Tax Strategies for Health & Welfare Plans: VEBAs and Section 79 Plans

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Table of contents

What is an AMOEBA Plan?

A corporate sponsored, tax deductible employee benefit plan that can be adopted as either a 419A(f)(6) Multiple Employer Health and Welfare Benefit Plan or a Group Life Plan under Section 79.

What is a Multi-Employer Welfare Benefit Plan?

A single plan adopted by 10 or more sponsoring employers. A Welfare Benefit Plan is intended to provide all eligible employees with certain benefits such as medical, disability, and group term life insurance.

A Welfare Benefit Plan is not a pension benefit plan. It is not intended to provide retirement benefits or benefits upon attaining a pre-determined retirement age.

Furthermore, a welfare benefit plan is not a deferred compensation plan. These distinctions are important as special rules, which govern the deduction of contributions to retirement, or deferred compensation plans do not apply to Welfare Benefit Plans.

A Welfare Benefit Plan may be established as either a tax-exempt VEBA Trust under I.R.C. 501(c)(9), or a taxable trust under 419A. The benefits available to employees under a taxable welfare benefit plan generally do not differ from those available under a tax-exempt plan (i.e., a VEBA).

What is a VEBA?

A VEBA is a Voluntary Employees’ Beneficiary Association, a tax-exempt organization that is described in 501(c)(9) of the Internal Revenue Code and may have received a tax-exemption letter from the Internal Revenue Service (IRS).

The plan generally provides for the payment of specific benefits to its members or their dependants or designated beneficiaries. A VEBA is a trust with an independent third party fiduciary as its trustee, usually a bank or trust company. VEBAs have a legislative history that spans almost 70 years.

What is a 419A Plan?

A benefit plan that provides specific benefits through a taxable trust as opposed to a tax-exempt trust. 419A plans are not subject to the same restrictions and limitations as VEBAs. 419A plans have a legislative history that began in 1984 under DEFRA, and has been the subject of further amendments through proposed legislation. 419A plans, like VEBAs, are trusts that use an independent third party trustee, usually a bank or a trust company.

What authority in the Internal Revenue Code permits favorable treatment of these types of plans?

1. 501(c)(9): Enabling legislation goes back to 1928.

2. 419A: Corrective legislation enacted 1984.

3. 419A(f)(6): Subset of above delineating qualification and permissible benefits.

4. Section 79.

What is a Multiple Employer Welfare Benefit Plan?

A Multiple Employer Welfare Benefit Plan is a single master plan (trust) into which a group of at least 10 or more employers make contributions for the purpose of providing qualifying benefits for all eligible employees.

A Multiple Employer Welfare Benefit Plan qualifies for special tax treatment under IRC 419A(f)(6). This section describes the 10 or more employer exceptions as follows:

Statutory Requirements:

  1. No employer regularly contributes more than 10% of total annual contributions to the plan.
  2. No experience rating as to individual employers.
  3. A plan to which more than one employer contributes (i.e. a single plan)
  4. Employees are responsible for taxable income based on PS58 rates.
  5. Must have at least 2 employee participants.

Applicable Benefits:

  1. Medical Benefits
  2. Disability Benefits
  3. Group term life insurance benefits that do not provide directly or indirectly for any cash surrender value or other money that can be paid, assigned, borrowed or pledged as collateral for a loan.

What is a Section 79 Plan?

A corporate sponsored, tax deductible Group Term Life insurance employee benefit plan available to corporations only. In an “S” Corporation, deductible benefits may be limited to a maximum of $50,000.

Is a Welfare Benefit Plan or a Section 79 plan a qualified retirement plan?

No. These plans are not qualified retirement plans. These plans are not subject to the rules of IRC 401, which is the governing authority for retirement plans, because it does not fit the definition of a retirement program.

These plans will not file a request for an individual employer determination letter with the IRS under that section, because it is not a retirement plan but rather is a plan that provides current health and welfare benefits. It is therefore not subject to the restrictive rules under which retirement plans must operate.

For example, Welfare Benefit Plan distributions are not subject to the rules for premature withdrawal penalties (prior to age 59 1/2) nor are they subject to the minimum distribution rules for deferred withdrawals (beginning at age 70 1/2). In addition, a Welfare Benefit Plan is not subject to the contribution limitations of IRC 415.

Is a Welfare Benefit Plan or Section 79 plan a non-qualified deferred compensation plan?

No. A Welfare Benefit Plan is not a deferred compensation plan. A Welfare Benefit Plan is not set up to pay benefits at a specific time or date. Nor does it only provide discriminatory benefits for highly compensated or key employees.

A Welfare Benefit Plan is a plan that benefits all eligible participants. Current contributions made by the employer are tax deductible under IRC 162.

This differs substantially from a non-qualified deferred compensation plan, which are usually set up only for highly compensated key employees, under which the employer gets no current tax deduction, but gets a deduction when the funds are actually paid out to the key employee.

Is a Welfare Benefit Plan subject to ERISA compliance?

Yes. A Welfare Benefit Plan that receives employer contributions is subject to Title I of ERISA(the Employee Retirement Income Security Act of 1974). 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.

In addition, the employer must file annual IRS Form 5500. The trustee of the Welfare Benefit Plan is subject to all of the fiduciary, disclosure and reporting rules of ERISA(990) form.

What benefits can be provided through these plans?

These plans can provide group term life insurance benefits, which do not provide directly or indirectly for any cash surrender value or other money that can be paid, assigned, borrowed or pledged as collateral for a loan. Welfare Benefit Plans may also provide medical and disability. Neither plan can provide retirement, severance, savings plan, malpractice and property casualty insurance benefits.

What are the general tax advantages of these plans?

The sponsoring entity is allowed a current year’s tax deduction for current year’s contributions to the plan. Individual employees generally pay no income tax on amounts contributed on their behalf except to the extent of economic gain measured by PS58 rates or insurance carrier alternative rates for death benefits (usually an insignificant amount) in a Welfare Benefit Plan, and table I rates in a Section 79 plan.

How do these plans operate?

Generally, the plan works as follows:

  1. The employer consents to become party to a trust.
  2. The employer adopts benefits under the plan.
  3. The employer makes contributions to the plan to fund these benefits.
  4. The employer takes an income tax deduction equal to its annual contribution.
  5. The trustee of the plan secures contracts (i.e. life, health, and disability insurance) on each participating employee. These contracts are used to insure the plan’s obligations to the participants and their beneficiaries. The contributions to the plan are beyond the reach of the sponsoring employer and its creditors.
  6. The employer provides the Contract Administrator with initial and annually updated employee census data. The Contract Administrator provides full plan administrative support, all employee benefit statements, and all other forms and reports.
  7. The trustee holds all plan contracts and provides periodic reports to the Contact Administrator.

What type of businesses can participate in a Welfare Benefit Plan?

Any type of business entity (C Corp, S Corp. Partnerships, LLC, LLP, P.A., P.C.) that is generally profitable, whose employees have earned income (wages) and has at least two eligible employees (including owner employees) that participate. In the case of a IRC 419A plan it is advisable for the business owner to incorporate.

What type of business can participate in a Section 79 Plan?

Generally, only a corporation can derive any benefit from participation in this plan.

Who may participate in these plans?

All employees of the sponsoring employer may be eligible to participate on a voluntary basis.

What maximum eligibility requirements may a sponsoring employer establish in these plans?

Employees in the following categories may be excluded from participation:

  • Any employee with less than (1) years of service
  • Any employee under the age of 21
  • Any part time (1,000 hours of service) or seasonal employee
  • Union members

Can benefits be discriminatory?

No. Benefits must be uniform and proportionate among all employees of a sponsoring employer.

Are their limits on annual contributions by an employer to a plan?

