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Guest m_johnson_90

Section 125 plans and VEBAs

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Guest m_johnson_90

Are Section 125 plans that are held in a trust considered VEBAs?

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A trust can not qualify as a VEBA unless it obtains a tax-exempt status letter from the IRS. See IRC 505©.

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Guest John Koresko

To the extent that a 125 plan offers welfare benefits, it could qualify as a VEBA or a non-VEBA welfare plan. The regulations contemplate employee-pay-all plans similar to a cafeteria plan. See also, sec. 419A(f)(5). However, if the 125 plan has a 401(k) element, that would not be permitted if VEBA status were desired.

In order to be an exempt org., a VEBA must comply with nondiscrimination rules of sec. 505 and submit an application for determination within 18 months of beginning operations. sec. 505©. Even if the Service denies the application, the taxpayer can still take the position it is exempt and institute a declaratory judgment action.

For example, IRS still adheres to geographic locale restrictions. It would probably reject a plan that did not include them. Yet a court would probably be favorable because of Water Quality Assn. v. U.S., in which geographic locale restrictions in the regs were declared invalid.

Interestingly, IRS uses the term VEBA in the generic sense to describe taxable welfare plans. See, Notice 95-34.

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Interesting that the IRS would refer to taxable trusts as VEBAs. My comment was based on the assumption that only a tax-exempt trust would be a VEBA because VEBAs are defined in IRC 501, which deals with tax-exempt organizations.

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I disagree with the following statement by John Koresko:

Interestingly, IRS uses the term VEBA in the generic sense to describe taxable welfare plans. See, Notice 95-34.

Set forth below is the actual wording from Notice 95-34:

Finally, in response to questions raised by taxpayers and their representatives, we note that the Service has never issued a letter ruling approving the deductibility of contributions to a welfare benefit fund under section 419A(f)(6). Although a trust used to provide benefits under an arrangement of the type discussed in this Notice may have received a determination letter stating that the trust is exempt under section 501©(9), a letter of this type does not address the tax deductibility of contributions to such a trust.

I don't think that the IRS is guilty of mischaracterization alleged by John Koresko. The IRS just said that some of these trusts may be VEBAs. I don't see how anybody could attack that statement by the IRS.

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As noted above, a VEBA is a possible structure for holding cafeteria plan contributions. However, the better question is: should a trust formed for the purpose of holding cafeteria (flex) plan contributions be a VEBA? I would answer, "no".

With the "use it or lose it" rule widely accepted, the chance of a 125 plan needing to be exempt from income tax is almost nil. Moreover the restrictions imposed on VEBAs (extra nondiscrimination rules, geographical limitations, etc.) and the cost of filing with the IRS (who won't rule on the 125 plan anyway) make it undesirable to utilize a VEBA.

A simple grantor trust (taxable) is sufficient.

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