4123 / How are rebates and termination distributions taxed to participants in 501(c)(9) trusts (“VEBAs”)?

The IRS has privately ruled that payments made by a company to its employees from its general assets to reimburse employees for excess pre-tax and after-tax contributions to a VEBA were wages for FICA, FUTA, and income tax withholding purposes. If the employer had made the payments on behalf of the VEBA and then received reimbursement from the VEBA, the portion of the rebate attributable to employee after-tax contributions would have escaped that treatment.¹

Participants in an employee pay-all VEBA who were receiving disability benefits were not required to recognize income when, on termination of the VEBA, they received disability insurance policies purchased with VEBA assets providing precisely the same benefits. Further, disability benefits under the policies were ruled excludable from income under IRC Section 104(a)(3) to the extent that disability benefits from the VEBA were excludable under that section.²

On the termination of employee pay-all VEBAs and the distribution of their assets in cash, all participants were considered to have received income to the extent the distributions exceeded their contributions; those who had taken deductions for their contributions were considered to have received additional income in the amount of any contributions for which they had taken a deduction that reduced their tax liability in earlier years.³ Where the distributions did not exceed the employees’ contributions, the distributions were not wages for FICA or FUTA purposes.⁴