Are VEBAs Worth Another Look?

A dynamic planning vehicle for closely held businesses.


A VEBA MAY BE A GOOD WAY FOR CERTAIN BUSINESSES to cut taxes, provide benefits for employees—including owner-employees—and protect assets from personal and business creditors. VEBAs also can provide other benefits, including the opportunity for substantial estate tax savings.

A VEBA TRUST CAN PROVIDE A VARIETY OF BENEFITS, including life (death benefits), sickness, accident and other benefits related to the welfare of employees, their dependents and beneficiaries. Benefit payments are not based on the passage of time, but rather are triggered by a specific event.

A VEBA MUST HAVE AT LEAST TWO PARTICIPANTS. Benefits are based on annual compensation and age. The plan must comply with several provisions of ERISA and the nondiscrimination provisions of IRC section 505, which require that benefits not discriminate in favor of highly compensated employees. All VEBA assets must be held by an independent trustee for the benefit of plan participants.

CPAs CAN HELP VEBA PARTICIPANTS STRUCTURE survivor benefits so they are not subject to income or estate taxes. Plan participants can make an irrevocable beneficiary designation, usually an irrevocable trust for family members. Such a designation also could avoid having the funds included in the surviving spouse’s estate.

A VEBA DOES NOT FIT ALL SCENARIOS. CPAs should recommend it to profitable businesses that want to reduce their tax liability, companies that no longer can make contributions to qualified retirement plans, business owners that want to reduce or eliminate estate taxes and those seeking to protect assets from creditors.

ALLEN F. ROSS, PhD, is the principal business strategist for Asset Accumulation, Inc., headquartered in Great Neck, New York. Asset Accumulation produces educational seminars on tax planning strategies. He can be contacted via his company’s Web site, .

W hen small business clients complain they don't have enough tax deductions and ask for effective ways to reduce or defer taxes, what should a CPA recommend? While the exact answer depends on the individual facts and circumstances, there is a vehicle that, when properly designed, is a flexible—but underused—tax planning tool. It can reduce taxes for any type of business—sole proprietorship, partnership, S corporation, C corporation, limited liability company or limited liability partnership.

The vehicle is an IRC section 501(c)(9) tax-exempt trust, commonly referred to as a voluntary employee beneficiary association (VEBA). A VEBA is an employee benefit plan whereby sponsoring employers can provide certain benefits for employees, including owner-employees. The discussion here focuses on VEBAs that qualify as 10-or-more, multiple-employer health and welfare plans under IRC section 419A(f)(6).

CPAs can help business owners tailor a VEBA to fit a variety of needs and provide a number of advantages:

  • All contributions to and assets in the trust are protected from personal and business creditors.

  • A properly constructed VEBA can provide millions of dollars in estate tax savings because the survivor benefits can be income-and-estate-tax-free, with no gift taxes.

  • VEBAs can be beneficial in restructuring a business's buy-sell agreement.

  • Assets in a VEBA accumulate and compound tax-deferred.

  • A VEBA is flexible enough to allow businesses to make large deductible contributions in peak earning years and smaller or no contributions in lean years.

A CPA who thinks a VEBA may be the long-sought answer to a client's needs should read on to discover how, after more than 70 years, VEBAs still provide significant tax and other benefits to business owners and their employees.


The VEBA trust has a rich legislative and case history. (See the sidebar for more details.) Established in 1928, it was enhanced in 1984 and 1986 to allow closely held businesses to join a 10-or-more employer VEBA that received a favorable IRS determination letter making the trust tax-exempt. This multiple-employer trust must have an independent trustee such as a bank. A third-party administrator usually handles compliance filings, including form 5500 for sponsoring employers.

Why should a business consider a VEBA? As incomes increase, and the IRS reduces or eliminates conventional planning strategies, the need for this complicated but useful program has grown. The VEBA trust provides a number of significant tax, business and personal planning opportunities to companies and their owners; it can offer a variety of benefits, including those paid in the event of an employee's death, sickness or accident. The payment of benefits is not based on the passage of time, but rather is triggered by an event such as a participant's death or disability.

