor, which the taxpayer must reasonably rely in good faith on advice. Professional advisor must consider all facts and circumstances, not make any unreasonable assumptions, and relate the law to the actual facts.

V. IRS REGULATIONS (applies to VEBA only - not to WBP)

1. §1.501(c)(9)-1: Qualifications of a VEBA

An organization must meet al four of these requirements, if it is to qualify for tax-exemption under §501(c)(9):

(a) The organization must be an employees' association;

(b) Membership in the association must be voluntary;

(c) The organization provides for the payment of life, sick, accident or other benefits to its members and dependents or beneficiaries, and substantially all its operations are in furtherance of providing such benefits; and

(d) No part of the net earnings inures to the benefit of any private shareholder or individual.

2. §1.501(c)(9)-2: Membership in a VEBA; employees; description of VEBA

Membership must consist of individuals who are employees, and whose eligibility for membership is defined by reference to objective standards that constitute an employment-related common bond, such as a common employer or affiliated employers.

Employees of one or more employers engaged in the same line of business in the same geographic locale will be considered to share an employment-related bond for purposes of an organization through which their employers provide benefits. Employees of an association will be considered to share an employment-related common bond with members on the association.

Employees can include non-employees, so long as they share an employment-related bond. Sole proprietors may be included, so long as the employees are members of the association. But membership must consist of 90% of employees on one day of each quarter of the year.

Eligibility may be restricted by geographic proximity, or by objective conditions or limitations reasonably related to employment. But objective criteria may not be administered in a manner that limits membership or benefits to officers, shareholders or highly-compensated employees, or to give them benefits that are disproportionate.

Note that in Proposed Reg. §1.501(c)(9)-2, effective August 7, 1992, the IRS gave in to the holding in Water Quality Association Employees' Benefit Corp. v. U.S., (7th Cir. 1986), that held the "same geographic locale" provision of the above Regulation to be invalid. The Proposed Reg. provides a 3-state "safe harbor", by allowing that an area will be recognized as a single geographic area if it does not exceed the boundaries of 3 contiguous states that share a land or river with at least one of the others.

Employee is defined by reference to the legal and bona fide relationship of employer and employee.

There must be an entity having an existence independent of the member-employees or their employer. Membership must be voluntary, and an affirmative act is required on the part of the employee to join. However, an association is considered voluntary although membership is required of all employees, provided that the employees do not incur a detriment as the result of membership (e.g. deductions from pay).

The VEBA must be controlled by either:

(i) its membership, or

(ii) an independent trustee, such as a bank, or

(iii) by trustees, at least some of whom are designated by the membership.

There will be independent trustees if the VEBA is an employee welfare benefit plan as defined in §3(1) of ERISA and is subject to the requirements of Parts 1 and 4 of ERISA Subtitle B, Title I.

3. §1.501(c)(9)-3: Benefits of a VEBA; life, sick, accident or other benefits

Life benefit means a benefit payable by reason of the death of a member or dependent. A life benefit may be provided directly or through insurance. The benefit must consist of current protection, but also may include a right to convert to individual coverage through the association, or a permanent benefit as defined in the regulations under §79. Life benefit does not include a pension, annuity or similar benefit.

The term sick and accident benefits means amounts furnished in the event of illness or personal injury to a member or dependent. Benefits may be provided through reimbursement or through payment of premiums to a medical benefit or health insurance program. Also includes sick pay during a period in which the member is unable to work due to sickness or injury.

Other benefits include only benefits that are similar to life, sick or accident benefits. The benefit must be intended to safeguard or improve health, or to protect against a contingency that interrupts or impairs a member's earning power.

Examples are provided for qualifying other benefits, and examples are provided for nonqualifying other benefits.

4. §1.501(c)(9)-4: Prohibited inurement

No part of the net earnings of VEBA may inure to the benefit of any private shareholder or individual. There can be no disposition of property or the performance of services for less than fair market value or cost. There can be no unreasonable compensation paid to trustees or employees of the VEBA.

There can be no payment of disproportionate benefits to any member, unless pursuant to objective and nondiscriminatory standards. Payments to highly compensated personnel, or to officers and shareholders, may not be disproportionate in relation to benefits received by other members. Any differences as to payments in kind or amount must be justified on the basis of objective and reasonable standards.

Upon termination of a VEBA, assets remaining after satisfaction of all liabilities must be applied to provide (directly or through purchase of insurance) benefits pursuant to criteria that do not provide for disproportionate benefits to officers, shareholders of highly compensated employees.

VI. CASE LAW

1. Greensboro Pathology Associates, P.A. v. U.S. (Fed. Cir. 1982)(WBP)

Contributions to an educational benefit trust for the children of employees are currently deductible under §162. Benefits were available to all employees, not just owners or key employees. The plan was not a deferred compensation plan subject to §404 but rather is a welfare or similar benefit plan as described in Reg. §1.162-10.

The funds contributed to the plan would not revert to the benefit of the taxpayer. The benefits were not dependent upon the earnings of the taxpayer. The plan was not intended as a substitute for an increase in salary. The corporation has actually spent the money it wishes to deduct.

The plan was administered by an independent trustee, who was not controlled by the employer. The employer did not retain an inordinate amount of control over the funds so that the result is an illusory benefit.

