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Guest EMM118

VEBA maintained by an LLC with no common-law employees

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Guest EMM118

A client expressed an interest in establishing a VEBA to fund certain post-retirement medical expenses. The client maintains an LLC. Husband and wife are the only individuals who provide services to the LLC. There are no common law employees. Is this sufficient to satisfy the requirement that the VEBA's membership consists of individuals having an employment-related common bond?

Any advice you can provide would be greatly appreciated.

Ed

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Hey, Ed,

You might be able to fit the spouse of an LLC owner in as an 'employee' for IRC 105 and 106 purposes, and the LLC owner as him/herself the spouse of the 'employee'. The IRS issued two Coordinated Issue Papers on when a spouse of an owner might be treated as an employee, one on March 29, 1999 and the other on January 25, 2001. If you have difficulty locating these, contact me off board and I'll send you copies.

Of course, you'd want to analyze to see if you could fit in as an 'employee' that way per the definitions under IRC sections 501(a)(9) and 505, and the regs under them.

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I am assuming that the LLC is a disregarded entity for tax purposes (and the owner is a sole proprietor for tax purposes reporting the income and expenses of his business on Schedule C). How, if at all, are the contributions deductible for tax purposes, and if not deductible what is the perceived advantage of going to the trouble of establishing and maintaining a VEBA?

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Hi, jpod,

Take a look at PLR 200549008. If the spouse is an 'employee', then HRA accruals could be contributed to a VEBA, deducted by the LLC, excluded from the income of the spouse/employee and when paid out as benefits in retirement, excluded from the income of the retired employee, spouse and dependents.

Where the OP specified that the owner and spouse are the only two service providers to the LLC, this HRA rate could be set quite high--just as long as the entire compensation package meets section 162 deductibility.

This might be the angle that EMM118 is looking at.

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I always wonder about spousal employment in these cases. Is it worth it to pay compensation to the spouse and have the extra FICA/Medicare tax burden, and perhaps workers comp., unemployment insurance, etc., in order to secure additional retirement plan contributions, or in this case some tax shelter through the VEBA? Maybe, but I think you have to crunch the numbers.

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Regarding jpod's comment about the Schedule C and related tax deductions.

I realize that FOrm 1040 may pose limitations of deductions related to medical expenses (perhaps of the qualified direct cost nature), but could the individual take a medical deduction to fund the post retirement reserve? Maybe have it show up on page 1 of Form 1040 as an expense?

Yes, I suppose if the spopuse is an employee of the LLC (perhaps maybe even earning $0 W-2), then there could be deductions to the LLC to the VEBA.

Thanks.

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A VEBA would only be "necessary" for advance funding of future benefits, but arguably a grantor trust would work as well without the VEBA baggage.

A medical expense reimbursement plan would be sufficient for current expenses.

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Vebaguru your comments make sense, but could the LLC owner recieve the deduction for future medical expenses (i.e. reserves) on his 1040? Assuming he could not receive deduction for himself on the Schedule C.

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1. The owner of an LLC taxed as a partnership can only receive a deduction for current medical expenses on form 1040.

2. If the LLC is taxed as a "C" corporation, he could receive a deduction on his corporate return for contributions to a welfare benefit trust if those contributions are ordinary and necessary business expenses, to the extent that the deductions are permitted under sections 419 and 419A.

3. If the LLC is taxed as a "S" corporation, it is a more difficult question. IRS Publication 535 states:

Welfare benefit funds. A welfare benefit fund is a funded plan (or a funded arrangement having the effect of a plan) that provides welfare benefits to your employees, independent contractors, or their beneficiaries. Welfare benefits are any benefits other than deferred compensation or transfers of restricted property.

Your deduction for contributions to a welfare benefit fund is limited to the fund’s qualified cost for the tax year. If your contributions to the fund are more than its qualified cost, carry the excess over to the next tax year.

Generally the fund’s qualified cost is the total of the following amounts, reduced by the after-tax income of the fund.

  • The cost you would have been able to deduct using the cash method of accounting if you had paid for the benefits directly.
  • The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year. These claims can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits.

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