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Current developments, part I.

This two-part article provides an overview of current developments in employee benefits, including welfare benefit plans, executive compensation and retirement plan requirements. Part I focuses on developments in welfare benefit plans and executive compensation.

During the past 12 months, numerous cases, rulings and regulations on executive compensation, welfare benefits and qualified plan requirements were issued. This two-part article covers the most significant of these. Part I, below, covers developments and associated planning opportunities in executive compensation and the funding or payment of welfare benefits (e.g., health reimbursement accounts and retiree health, life and disability insurance). Part II, in the December 2003 issue, will examine significant developments in qualified retirement plan requirements.

Welfare Benefit Funds


Unfavorable decision: In a decision that did not surprise many practitioners, a district court (1) rejected a Sec. 501(c)(9) trust's contention that unrelated business taxable income (UBTI) should be taxed at corporate, rather than trust, rates. Sec. 511(b)(1) provides for taxation at trust rates for trusts described in Sec. 511(b)(2); a trust falls within that provision only if it would be subject to subchapter J but for its tax exemption. A nonexempt employee trust is subject to that subchapter; only its beneficiaries are exempt under Regs. Sec. 1.641 (a)-0(b). Thus, the court conclude that subchapter J would apply to a voluntary employees' beneficiary association (VEBA), and so it would be subject to the trust rates.

Taxpayers with welfare benefits subject to unrelated business income tax (UBIT) should consider a taxable welfare benefit fund, so that any deemed UBTI would be included in the employer's income and would be taxed at the lower corporate tax rates. (Taxpayers in a loss position would avoid taxation.)

Favorable decisions: Taxpayers subject to UBIT received a favorable ruling in Letter Ruling (TAM) 200317036 (2) when the IRS allowed an employer to aggregate two welfare benefit trusts when calculating UBTI. The employer maintained two separate trusts, one taxable and the other exempt under Sec. 501(c)(9), to fund retiree life insurance benefits. According to Sec. 419A(h)(1)(B), an employer can treat two or more trusts as a single fund to the extent not inconsistent with the purposes of Sec. 419, 419A or 512, but there is no published guidance as to when aggregation is consistent with the principles underlying those sections,The ruling points to a statement in the Sec. 419A(g) legislative history (3) (relating only to deemed UBTI), approving an employer's aggregation of taxable trusts, and states there is no reason not to allow the practice when one trust is taxable and the other is not.

The problem addressed in TAM 200317036 arises frequently in various forms. The ruling offers support for aggregation in similar circumtances (e.g., when two trusts provide medical benefits and it would be advantageous to combine their incurred, but not received (IBNR), reserves in computing UBTI or deemed UBTI). The IRS's position is less clear if either reserves or benefits are of different types. For example, can a life insurance trust's post-retirement reserves be combined with a medical trust's IBNR reserve? The ruling's logic suggests that the answer ought to be "yes." Both types of benefit could be provided through a single trust, and the reserves would be combined; separating the trusts, but keeping their reserves aggregated, "does not allow excess accumulation of income." Nonetheless, employers with those facts would be well advised to seek a private letter ruling.

In Sherwin-Williams Co. Employee Health Plan Trust, (4) the Sixth Circuit offered taxpayers another way to avoid UBIT, by applying a new method of calculating UBTI. In general, Temp. Regs. Sec. 1.512(a)-5T, Q&A-3(b) and Sec. 512(a)(3)(E)(i) provide that a VEBA's income is exempt-function income (and, thus, not UBTI) only "to the extent that the total amount set aside in the of the close of the taxable year...does not exceed the qualified asset account limit for such taxable year of the organization:" However, the court held, "the limit is on the amount of income that is still set aside at the end of the year, not to [sic] amounts that were set aside but were spent over the year's course." Thus, it held that the trust had no UBTI, because it spent all of its income during the year on administrative expenses. (5)