2. Bricklayers Benefit Plans of Delaware Valley, Inc. v. Commissioner (TC 1983)(VEBA)

The taxpayer was not an association of employees. Its members were tax-exempt welfare and pension funds, not individual employers. The taxpayer was in essence a cooperative of tax-exempt organizations, and not an association of employees within the meaning of §501(c)(9). Membership must be composed of individuals, not organizations.

The organization provided for the payment of pension benefits, and it was not an association of employees. Pension benefits are not similar to life, sick or accidental benefits. The IRS Regulations under §501(c)(9) were held to be reasonable and consistent.

NOTE: This case was decided prior to enactment of DEFRA in 1984, which added §419A(f)(6) to the Internal Revenue Code, providing for multi-employer WBPs.

3. Water Quality Association Employees' Benefit Corp. v. U.S. (7th Cir. 1986)(VEBA)

The "same geographic locale" provision of Reg. §1.501(c)(9)-2-(a)(1) was held to be invalid. This provision restricted membership in tax-exempt VEBAs to employers engaged in the same line of business in the same geographic area. The Court found that the provision was unduly restrictive and impermissibly excluded VEBAs that the statute otherwise exempts.

Geography alone has no reasonable or logical relation to the establishment of an "employment-related" bond to distinguish true VEBAs from commercial insurance ventures. The absence of geographically limiting words within §501(c)(9) reveals a congressional intent that exempt status was to be granted to VEBAs generally.

4. Sunrise Construction Company, Inc. v. Commissioner (9th Cir. 1988)(VEBA)

A VEBA plan was maintained, where the corporation claimed exempt status under §501(c)(9). The IRS refused to issue a favorable determination letter because the net earnings of the fund inured to benefit the sole shareholder.

The Court held that the VEBA was not tax-exempt, where:

(1) the amounts contributed far exceeded the amounts reasonable for the stated purposes of the contribution;

(2) excess funds were invested at the direction of the shareholder in a nonfiduciary manner; and

(3) the terms of the organizing agreement were not honored upon termination of the plan.

The plan was actually a separate fund controlled by the sole shareholder for his own benefit.

5. American Association of Christian Schools VEBA Welfare Plan Trust v. U.S. (11th Cir. 1988)(VEBA)

A trust established by a tax-exempt association of churches to provide a variety of insurance benefits to member school employees was denied tax-exempt status. The association covered over 1,000 participants in all 50 states. The association was not a VEBA.

Moreover, the trust failed to qualify under §501(c)(3) because it was not operated exclusively for religious purposes. The trust was not a religious organization because it operated like an insurance company with required premiums rather than voluntary contributions. The trust also did not qualify as an organization operated exclusively for the promotion of social welfare.

The trust did not qualify as a VEBA because it was not controlled by the employees through a trustee selected by the employees, and it granted higher-paid employees disproportionately greater benefits than lower-paid employees. The trust did not qualify for exemption as an association of churches that provides welfare benefits for its employees, because it was established before the effective date in 1985 allowing for such an exemption.

6. Wade L. Moser v. Commissioner (TCM 1989)(VEBA)

The corporation was entitled to a $200,000 deduction for a contribution to its VEBA as an ordinary and necessary business expense, under Reg. §1.162-10(a). No taxable income to the officers and directors resulted.

Although there was scant authority governing the deductibility of an employer's contribution to a VEBA, the terms of the association were found to be structured in accordance with all relevant regulations. There was no statutory or regulatory provision that prohibited a deduction for a contribution to the plan merely because a high portion (90%) of the costs of the insurance premiums and costs of the full funding of the severance benefit were for benefits attributable to the officers and directors. The fact that the officers could effect amendment or termination of the association did not give them total unfettered control of assets. Finally, the VEBA was operated in accordance with the plan provisions, and the assets did not revert to the employer or any shareholder, except as permitted pursuant to the plan provisions.

The severance benefit was computed as a function of a uniform percentage of compensation and years of service. There was an independent trustee, a trust company.

7. Lima Surgical Associates, Inc. VEBA v. U.S. (Fed. Cir. 1991)(VEBA)

A plan and trust set up to provide severance pay to employees of a medical corporation did not qualify as a VEBA, because it made payments of retirement benefits. Benefits were based upon level of compensation and length of service. Severance payments provided under a VEBA plan must qualify as life, sick or accident benefits or as similar welfare-type benefits. Any benefit that resembles a pension or annuity payable at the time of mandatory or voluntary retirement is a nonqualifying benefit for VEBA purposes.

This deferred compensation plan was similar to a pension or annuity because it became payable by reason of the passage of time rather than as a result of an unanticipated event. The plan was set up when the employer ended its pre-existing retirement plan. The only participant in the plan to obtain benefits did so upon retirement. By paying retirement benefits as part of its alleged severance pay arrangement, the plan was both organized and operated to pay nonqualifying benefits.

The VEBA was not controlled by an independent trustee, a "friendly" bank, but the employer did not control the bank and therefore it was found to be independent. The benefits provided under the plan were not limited to the type of benefits specified in the VEBA regulations [Reg. §1.501(c)(9)-3].

The benefit scheme established under the trust provided disproportionate benefits to the doctor-owners, violating the prohibition against private inurement.