A sponsoring business can deduct VEBA contributions as ordinary and necessary business expenses under IRC sections 162 and 461. Related Tax Court decisions have held that the expenses must be "reasonable." The regulations provide that the cost to a sponsoring employer of providing death, sickness, accident and other allowable benefits for employees is deductible. The level of reasonableness for contributions is discussed briefly in the tax and legislative history section (see sidebar on page 37), but if the employer's payroll, income, profits and expenses—taken as a whole—are sufficient, reasonable deductions can total hundreds of thousands of dollars. The ability to make smaller or no contributions in lean years helps employers maintain the plan during periods of poor business performance while trust assets accumulate and compound tax-deferred.

In a conservatively designed VEBA, all benefits should be fully insured from the date of an employee's participation, eliminating the risks associated with self-insured and partially insured plans. To satisfy the single-plan rule of the multiple employer provisions and still have all the assets provide benefits directly to plan participants, employers should adopt a fully insured VEBA. The single-plan rule for multiple-employer plans requires that, while there may be a variety of separate-benefit structures and separate accounting for each employer, all assets must be available to satisfy all claims at all times under Treasury regulations section 1.414(l)-1(b)(1). Thus, if there is a shortfall in assets to be paid by one employer, the trustee can take assets from all the employers participating in the trust. By fully insuring all benefits from day one, the shortfall problem is eliminated.

There is no vesting in a VEBA. The trust pays benefits to a plan participant or his or her beneficiary only after an unanticipated event such as illness or accident. In a death-benefit-only VEBA, no cash leaves the trust when an employee terminates his or her employment. The only right an employee has on termination is the opportunity to receive and convert his or her "bare" (no cash value) insurance contract to individual ownership. This has no effect on the trust since the employee withdraws no funds.

The Tax and Legislative History of VEBAs

T he history of the IRC section 501(c)(9) tax-exempt trust goes back to 1928. In the early years, unions, which established health and welfare benefit plans for their members, were the most prominent users. Soon after, large corporations began to set up individual VEBAs to provide certain welfare benefits. Eventually, smaller companies began their own programs. Unfortunately, abuses soon followed—with private planes, Swiss chalets and condos in Tahiti finding their way into the plans. In response, Congress and the IRS made extensive changes to VEBAs in 1984 and 1986, imposing substantial restrictions and limitations on who could participate and what and how much could be put into individual corporate VEBAs.

The 1984 and 1986 tax acts added IRC sections 419 and 419A(f)(6). Section 419 established limits on the level of contributions and their deductibility. Several exceptions were provided for plans that followed certain rules. A plan set up under section 419A(f)(6) is exempt from the severe limits. The essence of a properly designed 10-or-more, multiple-employer tax-exempt VEBA trust is as follows:

Ten or more employers (the client usually joins an existing multiple-employer VEBA).

No single employer controlling the plan (no employer regularly contributes more than 10% of total contributions to the trust).

An independent corporate trustee.

Contributions not based on the employer's claims experience.

Several Tax Court decisions followed. In Wade L. Moser , 56 TCM 1604 (1989), the Tax Court allowed a $200,000 deduction for a VEBA contribution made by a corporation owned by the Mosers. They were permitted to take the contribution as an ordinary and necessary business expense with no taxable income despite the fact that more than 90% of the benefits accrued to the owners and the owners could terminate or amend the plan in their discretion.

In Joel A. Schneider M.D., S.C. , 63 TCM 1787, TC Memo 1992-24 (1992), Dr. Schneider was a sole practitioner and sole stockholder, with one employee. He contributed over $1.1 million to three separate VEBAs over three years to fund $4.5 million in life insurance as well as disability, severance and education benefits. More than 98% of the benefits accrued to him. In a landmark decision, the court allowed the deductions, despite IRS challenges on issues of control, private inurement, deferred compensation, unreasonable compensation and discrimination in favor of highly compensated employees. The decision confirmed that large deductible contributions can be made to a properly designed, well-documented and administered VEBA. The court also said that as long as there was no potential for reversion to the sponsoring entity and an independent trustee controlled assets and investments, VEBAs could be used to deliver benefits to participants and beneficiaries when they do not discriminate in favor of highly compensated employees (meaning benefits are uniformly and proportionately available to all participants).

The IRS has issued several general counsel memoranda that legitimize the use of various VEBA funding techniques. In GCM 39440 (1985), the use of cash value life insurance contracts is permitted as long as the contracts are owned by the VEBA trustee, the cash accrues to the trustee and each participant, not the employer, has the exclusive right to designate a beneficiary. In GCM 39818 (1990), the IRS allowed that VEBA benefits did not favor owner-employees of small, closely held companies if the benefits were determined on the basis of a uniformly applied percentage or multiple of compensation and the plan required a length of service for eligibility.