If other courts follow this decision, it will be a boon to companies that would like to fund post-retirement medical benefits. Trust assets inevitably are greater than the UBTI account limit,because that limit (unlike the similar limit for deduction purposes) cannot include a reserve for such benefits. As a result, if a trust funds only retiree medical benefits, all of the trust's income is ordinarily UBTI. Reliance on Sherwin-Williams, if warranted, makes it easy to eliminate UBTI. Taxpayers considering relying on that case may want to create a trust in the Sixth Circuit to make it less vulnerable to IRS attack. It is not clear how the IRS will react to the Sixth Circuit's decision. (6)

Funding Reserves for Health Benefits

Welfare benefit funds received another boost when the Tax Court snapped the IRS'S Sec. 419 victory string in Wells Fargo & Co. (7) and approved immediate funding of a reserve for health benefits of current retirees. Sec.419 limits the deduction of contributions to fund welfare benefit plans. Sec. 419A(c)(2) authorizes "a reserve funded over the working lives of the covered employees and actuarially determined on a level necessary for (A) post-retirement medical benefits to be provided to covered employees..."; contributions up to this limit are immediately deductible (and often allowable as costs in rate-making or under cost-plus contracts). At the same time, plan assets reduce the liability that an employer has to disclose on its financial statements under Financial Accounting Standards Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The key question (on which the IRS and many plan sponsors have long been at odds), is: "Over what period may the reserve be funded?" The answer is particularly controversial when a large proportion of employees covered have already retired and have no future working lives.

The IRS's longstanding position is that the Sec. 419A(c)(2) language quoted above is actuarial shorthand for a funding method (the aggregate method) that spreads all of the benefit costs over the working lives of participants employed at the time of the calculation; the zero working lives of retirees are ignored. However, most plan sponsors prefer a method that will let them make contributions and claim deductions more rapidly.

In Wells Fargo, the court held that Sec. 419A(c)(2)'s plain language permits sponsors to fund benefits promised to current retirees immediately with de-ductible contributions. The court considered three possible funding methods that can plausibly be said to fit within the statute and chose the level-premium method. This method, use by the plan's actuary for calculating original funding, is a recognized pension funding method no longer widely used. It amortizes the liability attributable to each employee over his or her own anticipated future working life. For those no longer working, the amortization period is zero, so that sponsors can fully fund benefits in the year in which they create a trust. (8)

Salary Reduction Plans

Two IRS rulings addressed salary reduction plans. In Rev. Rul. 2003-62, (9) the IRS ruled that a plan participant cannot avoid tax on qualified retirement plan distributions by electing coverage under a Sec. 125 premium conversion plan or a flexible spending account.The ruling holds that those elections are ineffective for tax purposes, because Sec. 402 sets forth the exclusive rules for including qualified plan distributions in income. Because that section has no provision for excluding amounts that a participant elects to apply to medical expenses, the full distribution is taxable. However, the ruling addresses only Sec. 125 (and Sec. 106 to the extent that it incorporates Sec. 125), but not See. 105(b). Participants have for many years relied on the latter as support for excluding benefits received from Sec. 401 (h) account; there is no reason to think that the IRS disagrees with that treatment.

The IRS also ruled in Letter Ruling 200302032 (10) that employees could have tax-free health benefits if the employer, but not the employees, has a choice between retiree health benefits and Sec. 401 (a)/403(b) contributions. This ruling approves a school district's program under which retiring employees' unused sick leave is converted into a cash equivalent applied for their benefit through either (1) employer contributions to one of the district's retirement plans (it has both qualified mad Sec. 403(b) plans) or (2) establishment of a healthcare reimbursement account for post-retirement medical expenses. It holds, without discussion, that the assignmet-of-income doctrine espoused in Letter Ruling 9104050 (11) does not make the value of the sick leave immediately taxable to the employee; that ruling held that a similar arrangement resulted in immediate taxation when the decision on how to use sick-leave balances was left to employees. The later ruling offers a useful alternative, because the factors an employer considers in deciding how to apply sickleave balances are likely in most cases to lead to the same decisions as the employees themselves would have made.