8. Joel A. Schneider, M.D., S.C. (TCM 1991)(VEBA)

Solo professional corporation owned by a doctor set up 3 separate VEBAs for its employees, each with two participants (doctor and his assistant). Trustee was an independent bank. Assets held in the plan were dedicated to providing the employees and not the employer with benefits. Plan benefits attributable to doctor exceeded 95% of the aggregate benefits. The doctor retained the right to terminate the VEBAs. IRS claimed that retention to terminate constituted impermissible control over the VEBAs, making them investment vehicles for the owner. Tax Court rejected the IRS argument, and stated that control was not too much, so long as funds may never revert to or inure to the benefit of the employer. The minimal retention of control was not enough to make the benefits of the plan in any way illusory.

Contributions to plans which were designed to provide death, disability, termination and educational benefits were currently deductible business expenses rather than capital expenditures or prepaid expenses. Neither the control retained to amend or terminate the plans nor the benefit to be derived from employee loyalty resulted in a finding that the employer would realize a direct and continuing economic benefit or advantage of the sort that would require capitalization of expenses. The contribution to each plan for a particular year related only to the year in which the contribution was made.

9. Harry A. Wellons, Jr., M.D., S.C. v. Commissioner (7th Cir. 1994)(WBP)

A medical service corporation that established a severance pay plan for its employees could not deduct its plan contributions as ordinary and necessary business expenses. It had to deduct the contributions in the years plan benefits were actually paid to the plan participants. The plan did not have an exemption letter from the IRS under §501(c)(9). The plan was in substance a deferred compensation plan. Its participants received the benefits only after the termination of their employment.

Moreover, the amount of benefits received by a participant was contingent upon the length of time the participant had been in the corporation's employ and upon the amount of the participant's compensation while in such employ. 5 years service was required, and benefit amount was linked to level of compensation and length of service. The plan calculated the benefits paid based upon each participant's compensation, just as a retirement plan would. Since the benefits were deferred compensation, the deduction provisions of §404(a), not the deduction provisions of §162 apply.

The plan permitted voluntary severance of an employee, and the definition of severance did not exclude retirement from the events triggering the benefit.

10. General Signal Corporation v. Commissioner (TC 1994)(VEBA)

A corporation set up an individual VEBA to provide welfare benefits for it employees. The VEBA applied only to the employees of General Signal Corporation and its 40 domestic subsidiaries and 49 foreign subsidiaries, involving many thousands of employees. The amounts contributed were used primarily to satisfy benefit claims in the year following the year of contribution. Post-retirement benefits were also provided, but there was no reserve established for the purpose of paying such benefits.

The corporation had to meet the limitations and restrictions of §419, since it was not a multi-employer VEBA exempted from these provisions by §419A(f)(6). For example, the "account limit" on a "qualified asset account" for a taxable year is the amount reasonably and actuarially necessary to fund claims incurred but unpaid for such benefits, as well as administrative costs.

Because this case does not involve multi-employer WBPs, under the 10-or-more employer rule, the holdings of this case are not applicable to plans that qualify for exemption under §419A(f)(6).

11. National Presto Industries, Inc. v. Commissioner (TC 1995)(VEBA)

This is another individual VEBA applicable only to the major company that set it up, for the purposes of providing health and welfare benefits to its employees. The years under consideration were 1983 and 1984, and the taxpayer claimed deductions for VEBA contributions in excess of $3,000,000.

The issue turned on the taxpayer's right to accrue amounts set aside, but not yet paid to the VEBA trust. Since this case did not involve multi-employer WBPs, the holdings of this case are not applicable to plans that qualify for exemption under §419A(f)(6) from the restrictions of §419 and §419A.

12. Connecticut Mutual Life Insurance Company v. Commissioner (TC 1996)(VEBA)

This is another individual VEBA applicable only to the giant life insurance company that set it up, for the purposes of funding the cost of certain medical and group life insurance benefits, with a cost of $20,000,000. The years under consideration were 1984 and1985.

This case did not involve multi-employer WBPs, and therefore the holding of this case is not applicable to plans that qualify for exemption under §419A(f)(6).

The Court cited with favor Moser, supra and Schneider, supra, in which the taxpayers were allowed their full deductions, with no issue of prepayment. However, the Court held here that contributions that provide taxpayers with substantial, as opposed to merely incidental, future benefits must be capitalized.

13. Square D Company v. Commissioner (TC 1997)(VEBA)

Yet another individual VEBA for a large company, involving the same principles as the previous 3 cases interpreting the limitations and restrictions of §419 and §419A. This case is not applicable to plans that meet the qualifications of §419A(f)(6).

14. Booth v. Commissioner (TC 1997)(VEBA)

A well-reasoned case decided by the Tax Court on June 17, 1997, which supplied the needed guidance for sponsors of multi-employer WBPs, and for the employers that adopt these plans. The 9 taxpayers had all adopted plans sponsored by the Prime Financial group.

These were severance plans, structured as taxable trusts, which did not have tax-exemption letters from the IRS under §501(c)(9), and were multi-employer WBPs under §419A(f)(6).

