Posted
15 November 1999 - 12:48 AM
In response to GBurns:
The VEBA first appeared in the Revenue Act of 1928. The legislative history recites that Congress wanted to encourage people to join together in an organization to provide benefits as an alternative to regular insurance operations. The legislation was not limited as to particular benefits, although it became clear that these plans were to provide "welfare benefits." It is impossible to pinpoint exactly the date certain types of benefits began popping up, although the case law and IRS pronouncements go back decades ago. [ As an aside to your comment about malpractice tail VEBAs, the case of Anesthesiology Associates declared that a VEBA could not provide malpractice insurance since such insurance protected the employer, not the employees.]
For a complete discussion of the flaws of the Prime plan, I would refer you to: "419 Welfare Benefit Plans Require Careful Drafting to Survive IRS Attack," 3 Jrnl Tax Emp Ben 147 (Nov/Dec 1995). In the 1999 supplement to the Life Insurance Answer Book, Ch. 39 (Panel), there is a complete update with reference to the particulars of the Booth decision which declared Prime flawed, consistent with the aforementioned article.
The principal reason Prime turned out to flawed was failure to adhere to a fundamental design requirement of multiple employer plans. All assets of the plan were not available for the payment of any claim. As Judge Laro said: "Each employee's claim could be funded only from the account of the employee's employer and the employee had no recourse to the extent of any shortfall." 108 T.C. 524. Thus, the severance benefit of that plan failed the experience rating test: "The Prime plan accomplished [experience rating] by adjusting employees' benefits to equal their employer's contributions." 108 T.C. at 575. The trustee had the unilateral right to reduce benefits. This was a no no. The judge went on: "The trust agreement limited an employee's right to benefits to the assets of his or her employee group . . . ." "A single pool was simply not desireable because participating employers did not want to accept the risk that their contributions wwould be used to pay the severance claims of other employers' employee[s] . . . ."
The Laro common law test of experience rating is now virtually identical to the former test of single plan, as first defined in Reg. 1.414(l)-1(B)(1). In fact, IRS argued for application of that regulation. The Judge did not cite to it, but his analysis was virtually identical to what the regulation would command. [Of historical note, IRS Chief Counsel advised over 15 years previously that this regulation would be consulted with respect to multiple employer VEBAs which provided medical benefits. GCM 39284.]
Please refer to the first message I left in this topic. The IRS position in the case as articulated in its pretrial Memorandum of Issues filed in Tax Court, and thus Judge Laro's opinion, focused on the SEVERANCE BENEFIT. You see, Prime could not sell people on the idea that other people's employees might have rights to everyone's contributions. Thus, they created this idea of the "separate vault" that no one else could invade. Everyone with a little insight to union and non-union multiple employer welfare plans saw the charade for what it was. Of course, Prime trumpeted its marketing din and shoveled a lot of B.S. and convinced a lot of people that the traditional definitions would not apply to 419A(f)(6). Those who bought that explanation were simply foolish and shooting craps.
What Prime and 99% of the 419A(f)(6) operators missed was a very simple but extraordinary notion. If you can fully insure your benefits, it doesn't matter that you put all assets available for all claims. You see, the risk is not only on the trust, but the predominant risk has shifted to the insurance carrier behind the benefit. You can't do this with a SEVERANCE BENEFIT, because there is no ready market of carriers offering SEVERANCE insurance. However, if you use a DEATH BENEFIT [or other insurable benefits, for that matter], you can put all assets at theoretical risk, but the primary risk will always be on the insurance company through whom the trust reinsures the death benefit risk.
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The risk is the price of the deduction. The risk is real because of the possibility that the insurance coverage could be blown by human error or carrier insolvency. But once the plan gets big enough, it becomes irrelevant. For example, in a plan which is a client of mine, the cash values of policies exceed $50 million spread over 200+ employers. A $250,000 claim here and there would be immaterial, considering that more than $30 million in tax benefits have been derived by the employers. But the risk is small because of close monitoring and the pecuniary interest of insurance guys in writing the reinsurance coverage.
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This extraordinary notion, first appearing in that 1995 article, was accepted by IRS counsel in the Booth case. On page 9 of the Memorandum of Issues, Ms. Durning admits that while the severance benefit of Prime was experience rated, the death benefit was "a guaranteed cost contract" or "pure insurance" and was, therefore, not an experience rated arrangement.
Even this "abusive" plan, as people were so apt to describe Prime, was held to be a "reasonable construction of the statutory provisions" dealing with "a novel issue." Booth at 578. No penalties were assessed. In addition, IRS failed for the fourth time to get a welfare plan reclassified because of the right to terminate. The right to terminate does not create a deferred compensation plan. Booth, 108 TC at 564. Of course not. The VEBA regulations confirm this. Reg. 1.501©(9)-4(d).
Thousands of people have misconstrued Booth, principally because they failed to distinguish between the characteristics of the severance benefit and the death benefit. In addition, only a handful actually got the IRS and taxpayers' Memoranda from the Tax Court in order to reconcile the Laro opinion.
In their haste to label welfare benefit plan advocates as tax cheats, too many so-called experts have failed to discern the nuances of the Prime plan and the meaning of Booth. It was a lot easier to just say, "See, I told you so." In reality, though, Prime was easy to criticize because it was structurally unsound as a matter of historical precedent.
The death benefit, fully insured model, comports with the legislative history of 419A(f)(6). Congress said the plan has to look more like an insurance company than a "fund." All insurance companies reinsure their risks to some degree. The 419A(f)(6) VEBA reinsures all of its risks. You can't look any closer to an insurance company. Of course, a couple of states, like California, agree with that analysis.
The inability to overcome this plain fact has caused Treasury to petition Congress for a change. After all, if the plans were violating the law, there would be no need for new legislation. Treasury concedes that "experience rating" as a tool to regulate 419A(f)(6) is a failure, especially after the concession in the Booth papers. Surprising, Treasury is not seeking to curb 419A(f)(6) by attacking the deduction. It seeks to eliminate termination distributions and severance benefits. Treasury believes that people will stop using the plans if they can't get the money out through termination.
In reality, though, the attention given by Treasury confirms that permanent plans for estate planning purposes will be statutorily embedded as valid.
In conclusion, if a benefit can be insured, it will not be experience rated. If all of the trust assets are at least theoretically available for payment of any claim, it is a single plan. Thus, the fully-insured death benefit plan designed under the pseudo-insurance company paradigm is a much different animal than the Prime severance plan at issue in Booth.