Collectively Bargained Plans

Two administrative pronouncements--a ruling and regulations--highlight certain techniques that are deemed abusive and should be avoided. Since the enactment of Sec. 419, a cottage industry has sprung up to take advantage of the collective-bargaining exception to the strict deduction limits for welfare benefit trusts. Typically, a promoter forms a "labor union" (or buys permission from a reid union to use its name). The promoter then approaches small businesses and offers to "organize" their employees, including the owners. Bargaining leads to the employer's agreement to make contributions to a welfare benefit trust, often with more generous benefits for the owners than for rank-and-file employees. The promoter asserts that all contributions are deductible under Sec. 419A(f)(5) and that the Employee Retirement Income Security Act of 1974 (ERISA) preemption protects the trust from state regulation. (12)

Notice 2003-24 (13) states that this scheme will be a listed tax shelter transaction if either (1) a majority of employer contributions in any year are made on behalf of 5% owners and the employer contributions for at least one owner exceed $20,000 or (2) benefits are more favorable for owners than for other employees. The notice also observes that the collective bargaining exclusion is available only when assets to fund bargained benefits are held in a separate trust established exclusively for that purpose, a condition that may not be satisfied in many of the arrangements promoters are selling. Treasury has promised future regulations on this and other Sec. 419A(f) (5) requirements.

DOL regulations: Not coincidentally, final regulations (14) published by the Department of Labor (DOL) lay out the factors used in determining whether a welfare plan is collectively bargained for ERISA purposes. The final regulations do not differ materially from proposed regulations published in October 2000. The key provision is a list of factors indicative of bona fide collective bargaining. All of the factors need not be present in every case, but at least half will normally be necessary to pass. A trust that holds itself out as collectively bargained might want to seek a DOL hearing on its status if it is threatened with state regulatory action (but not preemptively before the state takes action).

The DOL regulation package also included final rules on Form M-1, Annual Report for Multiple Employer Welfare Arrangements (MEWA) and Certain Entities Claiming Exceptions (ECEs) .Three points about the filing requirements are notable:

* Entities that claim the benefit of the collective bargaining exception to MEWA status nonetheless must file Form M-1 during the first three years of their existence.

* As under the present rules, no MEWA filing is required if all em-ployers participating in the plan are under at least 25% common control. The preamble emphasizes, however, that the arrangement is substantively a MEWA unless the common-control percentage is at least 80%. That position had been token informally by DOL officials in the past, but had not been put into writing.

* Two new filing exceptions exempt "temporary MEWAs" that either come into existence as the result of changes of corporate control or For plans that are technically MEWAs by covering a small number of nonemployees (such as outside directors).

10-or-More Employer Plans

The IRS adopted final Regs. Sec. 1.419A(f)(6)-1, (15) which defines "10-or-more-employer plans" exempt from Sec. 419's strict deduction limits and effectively curbs many "abusive" plans previously marketed as a means of accumulating tax-free savings. The final regulations follow the proposed regulations in all but inconsequential detail. (16)

The Sec. 419A(f)(6) exemption does not apply to plans that use experience rating for individual employers. The regulations set forth the overall principle that a plan is experience-rated if the outcome to each employer, in terms of contributions and benefits, fairly closely approximates what would have happened had the employer set up an individual plan. Five factors are identified as raising a presumption that the purported 10-or-more-employer plan does that:

1. Separate accounting For contributions or expenditures for each employer.

2. Differential pricing among employers that cannot be accounted for by factors normally considered by insurance companies.

3. The absence of a fixed welfare benefit package provided for a fixed period at a fixed price.

4. Employer contributions that arc unreasonably high in relation to the benefits provided during the period to which they ostensibly relate.