The basis of the IRS attempted disallowance of the deductions was as follows:

1. The plan was not a welfare plan, but was one that provided deferred compensation;

2. The plan was alleged to be experience-rated;

3. The plan was not a single plan;

4. The plan contained no substantial risk of forfeiture;

5. P.S.58 costs must be included in the annual income of the participants.

6. Penalties should be imposed resulting from substantial understatement of tax.

The case supplied much needed guidance as to the proper manner to structure a multiple employer welfare benefit plan. This recent decision represents a landmark in the §419A(f)(6) area, in that it answers several important questions in favor of the taxpayer. The opinion also sets forth a roadmap of what factors need be present in order to qualify as a single plan that is not experience-rated. The taxpayers in Booth failed to meet all of these tests

The issues in Booth were:

(1) Whether or not the plan was a welfare benefit plan or a deferred compensation plan;

(2) Whether the provisions of §419A(f)(6) were met; and

(3) Whether there were any penalties resulting from substantial understatement of federal income tax.

Additionally, the Court provided guidance in several other important areas:

(4) Whether the ability of the employer to voluntarily terminate its participation in the plan constituted sufficient control as to tip the scales in favor of finding of deferred compensation;

(5) What constitutes a single plan as opposed to an aggregation of separate welfare benefit plans;

(6)The factors indicating that the relationship of a participating employer to the plan is similar to the relationship of an insured to an insurer;

(7) What degree of separate accounting was sufficient to prevent compliance with the single plan requirement; and

(8) The requirement that all assets of the trust be made available to all employees of all participating employers in the trust.

The Tax Court decided the issues of whether the plan was a welfare benefit plan and the tax penalty issue in a manner favorable to the taxpayer. The Court specifically ruled that the welfare benefit plan in question was more like the plan reviewed by the Court in Moser and Schneider, rather than being similar to deferred compensation in Wellons. This was so even though the plan in question had severance benefits.

The Court further held that no penalties were to be imposed, since the taxpayer's position was supported by a well-reasoned construction of the relevant statutory provisions.

However, the central issue of the case revolved about whether or not the plan met the multi-employer requirements of §419A(f)(6). Here, the Tax Court held that the taxpayer had not met its burden of compliance with the law.

Specifically, in the plan under review, only the assets of each individual employer were made available to each of its own employees. The plan assets as a whole were not available to all employees. This factor caused the Court to rule that the plan was not a single plan, but rather consisted of an aggregation of individual unique plans formed by separate employers who have banded together with certain common elements, such as a common trustee, sponsor and administrator.

In order for a plan to meet the Court's requirements of a single plan, there must be a single pool of funds for use by the group as a whole, to pay the claims of all participants. Having a plan where funds are disbursed solely for the benefit of the contributing employer's employees does not satisfy the single plan requirement.

The Court next dealt with the issue of experience rating, and the opinion provides and excellent analysis of this issue, based primarily on the legislative history of §419A(f)(6). The Court held that the relationship of a participating employer to a multi-employer plan must resemble the relationship of an insured to an insurer.

The Court distinguished between the term "experience rated", as defined by the Supreme Court in United States v. American Bar Endowment, 477 U.S. 105,107 (1986), and the term "experience-rating arrangements", which has a wider scope. The opinion stated that "The essence of experience rating is the charging back of employee claims to the employer's account". Since this was done in Booth, a finding was made that the plan utilized an experience-rated arrangement. The Court further found that the employer's relationship to the trust was more akin to the relationship of an employer to a fund, rather than of an insured to an insurer.

The Court summarily disposed of the government's argument that the power to terminate the plan constituted inordinate control over the plan, making it a plan of deferred compensation. The Court specifically stated that this power to terminate was akin to the power of an owner-shareholder to terminate a corporate pension plan at will, which does not lead to a finding of prohibited control. In the absence of legislation in this area, the Court refused to adopt the principle that severance benefits in a welfare benefit plan are limited to cases where an employer could not voluntarily terminate its participation in a welfare benefit plan.

In the event that a Plan does not have any severance benefits available to its participants, then the Court's decision on this point provides even greater strength to the argument that there is no impermissible power to terminate the plan.

The Court relied on several factors to conclude that the plan in question was not a single plan, but rather was a collection of unique individual plans.

(1) The sponsor was required to maintain separate accounts and a separate accounting for each employee group.

(2) The Trust Agreement limited an employer's right to benefits under the Plan to the assets of his Employee Group.

(3) An annual valuation was performed for each Employee Group's Account, and no annual valuation was ever performed for the Trust as a whole.

(4) The Summary Plan Description (SPD) required by ERISA was prepared separately for each Employee Group.

(5) The Adoption Agreement signed by each Employer was very similar to an Adoption Agreement used by separate Employers establishing a separate plan under the terms of a master plan.

(6) Each Employer selected its employee's level of benefits, vesting schedule and minimum participation requirements, separate and apart from the selections made by the other Employers.

(7) Each Employer's contribution benefited primarily its Employees, and not the Employees of other Employers.

(8) The Trust Agreement provided rules under which an Employee's benefits would be reduced in the event of a shortfall in his Employer's account, without subsidy from the Trust as a whole.

(9) The Plan did not pool all claim risks within the Trust.

