Tax treatment of VEBAs and SUBs clarified
On Dec. 10, 2019, the IRS issued a final regulation applicable to voluntary employees’ beneficiary associations (VEBAs) and supplemental unemployment benefit trusts (SUBs), which are tax-exempt entities that exist to fund employee benefit programs. The final regulation explains the calculation of unrelated business taxable income (UBTI) by these entities. This final regulation (Reg. section 1.512(a)-5) is effective for taxable years beginning on or after Dec. 10, 2019.
Employers may establish a VEBA for funding certain benefits (such as healthcare and life insurance) or a SUB for funding supplemental unemployment benefits for their employees. Although VEBAs and SUBs are granted tax-exempt status by the IRS, they may owe tax on their investment income for a year if their total assets at the end of the year exceed the account limit calculated per section 419A.
Because of a court case, VEBAs and SUBs in certain jurisdictions claimed that investment income earned but spent during the year on benefit payments or administrative expenses did not count in the UBTI calculation. However, the IRS has now clarified that all investment income earned during a year should be considered when determining UBTI.
The IRS guidance addresses the UBTI computation for VEBAs, SUBs, and certain corporations that pay their entire net income to a VEBA, SUB, or social or recreational club. The IRS indicates that investment income earned by these entities during a year may be subject to unrelated business income tax regardless of whether the investment income is spent or retained, if the organization’s year-end assets exceed the account limit. The UBTI of the entity is the lesser of the investment income or the excess of the year-end assets over the account limit. Special exceptions apply to collectively bargained welfare benefit funds and entities funded by certain tax-exempt employers.
The gain on the sale or disposition of assets held by the entity is usually included in the UBTI calculation. However, the IRS final regulation clarified that special rules apply to the gain on the sale or disposition of certain property used by the entity.
Employers with entities subject to this final regulation should review the tax treatment of their entities with their tax advisors. Entities with UBTI may need to file Form 990-T to report unrelated business income tax.