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990 Requirements for VEBA

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Guest s_ben

Hello. I am new to VEBA's so if you can please bear with me...

1. Are there different codes to exclude the interest income, dividend income, gains/(losses) but the income is still not taxable - it doens't seem like it is excluded under Section 512? VEBA's do not have to pay tax on this do they? If they do, how do they report it?

2. You are supposed to report the information from all of the plans, correct - so each 5500 that is filed?

Thank you very much!

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Are there different codes to exclude the interest income, dividend income, gains/(losses)

Take a look at exclusion codes 25, 26, and 27.

The usual passive income exclusion codes (14-18) refer to specific provisions of I.R.C. Sec. 512(b). Althought most types of exempt organizations use these codes to exclude their passive income from federal taxation, Sec. 512(b) doesn't apply to a VEBA. Thus, those very familiar codes should never appear on a VEBA's Form 990.

You are supposed to report the information from all of the plans, correct - so each 5500 that is filed?

A plan files Form 5500; an exempt organization files Form 990. A VEBA is a trust (or, occasionally, a corporation) that's tax-exempt within the meaning of I.R.C. Sec. 501©(9). Form 990 reports the information for the exempt organization that's filing the return.

VEBA's do not have to pay tax on this do they?

Maybe, maybe not. VEBA's are subject to special rules. In general, a VEBA's unrelated business taxable income is any net income other than exempt function income (fees and contributions for providing benefits). But, there are numerous variations and exceptions to this general rule. The complex answer begins with I.R.C. Sec. 419A, and it's beyond the scope of this discussion.

If they do, how do they report it?

Form 990-T, Schedule G. You might find it helpful to read page 22 of the 2007 Form 990-T instructions.

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Insurance policies provide two types of tax-exempt income: tax-free inside buildup of cash value and death proceeds of life insurance. Inside buildup is never going to be taxable to the VEBA because it is unrealized. And if the insurance policy is surrendered the gain is realized and taxed.

Death proceeds of life insurance is a different issue. If the death proceeds are paid to a named beneficiary, as contemplated under 501©(9), there is no income at all to the trust: the income is paid to the beneficiary tax-free. If the death benefits are paid to the VEBA as a "conduit" for passing through to the named beneficiary, the treatment is likely the same: tax-exempt to the beneficiary, no net income to the VEBA.

If the VEBA owns a "key-person" policy and that person dies, the death proceeds are not excluded from the VEBA's income under IRC section 101(a). However, since the VEBA is a tax-exempt entity, the death proceeds would still only be taxed if the income was unrelated business taxable income. UBTI includes plan earnings on medical accounts. (Since medical amounts are tax deductible to the employer upon contribution and distributed tax-free to the participant, they are accorded a double tax benefit and are therefore not permitted to accumulate tax-free inside a VEBA.) So the determination of whether the income may be taxable is made based on what the accumulation is attributed to.

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vebaguru wrote "if the insurance policy is surrendered the gain is realized and taxed."

I agree with that statement.

How would the amount be taxed, if the cash value was withdrawn or borrowed against, and the policy was still kept intact? Or, are you implying that is not an option.

I have 2 papers from the IRS which state that option is not available.

Vebaguru wrote "UBTI includes plan earnings on medical accounts."

Where in the code is that written?

My understanding is that if the amount contibuted for medical expenses is deductible, and thus, within the amounts allowed to be set aside, any growth from those contributions is not subject to UBTI.

I can provide the citations if you need them.

Don Levit

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Cash value loans are not taxable any more than bank loans. However, withdrawals will be taxable to the extent that they exceed the taxpayer's (or trust's) basis in the contract. IRS has taken the position that such loans may be prohibited transactions, although the DoL (which has primary responsibility for enforcement of PT rules) has not concurred. IMHO, IRS is wrong.