The Court has furnished a roadmap of what to do in order to qualify a plan as a multi-employer plan under §419A(f)(6), and how to avoid having a plan characterized as an experience-rated arrangement. The issues of deferred compensation characterization and the interpretation of the ability of the employer to terminate participation in the plan have been resolved in favor of the taxpayer. The issue of penalties appears to have been put to rest. The principal teaching of the case is that all assets must be available to satisfy the claims of all employees of all employers. Any partitioning of assets based upon the source of contribution from any specific employer must be forbidden. Of course, severance benefits should be avoided, so as to permit compliance with the law as set forth in the Booth case.

VII. IRS PRIVATE LETTER RULINGS (all relating to VEBAs)

1. 1991 - Private Letter Ruling - 9115035

Corporation created a tax-exempt VEBA in 1985. In 1986, corporation decided to stop funding the VEBA directly and to pay claim reimbursements and administrative fees directly to the administrator. No reserve fund was set up.

In 1989, corporation formed a new tax-exempt trust, and terminated the prior VEBA. Corporation proposed to transfer prior VEBA's cash to the new trust, to provide §501(c)(9) benefits to participants and to pay administrative fees. Participants of the VEBA are participants under the trust. Any termination surplus of the trust may be used only to provide benefits to participants or their dependents.

IRS ruled that transfer of VEBA's assets to the trust did not adversely affect trust's exempt status under §501(c)(9) or the exempt status of the VEBA. No prohibited inurement has occurred; no impermissible benefits will be provided. Transfer will not result in realization or recognition of gross income to the corporation. Finally, transfer will not subject the corporation to the 100% excise tax under §4976.

2. 1994 - Private Letter Ruling - 9401033

Corporation entered into a collectively bargained agreement to provide SUB (supplemental unemployment benefits) to its employees, in 1973. Trust was created, and was ruled exempt by IRS under §501(c)(17).

In 1989, corporation amended the agreement to provide other benefits. IRS ruled that the trust was an exempt VEBA, but would not rule that the trust's proposed benefit was a permitted severance benefit for purposes of §501(c)(9).

In 1992, corporation decided the VEBA would no longer be funded, VEBA would terminate, and all assets would be distributed to all participating employees on a pro rata basis in proportion to their respective account balances on the termination date.

IRS ruled that account limits prescribed in §419A(c) do not apply to the VEBA. Since the VEBA is a §501(c)(17) exempt trust, it is also a fund under §419(e)(3)(A). Therefore, it is a welfare benefit fund under §419(e)(1), since the fund provides SUB to its employees. All funds contributed for this purpose constitute a qualified asset account. Also, set-aside limitations of §512(a)(3)(E)(i) do not apply to the fund. Further, the distribution will not constitute inurement under §501(c)(9). Finally, the fund will not provide any disqualified benefit resulting from pro rata distribution because fund will not participate nor receive any portion of the funds assets.

3. 1994 - Private Letter Ruling - 9406008

The IRS ruled that the transfer of group term life insurance policies and amounts held in the retirement funding accounts for the benefit of retired employees did not result in taxable transactions.

IRS held that such a transfer does not result in the recognition of gross income or gain to participants or their beneficiaries. Nor would the corporation realize gross income or gain. Nor would the transfer be considered a reversion subject to the 100% excise tax under §4976. This is because the transfer does not give participants access to any portion of the assets transferred, nor do they have dominion over the assets.

Additionally, participants have no active participation in the execution of the transfers, and no part of the transferred assets are to be paid directly or constructively to them. Rather, the contracts are earmarked solely to provide group-term life insurance benefits to the participants.

This ruling applies to term insurance. However, under G.C.M. 39440, whole-life policies are treated similar to term insurance, provided they meet the requirements set forth in that G.C.M.

4. 1994 - Private Letter Ruling - 9414011

VEBA proposed to transfer all its assets to another VEBA. The surviving VEBA would hold all assets of the prior VEBA to be used to provide permissible benefits under §501(c)(9) to eligible employees of the employer. The surviving VEBA's trust agreement permits the employer to terminate the VEBA, provided that any trust funds remaining after payment of all claims be applied to provide various insurance benefits to employees.

IRS ruled that transfer of assets from one VEBA to another VEBA will not cause either VEBA to cease to be recognized as exempt under §501(c)(9), and will not result in the realization of or recognition of gross income to the employer. IRS further ruled that the employer is not liable for excise tax under §4976 as a result of the transfer.

5. 1994 - Private Letter Ruling - 9438017

A number of funds are exempt as VEBAs under §501(c)(9), and provide health benefits to employees. In order to streamline and improve the administration of benefits, reduce administrative costs, and have a uniform benefit policy for all employees, the funds will be merged into a master fund that is also an exempt VEBA.

IRS ruled that the merger of funds will not adversely affect the §501(c)(9) tax-exempt status of the merging funds or the master funds. Also, the transfer of assets to the master fund will not be subject to the §4976 excise tax.

6. 1994 - Private Letter Ruling - 9446036

An exempt business league created a VEBA for its employees. Purpose of the VEBA was to provide employees of the members of the league with medical, dental, sickness, disability, and life insurance benefits.

