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:: New Vehicle Dealership Audit Technique Guide 2004 - Chapter
13 - Voluntary Employees' Benefit Associations (12-2004)
Chapter 13 -
Table of Contents
In
the 1980’s, the tax treatment of
contributions to funded welfare
benefit plans changed with the
enactment of IRC sections 419
and 419A. This change is
important since larger
automobile dealerships tend to
use such funding to purchase
vehicles. If a dealership has an
employee welfare benefit plan
that is funded through either a
Voluntary Employees’ Beneficiary
Association (VEBA) trust or a
taxable trust, you will want to
verify that payments to the
trust comply with the rules of
sections 419 and 419A, as well
as certain other sections.
This chapter is included in this
Guide for agent awareness only.
In 1993, the former Industry
Specialization Program created
an Issue Specialist position for
audit issues involving sections
419 and 419A and VEBAs. As a
result of the reorganization,
ISP’s were placed in the
Pre-Filing and Technical
Guidance section of the Large
and Mid-Size Business division.
The ISP position was renamed to
that of “Technical Advisor.”
What
is a VEBA?
VEBA is an acronym for
"voluntary employees'
beneficiary association." They
are trusts that are exempt from
tax under the provisions of IRC
section 501(c)(9). A VEBA is a
"welfare benefit fund" to which
sections 419 and 419A will apply
if it is part of a plan of an
employer through which the
employer provides welfare
benefits to employees and their
beneficiaries. While welfare
benefit funds can also be
taxable trusts, most welfare
benefit funds apply for exempt
status as VEBAs in order to
reduce or eliminate income taxes
at the trust level. VEBA’s file
Form 990, whereas taxable trusts
file Form 1041.
A "welfare
benefit" is an employee benefit
other than those to which IRC
sections 83(h), 404, and 404A
apply. The most common types of
welfare benefits are medical,
dental, disability, severance
and life insurance benefits. It
is important to remember that an
examination of an employer’s
deduction for its contribution
to a welfare benefit fund is not
an examination of the trust
itself. The actual examination
of a VEBA trust itself must be
handled by an agent from the Tax
Exempt and Government Entities
division.
What do I need to do?
In order to determine if there
are potential examination issues
in this area, first ask the
taxpayer (or their
representative) about (1) the
nature of the employee benefit
plan, (2) the types of benefits
provided, (3) whether the
benefits are paid through a
welfare benefit trust, (4)
whether the plan or the benefits
provided under the plan purport
to be the subject of a
collective bargaining agreement
and (5) whether the trust
purports to be a 10-or-more
employer plan. Experience has
shown that the proper
examination of issues involving
sections 419 and 419A is very
fact intensive and involves
extensive legal and actuarial
analysis. Case development
generally involves the issuance
of third-party summonses to
obtain relevant information.
If
there are potential audit issues
in your case, you should obtain
copies of all documents relating
to the creation or adoption of
the plan and trust. This should
include copies of all
promotional material (including
any cost-benefit proposals and
legal opinions) and details on
all contributions made to the
fund and payments made from the
fund. If the plan involves
benefits that are provided
through either individual or
group insurance products, obtain
copies of the policies and/or
certificates of insurance and
details on all premiums paid and
policy values. You should also
obtain a listing of the
participants in the plan and the
type and amount of benefits
being provided to each
participant. Secure copies of
the Forms 5500 filed by the plan
and the Forms 990 or Forms 1041
filed by the trust. You should
also determine the names and
addresses of all third parties
involved in the plan (e.g.,
benefit consultants/ promoters,
insurance salespersons,
trustees, insurance companies,
etc.).
Audit
Potential
There are many closely-held
businesses claiming deductions
for contributions to welfare
benefit funds that claim to be
exempted from the deduction
limitations of sections 419 and
419A because they meet the
requirements of sections
419A(f)(5) (for separate funds
under collective bargaining
agreements) or 419A(f)(6) (for
10-or-more employer plans). In
1995, the Service issued Notice
95-34 warning taxpayers about
potential problems with promoter
claims regarding 10-or-more
employer plans. In 2000, the
Service issued Notice 2000-15
classifying such arrangements as
abusive corporate tax shelters.
Treasury issued Proposed
Regulations covering 10-or-more
employer plans on July 11, 2002.
The most recent Tax Court case
involving such plans,
Neonatology Associates, P.A., et
al., v. Commissioner, 115 T.C 43
(2000) aff’d 299 F. 3d 221 (3rd
Cir. 2002), found that the
majority of the contributions to
one such plan were actually
constructive dividends and thus
nondeductible to the corporation
and currently includible in the
shareholder’s income. The Court
upheld the Service’s imposition
of penalties on both the
corporate and individual
entities.
Since promoters of these
arrangements tend to promise
business owners current
deductions for benefits to be
received in the future, we
expect that the popularity of
these products will increase if
Congress enacts tax legislation
prospectively reducing the
individual federal income tax
rates. For more information on
the types of plans being
marketed, you can go to any
Internet search engine and
search under the terms: “welfare
benefit funds,” “VEBA,” “Section
419A(f)(6)” or “Section
419A(f)(5).”
Technicalities
In general, sections 419 and
419A limit an employer’s
deduction for contributions to a
welfare benefit fund to the
amount of the benefits actually
paid during the year by the fund
(determined using the cash-basis
method of accounting) plus a
limited allowance for reserves
for incurred but unpaid claims
and post-retirement medical and
life insurance benefits. Section
419A(c)(1) allows a limited
reserve for incurred but unpaid
claims for disability, medical,
SUB or severance pay and life
insurance benefits.
If
the fund qualifies as a separate
fund under a collective
bargaining agreement, in
general, section 419A(f)(5)
provides that there is no
“account limit” for such
reserves. Section 419A(f)(6)
provides, in general, that the
deduction limitations under
sections 419 and 419A do not
apply if the fund qualifies as a
10-or-more employer plan. In
order to qualify, the plan must
not maintain “experience-rating
arrangements” with respect to
individual employers, nor can
any employer normally contribute
more than 10% of the total
contributions made by all
employers.
Sections 419 and 419A are not
applicable if the benefits
provided by the plan are
determined to be deferred
compensation. In these
situations IRC section 404
controls. In general, section
404(a)(5) provides that an
employer’s deduction takes place
in the year in which the amount
attributable to the contribution
is includible in the employees’
gross income. However, if more
than one employee participates
in the plan, an employer can
only take a deduction if
separate accounts are maintained
for each employee.
In
all situations, sections 419 and
419A comes into play only if the
contributions to the fund are
otherwise deductible under the
Code. For example, if the
contribution was determined to
be a constructive dividend, and
thus not otherwise deductible,
then sections 419 and 419A would
not be applicable. (See, e.g,
Neonatology Associates, supra.)
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