IRS Notice
95-34
 
Cumulative Bulletin Notice 95-34, , 1995-1 CB 309, May 18,
1995.
Taxpayers
and their representatives have inquired as to
whether certain trust arrangements qualify as
multiple employer welfare benefit funds exempt from
the limits of section 419 and section 419A of the
Internal Revenue Code. The Service is issuing this
Notice to alert taxpayers and their representatives
to some of the significant tax problems that may be
raised by these arrangements.
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
section 419 and section 419A of the Code. Those
sections impose strict limits on the amount of
tax-deductible prefunding permitted for
contributions to a welfare benefit fund.
Section
419A(f)(6) provides an exemption from section 419
and section 419A for certain welfare benefit funds.
In general, for this exemption to apply, an employer
normally cannot contribute more than 10 percent of
the total contributions, and the plan must not be
experience rated with respect to individual
employers. The legislative history states that the
exemption under section 419A(f)(6) is provided
because "the relationship of a participating
employer to [such a] plan often is similar to the
relationship of an insured to an insurer." Even
if the 10 percent contribution limit is satisfied,
the exemption does not apply to a plan that is
experience rated with respect to individual
employers, because the "employer's interest
with respect to such a plan is more similar to the
relationship of an employer to a fund than an
insured to an insurer." H.R. Rep. No. 98-861,
98th Cong., 2d Sess., 1159 (1984-3 C.B. (Vol. 2) 1,
413).
In
recent years a number of promoters have offered
trust arrangements that they claim satisfy the
requirements for the 10-or-more-employer plan
exemption and that are used to provide benefits such
as life insurance, disability, and severance pay
benefits. Promoters of these arrangements claim that
all employer contributions are tax-deductible when
paid, relying on the 10-or-more-employer exemption
from the section 419 limits and on the fact that
they have enrolled at least 10 employers in their
multiple employer trusts.
These
arrangements typically are invested in variable life
or universal life insurance contracts on the lives
of the covered employees, but require large employer
contributions relative to the cost of the amount of
term insurance that would be required to provide the
death benefits under the arrangement. The trust owns
the insurance contracts. The trust administrator may
obtain the cash to pay benefits, other than death
benefits, by such means as cashing in or withdrawing
the cash value of the insurance policies. Although,
in some plans, benefits may appear to be contingent
on the occurrence of unanticipated future events, in
reality, most participants and their beneficiaries
will receive their benefits.
The
trusts often maintain separate accounting of the
assets attributable to the contributions made by
each subscribing employer. Benefits are sometimes
related to the amounts allocated to the employees of
the participant's employer. For example, severance
and disability benefits may be subject to reduction
if the assets derived from an employer's
contributions are insufficient to fund all benefits
promised to that employer's employees. In other
cases, an employer's contributions are related to
the claims experience of its employees. Thus,
pursuant to formal or informal arrangements or
practices, a particular employer's contributions or
its employees' benefits may be determined in a way
that insulates the employer to a significant extent
from the experience of other subscribing employers.
In
general, these arrangements and other similar
arrangements do not satisfy the requirements of the
section 419A(f)(6) exemption and do not provide the
tax deductions claimed by their promoters for any
one of several reasons, including the following:
(1)
The arrangements may actually be providing deferred
compensation. This is an especially important
consideration in arrangements similar to that in Wellons
v. Commissioner, 31 F.3d 569 (7th Cir. 1994), aff'g,
64 T.C.M. (
CCH
) 1498 (1992), where the courts held that an
arrangement purporting to be a severance pay plan
was actually deferred compensation. If the plan is a
nonqualified plan of deferred compensation,
deductions for contributions will be governed by
section 404(a)(5), and contributions to the trust
may, in some cases, be includible in employees'
income under section 402(b). Section 404(a)(5)
provides that contributions to a nonqualified plan
of deferred compensation are deductible when amounts
attributable to the contributions are includible in
the employees' income, and that deductions are
allowed only if separate accounts are maintained for
each employee.
(2)
The arrangements may be, in fact, separate plans
maintained for each employer. As separate plans,
they do not qualify for the 10-or-more-employer plan
exemption in section 419A(f)(6).
(3)
The arrangements may be experience rated with
respect to individual employers in form or
operation. This is because, among other things, the
trust maintains, formally or informally, separate
accounting for each employer and the employers have
reason to expect that, at least for the most part,
their contributions will benefit only their own
employees. Arrangements that are experience rated
with respect to individual employers do not qualify
for the exemption in section 419A(f)(6).
(4)
Even if the arrangements qualify for the exemption
in section 419A(f)(6), employer contributions to the
arrangements may represent prepaid expenses that are
nondeductible under other sections of the Internal
Revenue Code.
Taxpayers
and their representatives should be aware that the
Service has disallowed deductions for contributions
to these arrangements, and is asserting the
positions discussed above in litigation.
Finally,
in response to questions raised by taxpayers and
their representatives, we note that the Service has
never issued a letter ruling approving the
deductibility of contributions to a welfare benefit
fund under section 419A(f)(6). Although a trust used
to provide benefits under an arrangement of the type
discussed in this Notice may have received a
determination letter stating that the trust is
exempt under section 501(c)(9), a letter of this
type does not address the tax deductibility of
contributions to such a trust.
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