5. Payment of benefits for reasons other than illness, personal injury, death or involuntary termination of employment.

The experience-rating presumption may be rebutted; the regulation includes examples of acceptable plans in which one or more of the factors are present. Nonetheless, the presumption is a high hurdle to overcome.

Prospective buyers need to know that 10-or-more-employer plans that experience-rate by individual employer are listed tax shelter transactions; the IRS appears to be ready to examine and assess taxes. The final regulations are effective for employer tax years beginning after July 10, 2002, the date of the proposed regulations.

Executive Compensation

Compensatory Stock Options

Over the past few years, some executives deferred tax on equity compensation and converted compensation into capital gain, by selling a compensatory stock option to a family limited partnership or trust. The sale (usually to an entity benefiting the option holder or his or her relatives) was assumed to close the compensation transaction and fix compensation attributable to the option, due to an arm's-length disposition. (17) The seller takes the position that the note is an unfunded, unsecured promise to pay which, under Rev. Rul. 60-31, (18) is not required to be recognized until actual or constructive receipt. If the optioned stock increases in value, the partnership or trust exercises the option, recognizing no income on exercise (because it is not subject to Sec. 83), and paying tax at capital gain rates when the stock is sold.

However, Notice 2003-47 (19) declares that the sale of a compensatory option to a related person is a "listed transaction" under Sees. 6011 and 6111, and that the tax benefits generated by these transactions are not allowable. Temp. Regs. Sec. 1.83-7T(a) (20) also makes any sale to a related party a non-arm's-length transaction.

Interestingly, the notice's language implies that a transaction that did "reflect terms that would be agreed to between unrelated parties dealing at arm's length" might be acceptable; however, the IRS's true position appears to be that the statute demands an actual arm's-length relationship between the parties, not just arm's-length terms, which is the rule laid down by the temporary regulations.

According to Notice 2003-47, the IRS will insist on immediate income inclusion of the value of the deferred payment for the options, regardless of whether the sale is at arm's length. However, the notice's press release states that it has no affect on transactions between option holders and the persons to whom the services were rendered. Also, under Temp. Regs. Sec. 1.83-7TA(a), the transfer of an option back to the granting employer would normally be at arm's length. (21)

Nonstatutory Options

Rev. Rul. 2003-98 (22) discusses the tax results when nonstatutory options are involved in four corporate transactions. In three situations, an employer's stock is acquired by another corporation in a stock acquisition; employees holding compensatory options (1) receive options to purchase the acquirer's stock, (2) have their existing options cancelled in exchange for acquirer stock or cash or (3) have the original optioned property substituted for acquired shares. The ruling concludes that only the service recipient is entitled to a compensation deduction for the option exercise.

The fourth situation involves the complete liquidation of the acquired company. In that situation, the acquirer can deduct the compensation, because the target's tax attributes carry over under Sec. 381. The timing of the deduction conforms with the Sec. 83 timing rules.

Parachute Payments

Sec. 280G prohibits employers from deducting "excess parachute payments," and Sec. 4999(a) correspondingly levies a 20% excise tax on such payments. In August, 2003, the IRS issued final Regs. Sec. 1.280G-1, (23) which limits excessive payments to executives providing services to a corporation during a change in control. This occurs when a corporation has a greater-than-50% change in stock ownership, a significant change in asset ownership or a change in effective control. A disqualified individual subject to the rules must pay a 20% excise tax on excess parachute payments; the corporation cannot deduct the excess parachute payments. "Disqualified individuals" include: (1) certain shareholders, (2) officers (including officers of subsidiary corporations) and (3) the highest-paid individuals of the corporation (including domestic and foreign subsidiaries).

Although the final regulations largely follow the regulations proposed in February 2002, the final regulations do contain some changes, which include:

* A corporation that would qualify as an S corporation, but has not formally adopted S status, may use the exemption from the parachute payment rules for S corporations.

* Holders of options only (not stock) are not entitled to vote to exempt certain payments from classification as parachute payments.

* For purposes of the above exemption, the corporation may determine "shareholders" by looking at any day up to six months prior to the date of change of control, even if the vote did not occur on that day.

* A shareholder who would receive a parachute payment cannot vote his or her stock in a favor of a parachute payment to any individual.

* Any individual who has the title of "officer" is presumed to be an officer, unless he or she demonstrates otherwise. A facts-and-circumstances test will apply to determine whether individuals not designated as officers will be treated as officers covered by the rules.

* When calculating the value of accelerated vesting in a parachute calculation, the amount deemed contingent on change of control cannot exceed the present value of the accelerated payment (rather than the value of the entire amount vested, even though not paid).

* The regulations explicitly adopt the IRS's historically applied rule that, in a single transaction, only one change of control will be deemed to have occurred.

Stock option vesting: For Sec. 280G purposes, vesting of a stock option is treated as a payment in the nature of compensation. Thus, when option vesting is accelerated as a result of a change in control, the valuation of such options determines whether there is an excess parachute payment. The IRS addressed the valuation of such options in Rev. Proc. 2003-68(24) which provides for a general valuation rtde and a safe-harbor method based on Black-Scholes. Under the general rule, a taxpayer may use any valuation method consistent with GAAP and that takes into account the factors provided in Regs. Sec. 1.280G-1, Q&A-13. The safe-harbor method of Rev. Proc. 2003-68 and the method provided in Key. Proc. 98-34 (25) satisfy these tests.

Under Rev. Proc. 2003-68, a taxpayer can recalculate the value originally assigned to options at the time of the change in control if there is a change in the (1) term of the option due to a termination of employment or (2) volatility of the stock. Taxpayers can redetermine the value during the "redetermination period," defined as the 18-month period beginning on the date of the change in control, as long as the initial valuation was made in accordance with the procedure (i.e., consistent with GAAP). A recalculation must be determined as of the valuation date used in the initial calculation, using the same interest rate and option spread, but the procedure allows the use of a different method from that used in the original calculations, as long as both methods are consistent with GAAP.

Although Rev. Proc. 2003-68 is not effective until 2004,it provides that taxpayers may apply it for a change in control occurring prior to that. This creates a potential refund opportunity when application of Rev. Proc. 2003-68 would produce a lower valuation when compared to the assumptions initially used (e.g., longer option term or higher volatility).

Valuation of Split-Dollaar Arrangements

On Sept. 17, 2003, the IRS issued final regulations (26) oil split-dollar life insurance arrangements, generally applicable to any split-dollar life insurance arrangement entered into or materially modified after Sept. 17, 2003. A change made to an arrangement described in Notice 2002-8, (27) section IV, paragraph 4 is not a material modification, if the change is made solely to comply with that section. The final regulations also provide a nonexclusive list of other changes that will not result in a material modification. The final rules do not make significant changes to the proposed regulations discussed below.

The IRS promulgated the original proposed rules on taxation of economic benefits transferred to an employee or nonowner under equity split-dollar life insurance arrangements (an arrangement in which an employee receives a benefit in addition to current life insurance) in July 2002. The July 2002 proposed regulations did not specify how such econonmic benefits were to be valued. Thus, on May 9, 2003, the IRS issued supplemental proposed regulations (28) on valuing the economic benefits provided under equity split-dollar life insurance arrangements. The supplemental proposed regulations defined three types of economic benefits subject to taxation: the (1) cost of the current life insurance, (2) cash value of the policy to which the employee has current access and (3) value of other benefits to which the employee has access.

