IRS Issues Guidance on Reallocation of VEBA Assets

IRS has released guidance to address when assets held in a voluntary employee beneficiary association ("VEBA") to fund one type of welfare benefit are reallocated to fund other benefits under the plan. 

Background.  The Internal Revenue Code allows employers to prefund certain welfare benefits through VEBAs as long as they follow certain rules and stay within specified funding limits.  To ensure that employers follow applicable funding limits, the Code subjects excess VEBA assets to unrelated business income tax ("UBIT").  Thus, employers often try spend down VEBA surpluses, including reallocating excess VEBA assets to fund other welfare benefits.

Employers are also subject to a 100% excise tax on VEBA assets that  revert to, or are used for the benefit of, the employer.

IRS has previously issued a number of private letter rulings ("PLRs") confirming that the 100% excise tax does not apply to a transfer of benefits funds and liabilities between VEBAs.  However, these earlier PLRs also explain that:

  • Using amounts contributed to a VEBA for one type of benefit to subsequently fund another type of benefit may trigger the "tax benefit" rule if the new use is fundamentally inconsistent with the original use.  

 (NOTE: Under the tax benefit rule, a taxpayer who received a tax benefit from a deduction in an earlier tax year generally must recognize income in a later year if an event occurs that is fundamentally inconsistent with the premise of the initial deduction.) 

  • The reallocation of VEBA assets may be deemed a "reversion," thereby subjecting the employer to the 100% excise tax on the amount used to fund the new benefit. 

New PLRs.  IRS has released two PLRs regarding VEBA funds that were originally intended to pay for retiree health benefits but will now be reallocated to provide health benefits for active employees.

PLR 201530022.  An employer sponsoring a VEBA will segregate the reallocated amount in a separate subpart of the trust to pay active employees' health benefits.  While the employer acknowledged that it would be required to recognize the reallocated amount as income under the tax benefit rule, it asked IRS to confirm that the reallocation would not result in a reversion subject to the 100% excise tax. 

In response, IRS ruled that:

  • The tax benefit rule would apply because the employer had deducted the contributions for retiree medical benefits and that making those amounts available to fund benefits for active employees was fundamentally inconsistent with the premise for the deduction. 
  • Using VEBA assets to provide health benefits to active employees would not make the employer liable for the reversion excise tax because no portion of the VEBA would revert to the employer. 

PLR 201532037.  An employer that sponsored a VEBA which exclusively provided retiree medical benefits wanted to amend the trust to also provide active employees' health benefits and thereby spend down excess assets.  The employer requested the IRS to rule that the amendment and reallocation of assets for health benefits for active employees would not result in a "prohibited inurement," which otherwise could disqualify the VEBA.  (NOTE:  Under the Code, there can be no inurement to any private shareholder or individual resulting from the operation of the VEBA.) 

IRS ruled that the reallocation would neither result in a prohibited inurement to the employer nor cause the trust to fail to be a VEBA.

Takeaway for Employers.  In view of the rulings provided in the PLRs, employers that have previously considered reallocating VEBA assets to fund other permissible benefits should take a fresh look at the issue.  Employers interested in using this strategy, however, should keep in mind the following:

  • Legally, PLRs may only be relied upon by the recipient.
  • For ERISA-covered benefit plans, all affected benefits generally must be provided under the same ERISA plan (and the plan needs to permit reallocation) to satisfy ERISA's exclusive benefit rule.
  • Although, in the first PLR, the employer must recognize income under the tax benefit rule, this same amount may be deducted from the employer's income when it is used to fund active employees' benefits.

The PLRs are available at: