Voluntary Employees’ Beneficiary Association (VEBA) plans can be a good option for organizations that want to help fund medical benefits for employees or retirees over a long period.
Assets in a VEBA plan will accumulate tax free, unless subject to unrelated business income tax. This investment income may be necessary to fund future claims if employee and employer contributions aren’t substantial.
There are many rules from the IRS and Department of Labor that govern VEBAs. Following are general concepts of VEBAs and possible filing obligations for your plan.
What Is a VEBA Plan?
A VEBA plan is a welfare benefit plan with tax exemption under Internal Revenue Code (IRC) 501(c)(9). It provides for the payment of life, sick, accident, or other benefits to members and dependents of an association.
The net earnings of the plan can’t inure to any private shareholder or individual. Payments to individuals for welfare benefits wouldn’t be considered inurement to a private shareholder or individual.
The membership of this association includes individuals who are entitled to participate because of their employment relationship with the plan sponsor or employer.
Background on VEBA
VEBAs have existed in tax law since 1928. Any group of employees that share employment may establish a VEBA, and a company may establish a VEBA on behalf of its employees. A VEBA may be funded with employer or employee dollars or a combination of both.
A VEBA can be set up as a corporation or trust under applicable local law. The funds contributed to a VEBA and its earnings are held in a trust for the payment of benefits for its members.
What Are Tax Reporting Requirements for VEBA Plans?
A VEBA won’t pay tax on investment income except when that income is deemed unrelated business income. This is if the VEBA provides only for the payment of benefits established under the plan to its participants and dependents.
Under IRC 162, employer contributions to a VEBA plan are generally a deductible expense—an ordinary and necessary business expense. Depending on the type of benefit provided to employees, it may be taxable to the individual.
What Are VEBA Filing Requirements?
Because a VEBA is exempt under IRC 501(c)(9), the plan will file Form 990 and Form 5500. There may also be a 990-T required in addition to applicable state income tax returns.
VEBA Form Filing Details
Does a VEBA Pay Unrelated Business Income Tax (UBIT)?
A VEBA, according to IRC 501(c)(9), can be subject to UBIT.
The UBIT is defined as gross income, except for exempt function income, less deductions that are directly related to that income such as investment management fees.
Exempt Function Income
Exempt function income for a VEBA furthers the exempt function of the entity, such as contributed dollars from employers or employees.
Exempt function income can also include other income set aside for the provision of life, sick, accident, or other benefits that include connected reasonable administration fees.
There are limits to the amounts that can be set aside for a VEBA plan.
The amount of investment income that’s set aside to provide for the payment of life, sick, accident, or other benefits shouldn’t be considered for purposes of exempt function income. This is to the extent that total assets of the VEBA at the end of the taxable year exceed certain applicable account limits.
If these account limits are exceeded, investment income earned during the year may be subject to UBIT. This rule applies even though the plan may spend that income for the provision of benefits.
To comply with this rule, the UBIT for the plan for the taxable year would be the lesser of:
- The investment income for the taxable year
- The excess, if any, of the total amount of assets excluding amounts set aside for charitable purposes as of the end of the taxable year over the applicable account limit for the taxable year
The plan isn’t subject to the limits if substantially all plan contributions are made by employers that were tax exempt throughout the five-year taxable period ending with the taxable year in which the contributions are made.
To determine the amount of total assets, certain assets with useful lives extending substantially beyond the taxable year aren’t considered.
The applicable account limit is the amount reasonably and actuarially necessary to fund claims incurred as of the close of the taxable year and the administrative costs with respect to such claims.
The following example illustrates the calculation of a VEBA’s UBIT.
An employer established a VEBA plan on January 1, 2018. It provides health benefits to employees.
The plan year is January 1 through December 31. The plan receives employer contributions of $60,000 and $5,000 in investment income. The plan pays $72,000 in benefit payments for employees and $7,000 in administrative expenses.
All expenses incurred are in connection with the administration of the employee health benefits. The VEBA doesn’t set aside any income for charitable purposes. The total amount of the assets in the VEBA at year-end is $25,000. The applicable account limit that has been actuarially determined is $7,000.
The total amount of assets in the VEBA exceeds the applicable account limit by $18,000. This is $25,000 in assets less the $7,000 account limit.
The unrelated business income for the VEBA is $5,000 because the $5,000 investment income of the VEBA is the lesser amount of investment income versus the excess of the amount of assets of the VEBA as of the close of the taxable year over the account limit—$18,000.
This is a simple example to illustrate how the UBIT of the VEBA is calculated. Consult your tax advisor to determine if all facts and circumstances have been considered when calculating the UBIT for your VEBA.
We’re Here to Help
For guidance on whether a VEBA plan is right for your organization or any other questions regarding employee benefit plans, please contact your Moss Adams professional.
You can also visit our Not-for-Profit Practice page for additional resources.