While the valuation of the cost of current life insurance and other benefits has long been settled, the supplemental proposed regulations broke new ground as to the taxation and valuation of the cash value of the policy to which the employee has "current access." An employee has current acces to the cash value of the life insurance policy when (1) he or she can directly or indirectly access the cash value, (2) the cash value is not accessible by the policy owner or (3) the cash value is not subject to the claims of the owner's creditors. When current access exists, the cash value is includible in income. Generally, cash value is deternmined at year-end, without regard to surrender charges or to the type of access that the employee has to it.

Sec. 457 Regulations

The IRS issued final Regs. Sec. 1.457-1, (29) which made only minor changes to last year's proposed regulations. The most controversial area is the characterization of options granted to employees of exempt organizations as deferred compensation subject to Sec. 457(f). That position, implied in the proposed regulations, is spelled out unmistakably in an example in the final regulations. It rests on an expanded interpretation of the statute that contradicts the regulations under Sec. 3121 (v)(2), which, interpreting virtually identical language, hold that such options are not deferred compensation. Regardless, however, of legal debate, the appropriateness of the position from a tax policy standpoint makes successful challenge of the regulation unlikely, so the briefly popular practice of paying exempt organization executives compensation in the form of options to buy mutual funds or other property at a discount is unavailable. Under a grandfather rule, the tax treatment of options granted before May 9, 2002, is determined without regard to the regulations.

The remainder of the regulation deals with Sec. 457(b) deferred compensation plans, which are taxed under the rules that apply to for-profit organizations (no taxation until actual or constructive receipt), rather than under Sec. 457(f) (taxation when accrued amounts are not subject to a substantial risk of forfeiture). There are some major differences in the rules applicable to plans of governmental and nongovernmental exempt employers, largely because the former must be funded (See. 457(g)) and can accept rollovers from qualified plans, Sec. 403(b) plans and other government Sec. 457(b) plans, while the latter must be unfunded and can accept no roll-overs (although, under certain conditions, they may receive transfers from other nongovernmental Sec. 457(b) plans).

Reflecting these differences, government Sec. 457(b) plans are, like qualified plans, exempt from the constructive receipt doctrine, while accruals under nongovernment plans are taxable when paid or otherwise made available to the participant, with limited provisions for further deferral of distributions before they, become due. The regulations also allow govermnent plans to make bona fide loans to participants; a purported loan by a nongovernment plan is treated as a taxable distribution. In addition, govermnent plans need to establish separate accounts for rollovers that they receive front qualified or Sec. 403(b) plans, as distributions of those amounts before age 59 1/2 are subject to excise tax under Sec. 72(t). Despite the fact that rollovers are treated differently from Sac. 457(b) accumulations for excise tax purposes, the regulations subject both to the Sec. 457(d) ban on distributions before separation from service. The preamble indicates that the IRS may remove this restriction in the future.

In 2003, the annual vested accruals under a Sec. 457(b) plan are limited to $12,000 or 100% of compensation before elective deferrals, with additional contributions possible for employees who are age 50 or over or within three years of normal retirement age. Except for the special Sec. 457(b)(3) catch-up, the limits are identical to those under Sec. 402(g), but apply to nonelective as well as elective contributions. A plan that accepts excess contributions loses its eligibility status unless the excess, with attributable income, is returned to the employee by April 15th of the following year. The proposed regulations had no corrective mechanism for nongovernment plans, but the final version allows nongovernment plans to self-correct by distributing the excess deferrals by the first April 15th following the year of excess deferral. (30)

ISOs and ESPPs

The IRS issued (31) Prop. Regs. Sec. 1.421-1, providing guidance on incentive stock options (ISOs) and employee stock purchase plans. They make several changes to existing guidance, the most significant of which include:

* Inclusion of warrants in the definition of option;

* Ability to transfer an option to a trust as long as the employee is deemed the sole beneficial owner of the option under Sec. 671 and state trust law while the option is held in the trust;

* Inclusion of S corporations in the definition of corporation;

* Plan writings may be in electronic format, as long as they are enforceable under state law;

* A change in the granting corporation or in the stock available for award or purchase under the plan is deemed an adoption of a new plan, requiring shareholder approval;