VEBA was inactive from 1989 to 1994, but it plans to reactivate by using up its remaining assets to provide benefits to the current employees. The assets will be used to purchase insurance policies that will provide accidental and disability benefits as well as long-term care benefits. When the assets are exhausted, the VEBA will terminate.

IRS ruled that the benefits of the VEBA are permissible benefits under §501(c)(9). The proposed use of the VEBA's assets will not adversely affect its exempt status. The transaction will not result in the realization of gross income to the league or its members. IRS further ruled that the league members will not be liable for excise tax under §4976.

7. 1995 - Private Letter Ruling - 9505019

A VEBA, qualified as tax-exempt under §501(c)(9) plans to create 2 new VEBAs, one for union employees and another for nonunion workers. Existing VEBA will provide the initial funding for both new VEBAs by transferring assets to them. All the existing VEBA's liabilities will be assumed by the two new VEBAs.

After the transfer and assumption, the existing VEBA will terminate. Benefits the existing VEBA currently provided to a group of employees will continue to be provided by the new VEBAs.

IRS ruled that the transfer of assets to the 2 new VEBAs will not adversely affect the exempt status of any of the VEBAs. The transfer will not result in any taxable income to the existing VEBA or the two new ones. The transfer and assumption of liabilities will not result in any taxable income to the employer and will not subject the employer to §4976 excise tax.

VIII. GENERAL COUNSEL MEMORANDA (G.C.M.)(all relating to VEBAs)

1. 1983 - General Counsel Memorandum - G.C.M. 39052

The transfer of assets from one VEBA to another is permissible, without jeopardizing the exempt status of either VEBA, so long as otherwise applicable provisions relating to each of the VEBAs have been satisfied.

The transfer of assets by one §501(c)(9) trust to another will not result in inurement of net earnings to the benefit of any private shareholder or individual in this case. No trust assets would revert to any of the participating employers. The benefits will not result in prohibited inurement when such payments are pursuant to objective and nondiscriminatory standards, under Regulations §1.501(c)(9)-4(b).

IRS ruled that the transfer of funds will not affect the exempt status under §501(c)(9) of either VEBA. IRS provided the following guidelines, which if met will prevent prohibited inurement from occurring:

(1) Both trusts are exempt under §501(c)(9),

(2) The transferred assets will be used to provide permissible benefits,

(3) The participants of each trust share an employment-related bond, and

(4) The transfer is not used to avoid the applicable requirements of §501(c)(9) and the regulations thereunder that otherwise would apply to each VEBA.

2. 1985 - General Counsel Memorandum - G.C.M. 39440

Generally, only term life insurance under §79 is permitted in a VEBA, qualifying as a "life" benefit. The IRS ruled that employer-funded whole-life policies not subject to §79 can be used to fund benefits of VEBAs if the whole-life benefits meet three guidelines:

(1) the policies must be owned by the VEBA; and

(2) the policies are purchased through level premiums over the expected lives or working lives of the individual member; and

(3) the accumulated cash reserves accrue to the VEBA.

IRS ruled that so long as the policies meet these guidelines, the use of such policies to fund VEBA benefits is not necessarily inconsistent with the regulations under §501(c)(9).

But a VEBA will not qualify if the employer or the employer's committee (as opposed to the members of the organization) designates the beneficiaries. A VEBA will qualify if the life benefits provided are offset by the pre-retirement death benefit described in this case.

3. 1988 - General Counsel Memorandum - G.C.M. 39774

The transfer of the excess assets of a VEBA attributable to employer contributions to another VEBA for the continued provision of employee medical benefits does not constitute a reversion to the benefit of the employer under §4976(b)(1)(C).

Because the assets are to be transferred directly from VEBA #1 to VEBA #2, there is no other reason to view the transfer as a reversion for purposes of §4976. The 1984 Act (DEFRA) explains in the Bluebook that "If an amount is paid by a fund to another fund for the purpose of providing welfare benefits to employees of the employer, then the payment is not to be considered a reversion.

4. 1990 - General Counsel Memorandum - G.C.M. - 39818

VEBA benefits did not favor owner-employees of small, closely-held companies where benefits were determined on the basis of a percentage of compensation and the plan occasionally imposed a length of service restriction. However, the IRS cautioned that a VEBA that does not provide for the common welfare of all employees may be disqualified from tax-favored status and forced to distribute its assets on a taxable basis. Here, the trust violated the inurement proscription of §501(c)(9) because a dominant share of aggregate benefits is allocated to the owner-employee who maintains effective control over the trust. Therefore, the trust does not qualify for exemption as a VEBA under §501(c)(9).

Each of the organizations is composed of a small number of employees, and each provides a dominant share of aggregate benefits to a single highly compensated owner-employee. A uniform percentage of compensation is a permissible restriction on eligibility for such benefits even if applied to a small membership group composed of employees receiving widely disparate levels of compensation. A length of service requirement may constitute a permissible restriction on eligibility for severance benefits if it does not have the effect of allowing disproportionate benefits to be provided to members of the prohibited group.

IX. IRS CURRENT POSITION ON WBPs

1. IRS Notice 95-34 - May 18, 1995

The IRS has called attention to significant tax problems that may be raised by multi-employer welfare benefit funds that are abusive, and not in compliance with the rules under §419A(f)(6). This Notice was directed at promoters that rely on the 10-or-more employer exemption, and that provide life insurance, disability and severance plan benefits.

