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Amended post-retirement VEBAs can fund current medical benefits

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Tax Hot Topics newsletterThe IRS ruled in No. 17-14975 that amendments to two trusts to allow for the provision of pre- and post-retirement medical benefits to employees would result in income recognition under the tax benefit rule. However, the amendments would not result in disqualified benefits, and the income recognized would be treated as potentially deductible contributions to the taxpayer.

The taxpayer at issue sponsored two trusts that qualified as welfare benefit funds, also known as voluntary employees’ beneficiary association (VEBA) plans, to provide post-retirement medical benefits for its employees under the same benefit plan. One trust provided benefits for retired, non-bargaining unit employees, while the other trust provided for retired, bargaining unit employees. The taxpayer also provided a medical benefit plan for its active, non-bargaining and bargaining unit employees, funded by the employer’s general assets.

For the tax year at issue, the taxpayer planned to merge the two medical plans for active and retired employees and amend the two trusts to provide funds for both pre- and post-retirement medical benefits under the merged plan. Under the tax benefit rule, the IRS held that because each trust would fund both pre- and post-retirement medical benefits after the plan merger, the taxpayer must include the amount previously deducted for pre-merger contributions to the trusts in its gross income. The tax benefit rule generally requires a taxpayer who receives a tax benefit from a deduction in a prior year to recognize the amount of that benefit as income in a later year if an event occurs that is fundamentally inconsistent with the premise on which the deduction was initially based.

The IRS reasoned that because the original contributions made to the taxpayer’s trusts were intended to provide medical benefits for only the taxpayer’s retired employees, the amendment to expand the trusts to also provide medical benefits to the taxpayer’s current employees would create an event that is fundamentally inconsistent with the premise on which the pre-merger contribution deductions were initially based.

The IRS further clarified that the use of trust assets to provide current medical benefits for the taxpayer’s employees would not result in the provision of a disqualified benefit, which is subject to a 100% excise tax. Furthermore, such provision of benefits would be treated as a contribution for purposes of the welfare benefit fund deduction rules of Sections 419 and 419A.

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Jeff Martin
Partner
Washington National Tax Office 
T +1 202 521 1526

Keith Mong
Managing Director
Washington National Tax Office 
T +1 202 521 1554

James Sanchez
Senior Associate
Washington National Tax Office 
T +1 202 861 4107

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