Fundamentals of voluntary employees' beneficiary associations.

• Author: Heroux, Mark

The voluntary employees' beneficiary association (VEBA), a vehicle tax-exempt under Sec. 501(c)(9), has seen its heyday come and go. Created to provide for employees' various insurance needs (life, health, dental, etc.), these entities were popular for years until legislation reduced their attractiveness. Certain employers had discovered that VEBAs seemed to be the perfect place to put assets available only to them and a small coterie of executives. Assets such as second homes, airplanes, and assorted other luxury items found their way into the VEBA's protection. The Deficit Reduction Act of 1984, P.L. 98-369, sought to curb these abuses and strengthened anti-discriminatory language.

While nowhere nearly as common as they once were, VEBAs still represent a distinct avenue by which employers can provide for their employees. VEBAs need to follow general rules similar to those of other tax-exempt organizations to retain their not-for-profit status, such as ensuring that no part of their net earnings inure to private individuals. Likewise, a VEBA's activities must substantially revolve around its mission of providing beneficiaries with whatever benefits the VEBA designates. Beneficiaries must be either members (employees with some employment-related bond), their dependents, or designated beneficiaries.

What makes VEBAs sometimes less than desirable are rules surrounding unrelated business income (UBI). VEBAs may set aside income to pay benefits to members and reasonable administrative costs. This income can be considered "exempt function" income, which is considered not taxable. This exempt function income in the VEBA context is defined in Sec. 512(a)(3)(B) as gross income from dues, fees, charges, or similar amounts paid by members of the organization in furtherance of the purpose for which the organization exists. This definition then excludes income that is not specifically to be used for the provision of life, sickness, accident, or other benefits, including reasonable administrative costs. One key aspect of this income, referred to as set-aside income, is that it must not exceed the amount necessary to pay future claims and administrative costs related to those claims.

Sec. 419(a) establishes the general rule that contributions to a welfare benefit fund cannot be deductible unless otherwise deductible in the tax year when paid. Sec. 419(b) goes on to explain that income must not exceed the organization's "qualified cost" for the year...