* The maximum aggregate number of shares that may be granted under the entire plan, including nonqualified options, restricted stock and other stock-based awards, must be specified in the plan for shareholder approval;

* Guidance on which options are taken into account each calendar year in complying with the $100,000 limit on initial exercise;

* Guidance to avoid disqualification of ISOs substituted or assumed during a corporate transaction (which now includes stock splits and dividends, corporate name changes and other events that the IILS may identify in future guidance); and

* Rules on modifications, extensions and renewals of ISOs, which are generally deemed newly issued ISOs.

Generally, taxpayers may rely on the proposed regulations for any ISO granted or stock transferred after June 9, 2003.

Sec. 83(b) Election and the Employer's Deduction

The Federal Circuit (32) held that S shareholders can deduct the fair market value of restricted stock transferred to the company's chief operating officer, despite his failure to report any income from the transaction. The employee purctmsed the stock, which was subject to a substantial risk of forfeiture, and made a Sec. 83(b) election, taking the position on his return that there was no bargain element to the sale. He concealed both the fact that he had made the election and his valuation of the stock from the shareholders. The shareholders learned about the election three years later when he left the company; the corporation then filed an amended return clainfing a deduction of over $20 million, equal to what it determined was the excess of the stock's value over the price paid for it.

The IRS did not allow the shareholders' refund claim stemming from the newly discovered deduction, because Regs. Sec. 1.83-6(a)(1) and Sec. 83(h) let an employer deduct only the value of restricted property that is actually included (not includible) in the service provider's income.Thus, the shareholders would have to await the outcome of the dispute between the employee and the IRS before they can claim a deduction and would be bound by a result that they have no power to affect.

However, the Federal Circuit cited numerous places in the Code in which "included" means "required to be included" rather than "actually reported." In addition, the legislative history and the IRS's contemporaneous interpretation (which was not changed until 1995), both indicated that the deduction was to equal the amount includible in a service provider's income. The court also said, "the IRS can at least participate in the cases involving both the employer and the employee and thus can take steps to protect itself against an inconsistent result. The employer, however, has no standing to participate in a dispute between the employee and the IR.S regarding the amount claimed by the employee as gross income from the section 83 transfer."

The court's decision disagrees with the Tax Court's holding in Venture Funding, Ltd.,33 but is the better-reasoned opinion. However, until the regulation is revoked or there is a preponderance of authority that the regulation is invalid, taxpayers deducting amounts that an employee has not included in income may want to disclose the position as one that disregards a regulation, to avoid an accuracy-related penalty under Sec. 6662. Also, reporting deficiencies are subject to their own penalties.


In the December 2003 issue, part II will focus on general retirement plan developments and planning.

(1) The Sherwin-Williams Co. Employee Health Plan Trust, ND OH, 10/2/02.

(2) IRS Letter Ruling (TAM) 200317036 (4/25/03).

(3) "In determining deemed unrelated income, at the election of the employer, two or more nonexempt welfare benefit funds of the employer may be treated as a single fund. H.R. Conf. Rep. No. 98-861, at 1163 (1984). Since deemed unrelated income of a welfare benefit trust is defined in section 419A(g)(2) as the amount that would have been in the fund's UBTI under section 512(a)(3) if the fund were a VEBA, and there is no indication that a different aggregation rule wax intended for non exempt welfare benefit funds than for VEBAs, we infer that Congress was assuming that an employer could elect to aggregate two or more VEBAs, or one or more VEBAs, and one or more non-exempt funds under section 419A(h)(1)(B) for purposes of calculating UBTI under section 512(a)(3)."

(4) Sherwin-Williams Co. Employee Health Plan Co. Trust, 330 F3d 449 (6th Cir. 2003)

(5) In effect, the court sub silentio invalidated the regulation, without discussing how it might lie beyond the scope of the IR.S's authority or conflict with the text of the statute.