The IRS cautions that such arrangements will not satisfy the requirements of the §419A(f)(6) exemption from the limitations of §419 and §419A, and will not support the tax deductions claimed by their promoters, if they violate any of the following four principles:

(1) the plan may not provide deferred compensation;

(2) the plan may not consist of separate plans maintained for each employer, by maintaining separate accounting of the assets attributable to each subscribing employer;

(3) the plan may not be experience-rated with respect to individual employers in form or operation; and

(4) the contributions may represent prepaid expenses that are nondeductible.

The Notice appears to be a warning shot by the IRS, to caution employers against joining WBPs that are abusive and not properly structured. If the promoter of a properly structured WBP gives credence to the issues outlined in the Notice, and does not violate the four points in the Notice, then the WBP will still qualify for the tax treatment afforded by the Internal Revenue Code, and specifically the DEFRA provisions.

The response to these principles, to be observed by responsible WBP sponsors, is as follows:

(1) Deferred Compensation. The Notice refers to Wellons v. Commissioner, a case where the Court held that a severance pay plan was actually deferred compensation. In that case, the severance benefit was dependent upon the member's compensation as well as number of years of service with the corporation. Both the Tax Court and the 7th Circuit described the plan as being similar to a pension plan, in that the right to receive benefits vested after a certain term of employment, the extent of benefits was related to years of service, and the receipt of benefits would not begin until after termination of employment.

In a properly designed WBP, there is no vesting, no requirement of years of service for payout, and no payment of benefits upon termination of employment. Where the employer maintains a "death benefit only" program, the employee must die in order for his beneficiary to receive any benefit. These features clearly distinguish a properly designed WBP from the Wellons situation.

There are two other distinctions between Wellons and a properly structured WBP. First, Wellons was decided under the law in effect prior to DEFRA (1984), so that the entire body of Private Letter Rulings, G.C.M.s and cases under §419A(f)(6) were not applicable. See 64 TCM 1501, footnote 3, indicating that all contributions were made by the corporation prior to the effective date of DEFRA, December 31, 1985. Secondly, it is not clear whether Wellons had a favorable IRS determination letter under §501(c)(9). See 64 TCM 1499, footnote 1, indicating that the exempt status of the plan was not before the Court. Where a WBP program is covered by DEFRA, in particular §419A(f)(6), authorizing 10-or-more employer plans, whether or not the WBP has a favorable IRS §501(c)(9) determination letter, the deferred compensation issue raised by the Court in Wellons should not present any problem to the sponsor or any of the subscribing employers.

(2) Separate Accounting. The properly designed WBP trust should not provide for separate accounting of the assets attributable to the contributions made by each subscribing employer, except for those records required by law to be maintained. In order for a sponsoring organization and the plan administrator to be able to file required Forms 5500 with the IRS, there must be a record of the contributions made by each employer. This type of record-keeping is specifically allowed by Reg. §1.414(1)-1(b)(1), which mandates the type of separate accounting that can and must be maintained in a pension plan. Since there are no regulations regarding the separate accounting issue in a WBP, compliance with the pension regulation should suffice for these purposes, so long as the fundamental requirement is met that all assets must be available to meet the claims of all employers.

A properly structured WBP does not permit separate allocations of contributions to accounts of employees of any participant's employer, a prohibition mentioned in the Notice. Also, in a conservatively designed WBP, there are no severance and disability benefits that could be subject to reduction if assets derived from an employer's contributions are insufficient to fund all promised benefits. Therefore, a WBP that intends to qualify for tax benefits allowed by the Code should not possess these riskier features.

(3) Experience Rating. A properly designed WBP will not possess any experience-rating features with respect to individual employers either in form or operation. This is because all trust assets are available to all participants, regardless of the identity of their respective employers. No formal or informal separate accounting will be maintained for each employer, other than as required by law, as set forth above.

There should be no expectation on the part of employers that their contributions will benefit only their own employees. The employer contributions should not be related to the claims experience of its employees, either formally or informally, and there should be no insulation of the employer from the experience of other subscribing employers. The payment of a death benefit to a participant of a particular subscribing employer should have no effect on the contributions of that employer.

The adherence to the above provisions should insure that there is no experience rating, contrary to the caution set forth in the Notice.

(4) Prepaid Expenses. There is absolutely no authority for the position in the Notice that employer contributions may represent prepaid expenses that are nondeductible under "other sections of the code". On the contrary, there is specific and cogent authority in the Tax Court in the Moser case and the Schneider case, which both specifically ruled on the issue of prepaid expenses.

In Moser, the Court allowed a $200,000 deduction, which the Court stated was the entire prefunding of the VEBA obligation, which consisted of the total severance benefits for the corporation's employees. The taxpayer testified that banks generally like to receive total prefunding, and that is why the contribution was made. Additionally, the corporation was concerned that it might not have the financial wherewithal later to fund the plan annually in an industry in which there was a chance that there would be a downward turn.