Unlike pension and profit-sharing plans, VEBA distributions to a participant before he or she is age 591Ž2 are not subject to penalties and there are no required distributions at age 701Ž2. This allows CPAs a much wider range of choices. If an employer decides to terminate its plan and distribute the proceeds, participants pay income tax only on the proceeds and are not penalized. If the employer wants to continue the plan for multiple generations (appropriate for family businesses), there is no forced distribution after participants reach age 701Ž2. In addition, the death or survivor benefit payable from a VEBA is both income-and excise-tax-free when paid to beneficiaries and can be structured to be excluded from a participant's estate without gift tax consequences.

A VEBA is not suitable for everyone. It is probably most appropriate for closely held businesses making substantial income and profit on a regular basis that have had to pay substantial personal or corporate taxes. If the owners need to protect assets from creditors or enhance their net estate with tax-deductible dollars, they will be very enthusiastic about VEBAs. It is equally important for CPAs to understand when a VEBA may not be appropriate. Certainly companies with cash flow problems or that pay little, if any, taxes are not candidates. Also, large corporations with thousands of employees would be better served by establishing a single-company VEBA (not covered in this article).

Although a VEBA is an appropriate and extremely beneficial business planning tool, it is not designed to fit all scenarios. Furthermore, it requires the organization sponsoring the VEBA to craft a custom-designed proposal to fit the needs of the business. Currently, most leading sponsors are independent organizations that have permission from major insurance companies to customize their existing contracts for placement inside a VEBA. CPAs must undertake due diligence to ascertain whether the particular provider group has the proper documentation and knowledge to complete the program. Most sponsors have dozens of employers in their VEBAs. The CPA's client usually will be added to a VEBA with similar businesses, based on standard industry classifications.


The VEBA has a number of specific design characteristics. A company's plan must have at least two individual participants (in a closely held business, a spouse can qualify as an employee). Actual benefits are based on the employee's annual compensation and age. The plan can set eligibility rules to include only full-time employees (1,000 hours) who have completed at least three years of service and who are at least 21 years of age and to exclude employees represented by collective bargaining.

A VEBA must comply with several provisions of ERISA and the nondiscrimination provisions of IRC section 505, which require that benefits not discriminate in favor of the highly compensated. The law does not consider proportional benefits based on compensation to be discriminatory (see Wade L. Moser , 56 TCM 1604 [1989]). In designing a benefit, only up to $160,000 of compensation can be used in 1999.

A VEBA trust must file Form 102, Application for Recognition of Exemption Under Section 501(a) , to receive a favorable letter of determination from the IRS and secure its tax-exempt status. Any VEBA trust that has not filed its notice, plan, trust and adoption documents with the IRS or received this letter is not a fully functioning tax-exempt trust.

As noted above, an independent trustee must hold all VEBA assets for the benefit of plan participants. In a death-benefit-only VEBA, the trustee is the applicant, owner and beneficiary of all life insurance contracts. Assets are not held in any participant's name; instead, each employer's plan assets are held in an unallocated reserve for the exclusive benefit of all participants, their dependents and beneficiaries. This structure provides the basis for VEBA assets to be free from personal and business creditors—unless there has been a fraudulent conveyance—since no individual has any right to the trust assets except when an event occurs to trigger a benefit payment. The plan must prohibit the reversion of assets to a sponsoring employer. Once the employer contributes funds to the VEBA, it can never receive any assets back.

Although the employer has no right to plan assets, it can amend or terminate the plan and determine the level of contributions and benefits. The employer's ability to make these decisions does not constitute disqualifying control of the plan but simply allows it to make the decisions necessary to properly manage and control its operations.


The VEBA trust is one of the most significant and least used estate planning tools available to CPAs. As their net worths grow, business owners increasingly look for tax-efficient ways to enhance their net estates. One of the VEBA's most attractive features is that CPAs can help clients structure survivor benefits so death benefits are not subject to income or estate taxes because plan participants have no "incidents of ownership" in the assets.

