The tax impact on pension plans, VEBAs and more
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Pension trusts exempt under Section 501(a) and employees' beneficiary association trusts exempt under Section 501(c)(9) are subject to a myriad of tax compliance requirements.

Pension trusts exempt under Section 501(a) and employees' beneficiary association trusts exempt under Section 501(c)(9) are subject to a myriad of tax compliance requirements.

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The tax impact on pension plans, VEBAs and more Presentation Transcript

  • 1. 22nd Annual Health SciencesTax ConferenceTax considerations for pensions, VEBAs andother institutional investorsDecember 3, 2012
  • 2. Disclaimer► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.Page 2 Tax considerations for pensions, VEBAs and other institutional investors
  • 3. DisclaimerErnst & Young refers to the global organization of member firms of Ernst & YoungGlobal Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. For moreinformation about our organization, please visit www.ey.com.This presentation is © 2012 Ernst & Young LLP. All rights reserved. No part of thisdocument may be reproduced, transmitted or otherwise distributed in any form or byany means, electronic or mechanical, including by photocopying, facsimiletransmission, recording, rekeying, or using any information storage and retrievalsystem, without written permission from Ernst & Young LLP. Any reproduction,transmission or distribution of this form or any of the material herein is prohibited andis in violation of US and international law. Ernst & Young LLP expressly disclaims anyliability in connection with use of this presentation or its contents by any third party.Views expressed in this presentation are not necessarily those of Ernst & Young LLP.Page 3 Tax considerations for pensions, VEBAs and other institutional investors
  • 4. Presenters► Brad Bond ► Bob Vuillemot Treasurer Ernst & Young LLP University Hospitals Pittsburgh, PA Cleveland, OH + 1 412 644 5313 robert.vuillemot@ey.com► Ben Pitchkites Ernst & Young LLP ► Jennifer Richter Indianapolis, IN Ernst & Young LLP + 1 317 681 7440 St. Louis, MO benjamin.pitchkites@ey.com + 1 314 290 1024 jennifer.richter@ey.comPage 4 Tax considerations for pensions, VEBAs and other institutional investors
  • 5. Objectives► Review federal and state tax issues impacting § 501(a) pension trusts and § 501(c)(9) voluntary employees beneficiary association (VEBA) trusts► Identify international tax implications and compliance requirements► Identify planning ideas to reduce US and foreign taxes of pension and VEBA trustsPage 5 Tax considerations for pensions, VEBAs and other institutional investors
  • 6. Pension trust tax considerations
  • 7. Background — Section 501(a) pension trusts► US corporate-defined benefit pension plan assets total approximately US$1 trillion► Average allocation to alternative asset class is 14% and is increasing ► Public pension plan average allocation is 20%► Composition of alternative asset investments: ► Private equity 45% ► Hedge funds 18% ► Real estate 31% ► Real assets 6%Source: Cliffwater LLC 2011 Survey, “Allocations to Alternative Investments.” Composition percentages reflect public pension fund allocations.Page 7 Tax considerations for pensions, VEBAs and other institutional investors
  • 8. Tax considerations for pension trusts► Investment structuring► Obtaining treaty benefits► Reclaiming foreign withholding at source► Domestic tax compliance ► Federal tax compliance ► State tax compliance ► Information returns — e.g., reportable transactions, foreign activities► Foreign tax compliance► Accounting Standards Codification (ASC) 740► Qualification issues► Forms 5500Page 8 Tax considerations for pensions, VEBAs and other institutional investors
  • 9. Domestic taxation of pension trusts► Pension trusts are exempt from federal income tax under § 401(a) and § 501(a).► Pension trusts are not required to file Form 990, but are required to file Form 990-T if they earn unrelated business income (UBI) of more than US$1,000.► Note that pension trusts are entities separate from their sponsors.► Standard trust tax rates under § 1(e) apply.► Currently, 35 states and DC also tax unrelated business taxable income (UBTI) of pension trusts.Page 9 Tax considerations for pensions, VEBAs and other institutional investors
  • 10. Unrelated business income tax (UBIT)► Income from an “unrelated” trade or business► Income from property that is leveraged, i.e., that the taxpayer borrowed money to buy, or continued debt in order to carry (debt-financed property) ► Limited exception for certain real property indebtedness ► "Income" subject to UBIT includes both income derived from, and gain on the sale of, debt-financed assets that produce income subject to UBIT► Standard federal tax rates (35%, plus possible state tax)Page 10 Tax considerations for pensions, VEBAs and other institutional investors
  • 11. UBI information provided by partnerships► Section 6031(d) of the Internal Revenue Code (IRC) states: “the information required … to be furnished to its partners shall include such information as is necessary to enable each partner to compute its distributive share of partnership income or loss … in accordance with section 512(a)(1).”Page 11 Tax considerations for pensions, VEBAs and other institutional investors
  • 12. Compliance overview — Form 990-T ► Qualified plans (e.g., pension trusts) are not required to file Form 990. ► Qualified plans file Form 990-T if they earn more than US$1,000 of UBTI. ► Note earlier due date for trust returns (April 15 for calendar year trusts)Page 12 Tax considerations for pensions, VEBAs and other institutional investors
  • 13. Domestic compliance Federal filing requirements State filing K-1s Foreign bank requirements (and other info) account reports Filing requirements resulting from foreign transactionsPage 13 Tax considerations for pensions, VEBAs and other institutional investors
  • 14. K-1 analysis — objectives► Federal UBI► State UBI► Classification of UBI — passive/non-passive► Foreign filing requirements► Reportable transactionsPage 14 Tax considerations for pensions, VEBAs and other institutional investors
  • 15. Unrelated business income concepts► There are three typical ways that a fund organized as a partnership may generate UBI: ► Operation of a trade or business ► Example: an oil and gas partnership ► Borrowing to make investments ► Example: a commodities fund that borrows to make large investments in futures contracts ► Flow-through from other investments ► Example: a fund of funds that invests in other partnerships ► Depreciation recapture under Sections 1245 or 1250Page 15 Tax considerations for pensions, VEBAs and other institutional investors
  • 16. Unrelated debt — financed income► 514(c)(9) exception ► Debt-financed income from real property is excluded from UBI for “qualified organizations.” ► Qualified organizations ► Section 170(b)(1)(A)(ii) educational organizations and their Section 509(a)(3) supporting organizations ► Section 401 qualified trusts ► Section 501(c)(25) multiple parent real property holding organizationsPage 16 Tax considerations for pensions, VEBAs and other institutional investors
  • 17. Identification of federal UBI► Total UBI should be disclosed and marked with the appropriate code: ► 05 Form K-1 — code “P” ► 06–11 Forms K-1 — code “V”Page 17 Tax considerations for pensions, VEBAs and other institutional investors
  • 18. Identification of federal UBI (cont.)Page 18 Tax considerations for pensions, VEBAs and other institutional investors
  • 19. Identification of federal UBI (cont.)Page 19 Tax considerations for pensions, VEBAs and other institutional investors
  • 20. Identification of federal UBI (cont.)Page 20 Tax considerations for pensions, VEBAs and other institutional investors
  • 21. Identification of federal UBI (cont.)Page 21 Tax considerations for pensions, VEBAs and other institutional investors
  • 22. IRC Section 469 — passive activity losslimitation► § 469 limits the deductions and credits taxpayers may claim related to passive activities.► General rule: net losses from a taxpayer’s passive activities (passive activity losses or “PALs”) may not be used to offset net income from the taxpayer’s non-passive activities. ► PALs may be carried forward and used to offset passive income in future years, and may be deducted fully when taxpayers dispose of their interest in the passive activity.Page 22 Tax considerations for pensions, VEBAs and other institutional investors
  • 23. Classification of UBI — passive/non-passive► Need to break UBI into three categories: ► Passive ► Portfolio ► Non-passivePage 23 Tax considerations for pensions, VEBAs and other institutional investors
  • 24. Classification of UBI — passive/non-passive(cont.)► Portfolio income/loss ► Not subject to passive activity loss rules ► Includes debt-financed income (not derived in the ordinary course of a trade or business) from interest, ordinary dividends, annuities or royalties, gain or loss on the sale of property that produces such income or is held for investment, and related deductions ► Consists of specific Schedule K-1 line itemsPage 24 Tax considerations for pensions, VEBAs and other institutional investors
  • 25. Schedule K-1 instructions ► The Schedule K-1 instructions identify the line items that are considered portfolio income.► The corresponding Box 13 deductions (e.g., investment interest expense) are considered to be “portfolio” in nature.Page 25 Tax considerations for pensions, VEBAs and other institutional investors
  • 26. Portfolio income on the Schedule K-1Page 26 Tax considerations for pensions, VEBAs and other institutional investors
  • 27. Portfolio deductions on the Schedule K-1Page 27 Tax considerations for pensions, VEBAs and other institutional investors
  • 28. IRS Form 8582► Passive activity loss limitations► Determine allowable passive activity loss for the year and suspended portion to carry forward► Do not report losses from publicly traded partnerships (PTPs)Page 28 Tax considerations for pensions, VEBAs and other institutional investors
  • 29. Publicly traded partnerships — § 469(k)► What is a PTP? ► Any partnership if: ► Interests in the partnership are traded on an established securities market or ► Interests in such partnership are readily tradeable on a secondary market (or substantial equivalent)Page 29 Tax considerations for pensions, VEBAs and other institutional investors
  • 30. Schedule K-1Page 30 Tax considerations for pensions, VEBAs and other institutional investors
  • 31. Publicly traded partnerships — general rules► You can not offset loss of a PTP against anything other than income of the same PTP.► If there is an overall loss and less than the entire interest in the PTP was disposed of, losses are allowed only to the extent of the income, and the excess is carried forward and can be applied against future income from the PTP.► If there is a loss and the entire interest in the PTP was disposed of, the losses are not limited by the passive loss rules.Page 31 Tax considerations for pensions, VEBAs and other institutional investors
  • 32. Potential filings due to alternativeinvestments► Form 5471► Form 8865► Form 926► Form 8858► Form 8621► Reports of foreign bank and financial accounts (Form TD F 90-22.1)Page 32 Tax considerations for pensions, VEBAs and other institutional investors
  • 33. Potential filings related to foreigntransactions► Transfers to foreign partnerships and corporations ► Transfers to foreign partnerships are required to be reported on Form 8865 — “Return of U.S. Persons With Respect to Certain Foreign Partnerships.” ► Transfers to foreign corporations are required to be reported on Form 926 — “Return by a U.S. Transferor of Property to a Foreign Corporation.”Page 33 Tax considerations for pensions, VEBAs and other institutional investors
  • 34. Reportable transactions► Five categories of reportable transactions 1. Listed transactions 2. Confidential transactions 3. Contractual protection transactions 4. Loss transactions 5. Transactions of interestPage 34 Tax considerations for pensions, VEBAs and other institutional investors
  • 35. Loss transactions► Section 165 losses► Reporting thresholds ► Corporations — US$10 million in any single tax year; US$20 million in any combination of tax years ► Trusts — US$2 million in any single tax year; US$4 million in any combination of tax years ► Exception — Section 988 foreign currency losses — US$50,000 threshold for any single tax yearPage 35 Tax considerations for pensions, VEBAs and other institutional investors
  • 36. States that tax UBI from pension trusts State UBI State UBI State UBI Alabama Taxable Kentucky Not taxable North Dakota Taxable Alaska Taxable Louisiana Taxable Ohio Not taxable Arizona Taxable Maine Taxable Oklahoma Taxable Arkansas Not taxable Maryland Taxable Oregon Taxable California Taxable Massachusetts Not taxable Pennsylvania Not taxable Colorado Taxable Michigan Taxable Rhode Island Taxable Connecticut Taxable Minnesota Not taxable South Carolina Taxable DC Taxable Mississippi Taxable South Dakota Not taxable Delaware Not taxable Missouri Taxable Tennessee Taxable Florida Taxable Montana Taxable Texas Not taxable Georgia Taxable Nebraska Taxable Utah Taxable Hawaii Taxable Nevada Not taxable Vermont Taxable Idaho Taxable New Hampshire Not taxable Virginia Taxable Illinois Taxable New Jersey Not taxable Washington Not taxable Indiana Taxable New Mexico Not taxable West Virginia Not taxable Iowa Taxable New York Taxable Wisconsin Taxable Kansas Taxable North Carolina Taxable Wyoming Not taxablePage 36 Tax considerations for pensions, VEBAs and other institutional investors
  • 37. Structuring considerations► Alternative investments may generate UBTI ► UBTI can be “blocked” by interposing an entity treated as a corporation for US tax purposes. ► A blocker doesn’t eliminate the economic cost of UBTI; it just means that the pension trust won’t have to do the compliance itself. ► In some cases, a blocker can make matters worse. ► Dividends on US stocks earned directly by a tax-exempt entity, or through a partnership, are exempt from UBIT (unless debt-financed property). ► Dividends on US stocks earned by foreign corporations are subject to US withholding tax (quite possibly, 30%) and there is no way for the US owner to get it back.Page 37 Tax considerations for pensions, VEBAs and other institutional investors
  • 38. Hedge funds US US tax- Foreign taxable exempt investors investors investors US Delaware LP Cayman Corp. (foreign feeder) Master Fund Cayman LPPage 38 Tax considerations for pensions, VEBAs and other institutional investors
  • 39. Foreign tax issues► Foreign countries can impose tax on dividends, interest, profits from a local business and, in some cases, gains on sale of local investments.► A US pension trust might be exempt from some of these taxes. ► And even if it is exempt, it might need to get a local ruling.► Some US tax treaties give special benefits for US pension trusts, if they are properly and timely claimed.► Investing through a blocker might affect availability of US tax treaty benefits.Page 39 Tax considerations for pensions, VEBAs and other institutional investors
  • 40. VEBA trust tax considerations
  • 41. Background► Funding of welfare benefits by employers through a trust ► Welfare benefits include: medical, dental, supplemental unemployment benefits, sick and accident benefits, disability benefits, life insurance and severance pay► Irrevocable welfare benefit trust places assets beyond the reach of employer’s creditors► Distinction between welfare benefit “plan” and “trust”► Welfare benefit plan ► A “plan” is a program of benefits promised to employees — embodied in written plan document ► Form 5500 filed for “plan” (if 100 or more participants)Page 41 Tax considerations for pensions, VEBAs and other institutional investors
  • 42. Background (cont.)► Trust ► A “trust” is the employer’s vehicle for funding its obligation under a plan or plans. ► It is established by a written trust instrument naming the employer as settlor of the trust, appointing a trustee, and describing powers and duties of the trustee. ► The employer may fund some, or all, benefits under its plan through one or more trusts. Therefore, activity of the trust reflected on the Form 990 may not reflect financial statements of the plan (as shown on Form 5500).Page 42 Tax considerations for pensions, VEBAs and other institutional investors
  • 43. Typical funding via VEBA Trust Employer $ VEBA Trust $ 1. Employee 2. Care provider 3. Insurance companyPage 43 Tax considerations for pensions, VEBAs and other institutional investors
  • 44. Employer deduction using VEBA Trust► Prior to enactment of §§ 419 and 419A, acceleration of the deduction was generally allowed when the contribution was paid or accrued to the trust, irrespective of when the actual benefits were paid to employees. ► The ability to control timing of the deduction is a prime advantage associated with a trust. ► If a trust qualified for exemption of VEBA, then investment earnings were tax-free prior to 1986. ► Since 1986, deductibility of employer contributions to a trust fund is governed by §§ 419 and 419A.Page 44 Tax considerations for pensions, VEBAs and other institutional investors
  • 45. Employer deduction limitation► § 419(b) provides that the Qualified direct cost = cash-basis cost of current benefits paid amount of any employer by the fund deduction under § 419 Plus: addition to Addition to reserves shall not exceed the fund’s qualified asset funded for: account = “qualified cost” for the 1) disability 2) medical taxable year. 3) supplemental unemployment► Formula for qualified cost: benefits or severance pay 4) life insurance benefits [up to account limit] Minus: after-tax income = fund income less UBI or other tax Equals qualified cost = maximum deductionPage 45 Tax considerations for pensions, VEBAs and other institutional investors
  • 46. Voluntary employees beneficiaryassociations — exemption requirements► A VEBA is exempt from taxation under § 501(c)(9) if: ► The organization is an employees association ► Membership is voluntary ► The organization provides for the payment of life, sick, accident or other benefits to its members or their dependents ► No part of the net earnings inures to the benefit of any private shareholder or individual. Treas. Reg. § 1.501(c)(9)-1Page 46 Tax considerations for pensions, VEBAs and other institutional investors
  • 47. Section 501 (c)(9) VEBA exemptionrequirements► Same employer (or affiliated employer)► Same collective bargaining agreement or labor union► Same line of business in “same geographic locale”► Participants must be “employees” ► At least 90% of participants must be employees (or their spouses or dependents). ► Generally, employee status is based on employment tax status or collective bargaining. ► Partners and sole proprietors are not employees for purposes of the 90% test.Page 47 Tax considerations for pensions, VEBAs and other institutional investors
  • 48. Section 501 (c)(9) VEBA exemptionrequirements — voluntary and association► Voluntary ► Generally, an employee must affirmatively elect ► Considered voluntary even if membership is required as a result of collective bargaining or where there is no detriment to employees (e.g., reduction in pay for contributions)► Association ► Legal entity — almost always a trust (can be a corporation or an unincorporated association)Page 48 Tax considerations for pensions, VEBAs and other institutional investors
  • 49. Section 501 (c)(9) VEBA exemptionrequirements — control► A VEBA must be controlled by: ► Its membership, i.e., members elect or appoint administrators or trustees of VEBA ► Independent trustee(s) (i.e., bank) ► If the VEBA is exclusively a welfare benefit plan under the Employee Retirement Income Security Act of 1974 (ERISA), this requirement is automatically considered satisfied (very rarely is a VEBA not an ERISA plan). ► Trustees or fiduciaries, at least some of whom are designated by the membership► Most employee welfare benefit plans meet the control requirement by coming under § 3(1) of ERISA.Page 49 Tax considerations for pensions, VEBAs and other institutional investors
  • 50. Section 501 (c)(9) VEBA exemptionrequirements — permissible benefits► Life benefits — consist of current protection only and generally do not permit “permanent” life insurance (PLR 9903032)► Sickness and accident► Similar (other) benefits ► These are benefits designed to safeguard or improve the health of an employee (or dependents), or protect against contingency that interrupts or impairs earnings powerPage 50 Tax considerations for pensions, VEBAs and other institutional investors
  • 51. Section 501 (c)(9) VEBA exemptionrequirements — other benefits► Examples of “other benefits” (PLR 9801011) are: ► Holiday and vacation pay ► Recreational activities (athletic leagues) ► Child-care ► Temporary living expenses ► Supplemental unemployment compensation benefits — involuntary separation due to reduction in force, plant or operation shut-down, or similar event — § 501(c)(17) ► Severance ► Education/trainingPage 51 Tax considerations for pensions, VEBAs and other institutional investors
  • 52. Section 501 (c)(9) VEBA exemptionrequirements — non-qualifying benefits► Examples of non-qualifying benefits are: ► Commuting expenses ► Homeowner’s insurance ► Savings facilities ► Malpractice insurance ► Non-distress loans ► Pension/annuity ► Deferred compensation payable over time (vs unanticipated event)Page 52 Tax considerations for pensions, VEBAs and other institutional investors
  • 53. Section 501 (c)(9) VEBA exemptionrequirements — prohibited inurement► Facts and circumstances ► Unreasonable compensation to trustees or employees ► Non-arm’s-length transactions with entities related to trustees or fiduciaries► Prohibited inurement to employer ► “Excess assets” upon fund termination cannot revert to employer ► Loan to employer treated as prohibited inurement where loan was excessively large and improperly secured (GCM 39884) ► Transfer of assets from one VEBA to another does not affect the tax-exempt status of either VEBA and is not an employer reversion (PLR 9709006) ► Use of excess plan assets following plan termination to provide other qualified benefits does not constitute prohibited inurement so long as the benefits do not disproportionately benefit highly compensated employees (PLR 9740024)► Form 1024 is used for application for exemption and generally must be filed within 15 months after establishment of the VEBAPage 53 Tax considerations for pensions, VEBAs and other institutional investors
  • 54. Overview of UBIT rules for VEBAs► Unrelated business taxable income is taxed at corporate or trust rates (usually trust).► UBTI is the lesser of: ► Excess set-aside or ► Gross income (excluding exempt-function income) less applicable deductions ► Basically = “taxable” net investment income (interest, dividends, rents, royalties) ► Exempt-function income includes all fees paid by members of a VEBAPage 54 Tax considerations for pensions, VEBAs and other institutional investors
  • 55. Overview of UBIT rules for VEBAs — excessset-aside► Definition: Net assets in VEBA at year-end in excess of the qualified asset account (QAA) limit under § 419A.► An account receivable on the books of the VEBA does not constitute “assets set aside” for purposes of increasing the VEBA account limit.► QAA limit does not include reserves for post-retirement medical benefits (See Parker-Hannifin Corp. v. Commissioner of Internal Revenue, 139F.3d 1090).Page 55 Tax considerations for pensions, VEBAs and other institutional investors
  • 56. Qualified asset account limit► For qualified benefits, the amount reasonably and actuarially necessary to fund: ► Claims incurred but unpaid ► Reported to claims-paying agent ► Incurred but not reported (IBNR) ► No reserve allowed for amounts set aside to pay insurance premiums ► No addition to QAA for claims incurred but unpaid if benefits provided through insurance ► Administrative costs associated with claims ► Additional “reserve” for post-retirement medical and life insurance benefits (however, medical reserve excluded for purposes of excess set aside (see Code §512(a)(3)(E)(i) in UBIT calculation)) ► Special additional account limit for severance and supplemental unemployment benefitsPage 56 Tax considerations for pensions, VEBAs and other institutional investors
  • 57. Calculation of qualified asset account► Two acceptable methods for calculation: ► Actuarial certification (Code § 419(A)(c)(1)) ► Safe harbors (Code § 419(A)(c)(5)) ► Short-term disability — 17.5% of qualified direct costs (excluding insurance premiums) for immediately preceding tax year of fund ► Medical — 35% of qualified direct costs (excluding insurance premiums) for immediately preceding tax year of fund ► Long-term disability and life insurance — to be prescribed by regulations ► Safe harbor only valid if amount determined is “reasonable and actuarially necessary” to fund the benefits ► Safe harbor subject to IRS challengePage 57 Tax considerations for pensions, VEBAs and other institutional investors
  • 58. Calculation of qualified asset account (cont.) ► Example (all dollars in US): ► Acme VEBA incurred qualified direct costs for medical benefits in 2011 of US$100,000. ► The safe harbor addition to the QAA is $35,000 (35% of $100,000). ► However, at December 31, 2012, the actuaries have calculated the IBNR and unpaid claims reserves to be $25,000. ► Allowable additions to QAA will therefore be $25,000. ► If the taxpayer estimated QAA to be $40,000, without actuarial certification, then only $35,000, the safe harbor, would be allowed.Page 58 Tax considerations for pensions, VEBAs and other institutional investors
