On October 17, 2007, the Internal Revenue Service issued a revenue ruling taking the position that an employer’s contribution to a welfare benefit fund may not be deductible, in whole or in part, under section 419 to the extent the fund pays premiums on cash value life insurance policies. On the same day, the Service also issued two notices notifying taxpayers that it intended to challenge, retrospectively as well as prospectively, the claimed tax treatment of certain welfare benefit funds involving cash value life insurance promoted typically to small businesses as “section 419(e)” or “single employer” plans, and identified some of these arrangements as “listed transactions”; these notices are the subject of a separate Legal Alert.
In Revenue Ruling 2007-65 (click here for a copy), the Service considered the deductibility of contributions to a section 419 welfare benefit fund (not limited to the cases it deemed abusive in the two notices) where the fund pays premiums on cash value life insurance policies. The Service ruled that the fund’s qualified direct cost (a component of the amount deductible by the employer under section 419) does not include premiums paid on cash value life insurance policies whenever the fund is directly or indirectly a policy beneficiary, arguing that (i) qualified direct cost does not include fund expenditures that would not have been deductible if made directly by the employer and (ii) if the employer had purchased the policies directly, it would have ownership rights in the policies, in which case section 264(a) would have disallowed any deduction for premium payments. For welfare benefit funds that provide life insurance benefits, the Service provided limited transition relief for deductions in taxable years of employers ending before November 5, 2007. For welfare benefit funds that provide other than life insurance benefits, the Service observed that the employer’s contribution is deductible to the extent either it is paid out as welfare benefits for claims incurred in the current year, or it constitutes an allowable addition to a qualified asset account. For example, the ruling does not appear to question the deductibility of allowable contributions to a post-retirement medical reserve under a VEBA simply because the VEBA purchases cash value life insurance.