IRS challenges deductibility of contributions to certain multiple employer welfare benefit funds.

• Author: Josephs, Stuart R.

Background

Taxpayers and their representatives have inquired as to whether certain trust arrangements qualify as multiple employer welfare benefit funds exempt from the limits of Secs. 419 and 419A. In response, the IRS issued Notice 95-34 to alert taxpayers and their representatives to some of the significant tax problems that may be raised by these arrangements.

Generally, contributions to a welfare benefit fund are deductible when paid, but only if they qualify as ordinary and necessary business expenses of the taxpayer and only to the extent allowable under Secs. 419 and 419A. These sections impose strict limits on the amount of tax-deductible pre-funding permitted for contributions to a welfare benefit fund.

Sec. 419A(f) (6) provides an exemption from Secs. 419 and 419A for certain welfare benefit funds. Generally, for this exemption to apply, an employer normally cannot contribute more than 10% of the total contributions and the plan must not be experience-rated with respect to individual employers.

In recent years, a number of promoters offered trust arrangements that they claim satisfy the requirements for the 10-or-more-employer plan exemption and that are used to provide benefits such as life insurance, disability and severance pay benefits. These promoters claim that all employer contributions are deductible when paid, relying on the 10-or-more-employer exemption from the Sec. 419 limits and on the fact that they have enrolled at least 10 employers in their multiple employer trusts.

These arrangements typically are invested in variable life or universal life insurance contracts on the lives of the covered employees, but require large employer contributions relative to the cost of the amount of term insurance that would be required to provide the death benefits under the arrangement. The trust owns the insurance contracts. The trust administrator may obtain the cash to pay benefits (other than death benefits) by such means as cashing in or withdrawing the cash value of the insurance policies. Although in some plans benefits may appear to be contingent on the occurrence of unanticipated future events, in reality most participants and their beneficiaries will receive their benefits.

The trusts often maintain separate accounting of the assets attributable to the contributions made by each subscribing employer. Benefits are sometimes related to the amounts allocated to the employees of the participant's employer. For example...