An employer established a presumed VEBA three years ago. At the time, I had not read the IRS Memo on Processing VEBA exemption applications and was unaware of the increased review on these smaller VEBA's. The employer made three annual contributions of $100,000. Amounts were invested in mutual funds that are now valued at $250,000. After more than two years, the IRS has indicated that an exemption letter will not be issued. All participants are owner-employees and their parents (HCEs through stock attribution rules). We can challenge the initial ruling or withdraw the exemption application.

If we withdraw application, can we take the $250,000 and put into an insurance product with no tax conseqiences? Amounts will be held in a non-VEBA trust. Are there also no current adverse tax consequences since assets have decreased in value?

Any thoughts on this matter would be greatly appreciated.

Thanks. Ed

I'm no expert, but if the IRS won't issue tax exemption letter then your run up from $100k to $250k during the earlier years would need to be reported as income. Those earlier years would have positive income, and more recent would have negative.

A VEBA is only a VEBA when it has been approved by the IRS. See IRC section 505. Short of that it is likely a taxable grantor welfare benefits trust.
Contributions to VEBAs are not inherently tax deductible, and contributions to welfare benefits trusts are not inherently non-deductible. The rules relative to tax deductions are found in IRC section 419 and 419A.
The only advantages to being a VEBA are: (i) The trust is "tax-exempt" and (ii) The IRS has reviewed and approved the trust. However, the tax-exemption is not worth much because medical accumulations are subject to UBIT in any event. And other benefits are generally disposed of during the current plan year. The benefit of being tax-exempt is illusory.
For all plan years you should be filing IRS form 1041 for the trust. Losses on investments will not be taxed in any event.
All welfare benefit plans are subject to nondiscrimination rules. cf, IRC section 79, section 105, section 505, section 414, etc.
You mention life insurance and this brings up additional issues. Review IRS Notice 2007-83 and 84 along with Rev Rul 2007-65 for guidance that may apply to such arrangements. Generally, life insurance plans for owners are not tax-deductible as provided in IRC section 264.