As I told you on Prior thread, the reference is IRC 512(a)(3)(E) et seq. You might also wish to review the Tax Court case, Sherwin Williams v. Commissioner, 115 TC 33 (2000).

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vebaguru:

What specific excerpts in the case and code section you provided supports the concept of VEBAs using life insurance cash values?

What specific DOL regulations support the same?

Don Levit

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Is it possible that tax-exempt income, say from life insurance, could be subject to UBIT in a VEBA?

Don Levit

Don, if I'm reading your question correctly, you're not asking about the specific UBIT consequences of life insurance proceeds. I believe you're asking about the general issue of whether income that's not subject to federal income taxation for other taxpayers would be taken into account for a VEBA's net taxable income. You simply chose tax-exempt life insurance payments as an example.

The quick answer is, no, such income isn't UBI for a VEBA. For the purposes of this discussion, let's use the simpler and clearer example of tax-exempt interest from state and local governmental obligations.

A VEBA has a much broader and more inclusive UBIT base than most other types of I.R.C. Sec. 501© organizations. As discussed previously in this message thread, most 501© organizations get passive income exclusions under the applicable subsections of Sec. 512(b). But, Sec. 512(b) doesn't pertain to a Sec. 501©(9) organization. A VEBA has to look to Sec. 512(a)(3) and Sec. 419A for structural or operational reasons to exclude passive income. The steps are:

1. Begin with the VEBA's total revenue

2. Subtract any program service revenue -- receipts that are substantially related to and further the organization's exempt purpose. Exempt function revenue isn't subject to taxation, so there's no need to rely on a statutory exclusion or exemption to avoid taxation. For a VEBA, program service revenue is dues, fees, contributions, or similar amounts collected to fund benefits [i.R.C. Sec. 512(a)(3)(B)].

3. Subtract any excludable income. The exclusions available to a VEBA are narrow and apply only if certain conditions are satisfied. (Asset account limits, set-asides, and organizations exempted from the rules are beyond the scope of this discussion.)

4. Subtract any income that's nontaxable for some other provision found under general tax law. Going back to the example of state or local bond interest, this income is exempt from taxation under Sec. 103(a). (But beware of possible state income taxation and alternative minium tax adjustments to federal UBI; nothing in tax is ever simple!)

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Lori:

Thanks for your reply.

I am asking about specific UBTI consequences, not whether the amounts are subject to income taxes.

When you wrote that a VEBA has a much broader and more inclusive UBTI base, I take that to mean that unless the income is specifically excluded from UBTI, it is subject to potential UBTI.

I understand that a VEBA does get passive income exclusions, if the income is derived from an appropriate amount set aside according to section 419A.

If the set aside is excessive, the income could be subject to UBTI.

Specifically, according to Treasury Regulation 1.512(b), it states, "The UBTI of a VEBA will equal the lesser of two amounts: the income of the VEBA or the excess of the total amount set aside as of the close of the taxable year.

Thus, if there is an excessive amount set aside, the income could be subject to UBTI, even if the income is income tax exempt.

At least, that's how I read it.

Don Levit

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The Internal Revenue Code, like the Bible, is not of private interpretation. (2 Peter 1:20) The income of the VEBA you refer to means net recognized income, not gross unrealized income (or other personal definition you might have).

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vebaguru:

And what specific section of the code supports your interpretation?

Are you saying that amounts that exceed the 419A account limit can be used to pay for qualified benefits of a VEBA, and not be subject to UBTI, if invested in non-taxable vehicles?

If yes or no, please supply the appropriate code section.

We are trying to learn here, together.

Don Levit

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Hi Don,

I believe that you've referenced Reg. Sec. 1.512(a)-5T, Q&A-3(b), which describes how to calculate the taxable amount of an excessive set-aside. A VEBA takes the lesser of (1) its unrelated business income (which is net of the set-aside) or (2) the excess of the set-aside over the qualified asset account limit. The regulation section doesn't define either amount, however, so we need to look back to the related Internal Revenue Code sections.