  • 59. Unrelated business income formulaUBI = the lesser of: (x-y) – (z-w) “excess assets” Or (p-q) – r “income” Where x = the assets of the fund y = assets not taken into account (facilities; assets with useful life > one year) z = account limit w = post-retirement medical reserves described in 419A(c)(2) (grandfathered amounts excluded) p = income of fund q = employer and employee contributions r = income from grandfathered post-retirement reservesPage 59 Tax considerations for pensions, VEBAs and other institutional investors
  • 60. Overview of UBIT rules for VEBAs► Exceptions to set aside limits under § 512(a)(3)(E): generally, no UBIT for excess set-asides for the following: ► Employee pay — all VEBAs ► Plan must have at least 50 employees ► Nonrefundable contributions ► Collectively bargained plans — must cover 90% ► VEBAs sponsored by tax-exempt employers are exempt from § 512(a)(3)(E)(iii). VEBA must have received funds from an employer which was tax-exempt for a five-year period.Page 60 Tax considerations for pensions, VEBAs and other institutional investors
  • 61. Recent UBIT case law developments► The interpretation of VEBA UBIT rules is split among federal courts where actual expenditures during the year exceed the amount set aside in excess of the account limit. ► Example (all dollars in US): ► VEBA has year-end assets of $1,000 ► Year-end account limit = $750; excess set aside of $250 ► VEBA earned $200 in investment income and spent $300 in actual direct costs ► Taxpayers argued that $200 received in investment income was part of $300 spent in direct costs, therefore, no UBI since all investment income “spent” on direct costsPage 61 Tax considerations for pensions, VEBAs and other institutional investors
  • 62. Recent UBIT case law developments (cont.)► Sherwin-Williams Co. v. Commissioner of Revenue: 330 F.3d 449 (2003) ► The Tax Court rejected the above interpretation but the Sixth Circuit Court of Appeals (“Sixth Circuit”) held that VEBA trust investment income may be set aside and used separately before tax year-end to pay reasonable costs of administering health care benefits, thereby avoiding § 512(a)(3)(E) exempt-function income limits. ► AOD 2005-002: The IRS won’t acquiesce to the Sixth Circuit holding; will only follow in Sixth Circuit. The IRS position is that amounts spent during the year cannot be specifically sourced, for UBTI purposes, to the VEBA’s investment earnings for the year.Page 62 Tax considerations for pensions, VEBAs and other institutional investors
  • 63. Recent UBIT case law developments (cont.)► CNG Transmission Management VEBA v. United States, 84 Fed. Cl. 327; EBC 2790 (2008) ► The US Claims Court agreed with the IRS’ interpretation, and rejected the Sixth Circuit, concluding that the taxpayer’s view was contrary to temp. regs., which it found reasonable and entitled to deference. ► Northrop Corp. Employee Insurance Benefit Plans Master Trust v. United States, No. 08-23 T (Ct. Fed. Cl., June 28, 2011) — followed CNG and held that a VEBA could not avoid limitation on exempt function income under Code Sec. 512(a)(3)(E)(i) merely by allocating investment income toward payment of welfare benefits during the course of the year.Page 63 Tax considerations for pensions, VEBAs and other institutional investors
  • 64. Miscellaneous issues► VEBAs use trust tax rate schedule and follow other trust rules to calculate income on the 990-T► Form 1041 Schedule D used to calculate rates for capital gains and qualified dividends► Trust limitation on net capital losses of $3,000 applies► Passive activity loss rules apply► Excise tax under 4976(b)(3) could apply to the return of funds to the employer; tax = 100% of amounts returned► Aggregation rule — § 419(h)(1)(B): permits aggregation of two or more funds at election of employer; possible to minimize UBI by combining multiple VEBAs of same employerPage 64 Tax considerations for pensions, VEBAs and other institutional investors
  • 65. Questions?