Generally speaking, there are no limits, so long as “income replacement” type benefits, like life and disability, bear a uniform relationship to compensation for all participants. Deductions are permitted if they are “ordinary and necessary.” (sec. IRC 162)

Since plan benefits also bear some resemblance to compensation, the amount of benefits, and the cost of the benefits must be considered, along with all other compensation received by an employee, and the total must be “reasonable”.

The United States Tax Court has permitted the following annual deduction amounts for single employer Welfare Benefit Plans: 1983 – $405,151; 1984 – $367,683. (see Schneider vs. Commissioner).

When must contributions be made?

Contributions must be made no later than the last day of the sponsoring employer’s fiscal year (usually the end of the calendar year).

Are contributions required for a fixed period of time?

Yes. Generally, contributions are intended to fund benefits during the employees normal working lifetime or until an employee terminates employment.

What if an employer needs to modify or cease making contributions to the plan?

If modification of contributions are needed, the plan can be amended. Of course, a decrease in contributions would result in a decrease in plan benefits. An increase in contributions would require an increase in plan benefits, and would be subject to underwriting requirements. Adjustments based upon changes of modal factors may or may not change plan benefits.

What happens to an employee’s benefit when employment terminates?

When employment terminates, an employee has an option to convert up to the full benefit that is in force at the time of the termination. The conversion is made to an individually owned personal policy. If death occurs within the 30 days after termination the full benefit will be paid.

What are an employee’s options on conversion?

On conversion, the employee may elect a face amount up to, but not exceeding, the group term life insurance amount that was in force. The converted policy is a personally owned, permanent life contract requiring premiums to be paid by the policy owner.

Are employer contributions to a plan subject to Social Security, Federal Unemployment or Withholding Taxes?

No, employer contributions for Welfare Benefit and Section 79 plan benefits would not be considered “wages” for those purposes.

What are the tax effects of benefits when received under the plan?

Benefits payable on the death of a participant are exempt from income under IRC 101(a). Benefits provided through a Welfare Benefit Plan have no cash value. Therefore, upon termination of employment, the policies providing these benefits can be taken over and maintained individually with no tax consequences.

Can plan benefits be continued after retirement?

No. Welfare Benefit Plans can provide benefits only during the course of employment.

How safe are these plans against claims of creditors of the employer or the participants?

The employer has no ownership interest in the plan benefits, and under the terms of the plan the employer has no right to have any of the contributions revert back to the employer. Therefore, the contributions and benefits of the plan are not subject to the employer’s creditors.

Similarly, the participants have no current ownership interest in the contributions and benefits in the hands of the plan trustee, which is an independent trustee not under control of the participants. Therefore, the plan will not be subject to claims of creditors of any of the parties to the plan.

Furthermore, since proposed funding instruments have no “cash value” element during employment, there is no attachable “asset” under any circumstances.

Can an employer maintain both a Welfare Benefit Plan, or Section 79 and a qualified retirement plan?

Yes, because each accomplishes its own separate purpose. One is providing life benefits, whereas the other is aimed at providing retirement benefits. A welfare benefit plan should not be considered a replacement for a qualified retirement plan, but rather as a separate plan to accomplish another goal.

Are benefits provided through these plans vested?

Employees are not “vested” with respect to benefits. Plan benefits never vest until an event triggers the payment of a benefit (e.g. death).

Are leased employees or employees of affiliated companies or those part of a controlled group of companies eligible to participate in a Welfare Benefit Plan?

Yes, the same rules that apply to ERISA plans also apply to VEBAs and Section 79 plans, although these rules are generally not regarded as being applicable to IRC 419A Plans. However, it would still be advisable to adhere to these rules in an IRC 419A Plan.

What is group term life insurance?

Group term life insurance is a term life insurance policy issued under a master group contract by an insurance carrier to an employer or trust (e.g. a Welfare Benefit Plan or Section 79 plan) for the purpose of providing life benefits to the participants. This group insurance also provides all eligible participants the right to convert the coverage to an individually owned personal policy after the participant has ended his/her employment.

Is the right to convert to an individual contract guaranteed?

Yes. State law mandates that all participants under the group insurance contract have the right to convert to an individually owned personal policy.

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