In response to argument by the IRS that no deduction should be allowed in excess of an actuarially determined annual contribution amount, and that this represented prepaid expense, the Court disregarded the IRS position and allowed the entire expense. The reason that the Court found that there was no prepaid expense is that under the terms of the VEBA, no amendment could be made to allow any part of the VEBA assets to revert to the corporation, or to be used or diverted for any purposes other than the exclusive benefit of the members. The Court specifically held that there is no authority that requires contributions to a VEBA to be based on actuarial calculations.

In Schneider, the Tax Court ruled on contributions in a 3-year period of $405,000, $378,000 and $367,000, in the years 1983, 1984, and 1985. In allowing the entire contribution for all 3 years, the Tax Court again struck down the IRS argument that there were prepaid expenses represented by the payments into the trust. The Court found that there was no possibility of reversion to the corporation, and therefore no prepaid expense. The Court cited with favor Moser for the principle that the prohibition of reversion of any funds to the employer negated the capital asset argument. The Court further held that the payments were not held to constitute prepayments for future expenses, since at the time of payment there was no way of knowing when the need would arise.

Therefore, based upon these two Tax Court cases, as well as the failure of the IRS to cite any authority in the Code for the principle of prepaid expenses, it appears that this argument is at best an empty threat by the IRS.

In conclusion, although the Notice must be given respect by any responsible WBP sponsor or promoter, it appears that it is entirely possible to structure a WBP which is non-abusive, and meets all the criteria set forth in the four issues enunciated by the IRS as prescribed features.

X. LIFE INSURANCE FUNDING BY "DEATH-BENEFIT-ONLY" WBP

In order to maintain a death benefit only WBP, the only funding vehicle available is life insurance. There are several important reasons why this principle must be observed.

First, the use of life insurance contracts as the funding medium eliminates any issues of experience rating, separate accounting and the like, since by definition it is unlikely that there will be any invasion of assets. Keeping in mind the goals of the WBP program, this investment makes the most sense. If investments other than life insurance were utilized, the problem of risk sharing would create huge administrative difficulties. The need to collect from employers certain levels of funding might possibly be considered experience-rating, which is prohibited under the Code. The use of insurance contracts assures the participating employers of the ability for the plan to perform as designed, by insuring that the benefits for each employer have been appropriately funded.

The use of other funding media, such as annuities, mutual funds or other securities investments, can cause potential IRS problems. Since the WBP, by reason of IRS regulations and other pronouncements, cannot be a deferred compensation plan, qualified retirement plan or annuity, then the use of life insurance for funding takes the WBP as far away from these prescribed investments as possible.

By using life insurance as the sole funding medium, the issue of state regulation of a WBP or a multiple employer welfare arrangement as an insurance company disappears. There is ample Federal authority holding that so long as welfare benefits are fully insured, there is no possibility that a state can regulate a WBP as an insurance company.

Finally, the use of modern insurance contracts, such as variable life insurance, allows for investment results which are comparable to other types of financial investments.

XI. DISTINCTIONS BETWEEN VEBA AND WBP

1. IRS Determination Letter under §501(c)(9)

A VEBA secures a favorable IRS determination letter, upon submitting IRS Form 1024. Once a favorable determination letter has been received, it will be more difficult for the IRS to attack the plan as deferred compensation or a retirement plan.

A WBP does not request and IRS determination letter, nor is it eligible to obtain such exemption.

2. $150,000 Compensation Limit

A VEBA is subject to the $150,000 compensation limit, for its highly compensated employees.

A WBP has no limit on compensation that can be utilized in computing the multiple of compensation benefit.

3. Common Business and Geographical Restrictions

A VEBA must comply with the employment-rated affiliation rules and the geographic limitation rules (3-state safe harbor).

A WBP can be installed for any type of business located in any geographic area, with no particular relationships.

4. Controlled Group and Affiliated Service Group Limitations

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 WBP must cover only employees of its own business entity, and need not cover controlled groups or affiliated service groups.

XII. CONCLUSION

As made clear by the complexities demonstrated in this outline, the road to a successful WBP is winding and obscure, and the authority relied upon as set forth above should provide a satisfactory roadmap to reach the desired destination. The pitfalls of adopting an "abusive" WBP could produce a disastrous result.

Congress has specifically provided the vehicle for a properly structured multi-employer WBP by the passage of DEFRA in 1984. Although the IRS has had over 14 years of experience, including the issuance of over a dozen private letter rulings and a dozen G.C.M.s, the IRS does not consider this issue to be of sufficient importance to propound regulations under §419A(f)(6). Even the latest missile fired by the IRS in the form of Notice 95-34 has missed its target, as it is only directed at "abusive" WBPs, and allows properly designed WBPs to operate within the law. It is axiomatic in tax law since 1913 that a taxpayer has the right to minimize his tax burden by the use of all tax-planning techniques that are sanctioned in the Internal Revenue Code.

At the present time, there is no pending legislation to adversely affect WBPs. There is a 70-year history in the VEBA area, which permits all of the issues to be dealt with in a sophisticated and favorable manner, so as to minimize the tax risks, and maximize the opportunities for tax advantages.

Finally, the WBP offers a powerful employee benefit that can reward employee loyalty by providing significant financial incentives.

PRUSKY LAW ASSOCIATES, P.C.

620 Two Penn Center Plaza

Philadelphia, PA 19102

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The "W B P" - The

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1998 EDUCATIONAL OUTLINE

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