(6) Taxpayers outside the Sixth Circuit could take the position on a currently filed return. However, if this case is relied on to avoid UBIT, disclosure may be require, as this calculation is in disregard of a regulation.

(7) Wells Fargo & Co., 120 TC 69 (2003).

(8) In Wells Fargo. id., the court opted for the level-premium method, because it ensures that each employee's benefit will be fully funded by the time that he or she reaches retirement and it starts the funding period with the establishment of the trust (rather than earlier, as with the entry-age normal method). That conclusion is most congruent with the legislative history and will be difficult to overturn on appeal.

(9) Rev. Rul. 2003-62, IRB 2003-25, 1034.

(10) IRS Letter Ruling 200302032 (1/10/03).

(11) IRS Letter Ruling 9104050 (11/1/90).

(12) ERISA Section 3(40) allows states to regulate multiple-employer welfare arrangements (MEWAs) under their insurance laws, but excepts collectively bargained MEWAs from state jurisdiction.

(13) Notice 2003-24, IRB 2003-18, 853.

(14) 68 FR 17471 (4/9/03).

(15) TD 9079 (7/17/03).

(16) The IRS issued the proposed regulations last year to shut down "abusive arrangements" after years semi-satisfactory litigation; see Robert D. Booth, 108 TC. 524 (1997); Neonatology Associates, PA., 115 TC 43 (2000), aff'd, 299 F3d 221 (3d Cir. 2002).

(17) See Sec. 83(a) and Regs. Sec. 1.83-7(a) and-1 (b)(1).

(18) Rev. Rul. 60-31, 1960-1 CB 174.

(19) Notice 2003-47, IRB 2003-30, 132.

(20) TD 9067 (7/2/03).

(21) Temp. Regs. Sec. 1.83-7T(a) states, "a sale or other disposition of [an] option to a person related to the service provider "is, per se, not at arm's length. "Related" person" is as defined by Secs. 267(b) and 707(b)(1), with some modifications (a 20% rather than a 50% ownership test and inclusion in the "family" of all spouses of family members). In no case, however, is the option grantor or the entity for which the services are performed treated as a related person.

(22) Rev. Rul. 2003-98, IRB 2003-34, 378.

(23) TD 9083 (8/4/03).

(24) Rev. Proc. 2003-68, IRB 2003-34, 398.

(25) Rev. Proc. 98-34, 1998-1 CB 983.

(26) TD 9092 (9/17/03).

(27) Notice 2002-8, IRB 2002-4, 398.

(28) REG-164754-01 (5/9/03).

(29) TD 9075 (7/11/03).

(30) The final regulations are generally effective for tax years begriming after 2001. Strict compliance with the provisions that reflect the Economic Growth and Tax Relief and Reconciliation Act of 2001's amendments to Sec. 457 is not mandatory, until tax years beginning after 2003; until then, good-faith compliance with the statute is sufficient.

(31) REG-122917-02 (6/9/03).

(32) James G. Robinson, 335 F3d 1365 (Fed. Cir. 2003).

(33) Venture Funding, Ltd., 110 TC 236 (1998), aff'd, 198 F3d 248 (6th Cir. 1999), cert. den.


* Taxpayers received favorable UBIT decisions on aggregating welfare benefit funds and calculating a VEBA's UBTI.

* The Tax Court approved immediate funding of a health benefits reserve for current retirees.

* The IRS issued several sets of regulations on 10-or-more-employer plans, parachute payments, splitdollar valuations, Sec. 457 rules and ISOs and ESPPs.

Deborah Walker, CPA


Deloitte & Touche

Washington, DC

Paul Wagenbach, J.D., LL.M.


Doloitte & Touche

Washington, DC

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Title Annotation:employee benefits and pensions
Author:Wagenbach, Paul
Publication:The Tax Adviser
Date:Nov 1, 2003
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