4117 / What is the prohibition on inurement of earnings to private individuals that is applicable to a 501(c)(9) trust ("VEBA")?

Except in payment of permissible benefits, no part of the earnings of a VEBA may inure to the benefit of any private shareholder or individual.¹ A return of excess insurance premiums to the payor, based on mortality or morbidity experience, is not prohibited.² In addition, the refund of contributions to an employer, which had been paid after a collective bargaining agreement had ended but during the pendency of a labor dispute with a union, did not constitute inurement.³

On termination of a plan, there is no prohibited inurement if, after satisfaction of all liabilities to existing beneficiaries, remaining assets are applied to provide permitted benefits pursuant to criteria that do not provide for disproportionate benefits to officers, shareholders, or highly compensated employees.

A distribution to members on dissolution of a VEBA made on an objective and reasonable basis not resulting in unequal payments to similarly situated employees or disproportionate distributions to officers, shareholders, or highly compensated employees will not be prohibited inurement.

Assets of a VEBA may not be distributable to contributing employers on dissolution, either under the trust document or by operation of law, unless the distribution is applied to provide permissible benefits in a manner that does not result in disproportionate benefits for officers, shareholders, or highly compensated employees of the employers.⁴

A transfer of assets from a VEBA to a separate nonexempt trust resulting from the termination of a sick leave/severance plan component of the VEBA and then to a bank account to be distributed to employees who participated in the terminated trust was not considered prohibited inurement as funds apparently were used to pay qualifying Section 501(c)(9) benefits.⁵

In terminating a VEBA, use of the assets in a postretirement medical reserve to pay health care claims of employees who had retired prior to the effective date of the VEBA did not constitute prohibited inurement or a reversion of plan assets to the employer because the use of the reserves for an additional class of retirees was consistent with the purpose of the reserve.⁶

The termination of the life insurance portion (the retiree life plan) of a welfare benefit plan that was a non-exempt trust and the subsequent transfer to a VEBA of the assets remaining after the purchase of individual paid-up policies to satisfy the obligation of the retiree life plan and the subsequent use of those remaining assets to provide payment of permitted benefits other than life insurance did not result in prohibited inurement to the employer.⁷

Where an employer intended to reactivate a previously inactive VEBA by using the remaining assets to purchase one or more insurance policies that would provide accidental death, disability, and long-term care benefits to current employees and then terminate the VEBA on exhaustion of such assets, the proposed use of the net assets would not affect the tax-exempt status, that is, there was no prohibited inurement, because the assets would be used to provide benefits contemplated by IRC Section 501(c)(9).⁸

A general counsel memorandum concluded that a transfer of assets from an employer’s VEBA to a 401(h) arrangement under a qualified pension plan of the same employer, providing retiree health benefits, would result in inurement of earnings from the VEBA to the employer, inasmuch as a 401(h) arrangement is required to provide for return to the employer of assets remaining in the account after satisfaction of all liabilities under the plan ( Q 3942).⁹

The transfer of excess assets from a terminating VEBA to a successor VEBA to fund permissible VEBA benefits for the employer’s employees generally should not result in prohibited inurement.¹⁰

The transfer of a terminated VEBA’s remaining assets to an exempt educational trust fund did not result in prohibited inurement.¹¹ No inurement resulted from the termination of a VEBA and transfer of assets back to its original tax-exempt sponsor, which had operated as a charity hospital and was operating as a charity only, because the assets were to be distributed by the charity for charitable purposes, with the remaining assets to be distributed to the charity’s former employees who were currently working for the new hospital.¹²

The termination of a VEBA and distribution of remaining assets to a 501(c)(3) private foundation did not result in a reversion because the foundation was not an employer with respect to the trust, nor was it an organization that otherwise was merely an alter ego of the employer; instead, the foundation was a charitable organization whose assets were dedicated to charitable purposes and that could not be used for the private benefit of the employer.¹³

The substitution of a successor company for the original company in a VEBA trust document did not constitute prohibited inurement.¹⁴

The IRS has indicated tax-exempt status may be denied where principal shareholders receive a dominant share of aggregate benefits and effectively control the organization.¹⁵

In administrative proceedings prior to litigation in the Lima Surgical case, the IRS found a violation of the inurement proscription because the owner-employees were entitled to a dominant share of severance benefits and controlled the corporation. The court found a violation of the prohibition against private inurement because the dominant benefits were based on both level of compensation and length of service but did not explicitly analyze whether owner-employees also effectively controlled the plan trust.¹⁶ On appeal, the circuit court did not address the lower court’s inurement ruling, but the IRS conceded that the arrangement did not violate the prohibition against inurement.¹⁷

The IRS disqualified a VEBA because it failed to satisfy the requirement of no prohibited inurement. The IRS concluded that the plan, in substance, was not adopted or operated as an employee benefit plan, but was merely a separate fund controlled by the controlling family for the primary benefit of two members of the controlling family, with the incidental coverage of other employees of the corporation being merely a cost of attempting to secure tax-exempt status.¹⁸

In another disqualification due to prohibited inurement, the IRS privately ruled that the trust was established for the personal and private benefit of the company president and his wife, the universal life policies in the plan were not eligible for inclusion in a Section 501(c) (9) trust because they allowed for periodic payments and loans, and the trust was disqualified because it was not controlled by an independent trustee as required in the Treasury regulations.¹⁹

A loan from a VEBA to its members’ employer might violate the prohibition against private inurement.²⁰