In construing the term "unrelated business taxable income" under Sec. 512(a)(3)(A), the income exclusions under general tax provisions are taken into account. If an item isn't taxable for any other taxpayer, it won't be included in a VEBA's taxable income. See Rev. Rul. 76-337 and TAM 199932050; tax-exempt interest was excluded from the UBIT base of a Sec. 501©(7) and Sec. 501©(9) organization, respectively, because of the general exemption provided by Sec. 103(a).

Sec. 512(a)(3)(B) expands a VEBA's exempt function income to include a valid amount of income set aside. The set-aside is an amount carved out from the VEBA's otherwise unrelated business taxable income, reserved to pay for benefits and related administrative costs and, thus, not subject to UBIT. Because the set-aside is a sort of "subset" of the normal UBIT base, it already excludes any tax-exempt income.

Thus, the regulation section is telling us to compare apples-and-apples, not apples-and-oranges. If the excess set-aside is the lesser amount, it won't bring tax-exempt income back into the UBIT calculation.

It's worth emphasizing that Reg. Sec. 1.512(a)-5T is used only for the purpose of computing the excess set-aside that gets tossed back into the UBIT base. A VEBA might also have unrelated business income in the broader sense -- income derived from an unrelated trade or business regularly carried on. Such income remains taxable.

This stuff really is migraine-inducing, don't you think?

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Lori:

I am glad you brought up TAM 199932050.

You are correct that it states ""Thus we conclude that to the extent interest on tax-exempt bonds is excluded from gross income under section 61 by reason of section 103, it is also excluded from gross income of a VEBA under section 512(a)(3).

Therefore, such income is not included in the income of the VEBA under regulation 1.512(a)-5T. Q&A3(b)."

The next paragraph states, "However, pursuant to that regulation, the value of the Taxpayer's assets, including amounts received as interest on tax-exempt bonds, would be included in the amount set aside to provide welfare benefits in determining the amount of the excess set-aside under the second prong of the test, which is the amount by which the amount set aside as of the close of the taxable year exceeds the VEBA's qualified asset account limit under sections 419 and 419A.

Thus, if in any taxable year of the VEBA, the excess setaside is less than the VEBA's income, the amount of the excess setaside would generally be UBTI to the VEBA."

Thus, we see how even non-taxable income can be (indirectly) subject to UBTI, if there is an excessive amount set aside.

Don Levit

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Why, thank you for your kind words, George! But, I believe that we haven't resolved this extremely convoluted matter and are still working on it. I haven't had a chance to respond to Don's most recent message, because I need to dig more deeply into my research. I'll say this much for now -- I'm learning a great deal as we go along.

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Guest CaveMan

I have a different question regarding the Form 990 and VEBAs.

I understand that the definition of a 'related organization' changed in the 2008 Form 990. Has anyone looked at the question of whether a for-profit employer that sponsors a VEBA as a funding mechanism for its health plan is considered a 'related organization' with respect to the VEBA?

Thanks!

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even non-taxable income can be (indirectly) subject to UBTI, if there is an excessive amount set aside.

Take this simple hypothetical. VEBA is run on cash basis. So, it has no set-aside amount. Member contributions (X) to VEBA equal VEBA claims, fees and other expenses paid from VEBA every year (Y). However, during the year, contributions are held in a tax-exempt muni money fund until VEBA expenses are paid. The accumulation of interest (Z) from the money fund at the end of the year is UBTI. That amount (Z) is an excess of the set-aside amount, which is zero. If X equals Y continually every year, the entire accumulation of Z from year to year will be UBTI every year, no?

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Guest VEBAPLAN

Ron, they should pay you for the good legal info

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Guest VEBAPLAN

Ron, are you rich yet from the posters paying you?

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This stuff really is migraine-inducing, don't you think?

Your still on migraines? I graduated to cluster headaches several years ago.

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