The VEBA trustee owns the insurance contracts and each participating employee signs a beneficiary designation, which is held by the trustee. When an employee dies, the trustee receives the death benefits from the insurance company and pays the named beneficiary. To avoid having the VEBA death benefit proceeds included in his or her estate, the plan participant can make an irrevocable beneficiary designation, usually an irrevocable trust that benefits family members. Such a trust designation can also result in the funds' being excluded from the surviving spouse's estate. Under what circumstances will the proceeds be excludable? Using the standard contemplation-of-death rule, after three years the death proceeds are estate-tax-free. That rule may not apply, however, when the corporation sponsoring the VEBA deducts the insurance premium. Under those circumstances, the proceeds may be estate-tax-excludable immediately, without having to wait three years.

A business adopting a VEBA, in contrast with other estate planning tools, enjoys deductible contributions to the trust, which purchases insurance on participants' lives (including the owners or key employees). A VEBA also allows clients with larger estates to avoid the potential annual gift taxes that frequently result when the client uses a variety of other means to keep life insurance proceeds out of their estates. The CPA can, for example, recommend a VEBA to the corporate general partners of a family limited partnership that produces distributable taxable earned income. The VEBA lets the partners use pretax dollars to purchase death benefits that enhance the estate with millions of estate-and-gift-tax-free dollars. Without a VEBA, the client's only other option is to establish an irrevocable trust or partnership arrangement and contribute aftertax dollars.

Although a VEBA does not directly relate to a buysell agreement or dictate business succession, it can have considerable influence on an agreement's structure or cost. If the VEBA provides the beneficiary with millions of tax-free dollars, the need for large and immediate funds from a buysell agreement (whose objective is to fix what the family receives at the business owner's death) is greatly diminished. With the need for an immediate insurance-funded cash buyout eliminated, the buyout instead can be done over a period of years and funded largely by the business' ongoing cash flow. The availability of funds from a VEBA also means the buysell agreement can establish a more conservative value for the business, not an inflated one predicated on the family's need to receive a certain amount of money.


Unfortunately, some plans in the marketplace look like, or say they are, VEBAs but do not comply with VEBA rules. These plans (referred to as 419 plans) are health and welfare benefit plans that use a taxable trust as a funding vehicle and the provisions in IRC section 419A(f)(6) to determine contribution limits. These look-alike plans do not have a favorable IRS determination letter, do not follow the section 505 nondiscrimination rules and do not comply with all applicable ERISA requirements. Their proprietors believe they can avoid ERISA and the nondiscrimination rules by not filing with the IRS for a tax exemption. Such plans are not VEBAs, and CPAs should advise their clients to approach them with caution.

The 419 plans have additional problems. IRC section 4976 levies a 100% excise tax on any death benefit provided in a welfare benefit plan that does not comply with the section 505 nondiscrimination rules and uses those assets for postretirement benefits. Since 419 plans are discriminatory, benefits must terminate at the key employee's retirement, eliminating any estate planning opportunities beyond that point. Another attack on abusive welfare benefit plans is in IRS notice 95-34, which says any welfare benefit plan with the substantial likelihood of termination will have its contributions recharacterized as deferred compensation. These failings leave 419 plans open to IRS attack as deferred compensation and put them in danger of having deductions disallowed and penalties assessed under section 4976.

In Booth v. Commissioner , 108 TC no. 25 (17 June 1997), the court analyzed several issues concerning a 419 plan (also known as the "prime plan") and found it was a welfare benefit plan and not a form of deferred compensation. Unfortunately, the court also said it did not comply with the provisions of a single plan due to myriad interrelated concerns relative to vesting schedules, experience-rating arrangements and an arbitrarily determined "suspense account" to create an element of risk distribution. A VEBA does not have these features.

A VEBA can provide postretirement benefits and has no time or age limits on providing benefits to participants. During a participant's employment, he or she will be provided with a death benefit. The plan can establish criteria so qualified participants can continue to be eligible for death benefits even after retirement. Because a VEBA does not have any predetermined end, the IRS is unlikely to consider VEBA benefits a form of deferred compensation, meaning they can continue for many generations with no predetermined termination date.


One of the CPA's first responsibilities is to recommend a VEBA to only the right clients. The following types of businesses and business owners should consider a multiple-employer VEBA:

  • Profitable businesses that want to reduce their current tax liabilities.

  • Companies that no longer can make contributions to their qualified retirement plans because the plans either are overfunded or no longer favor the business owner.

  • Business owners hoping to reduce, eliminate or provide liquidity for estate taxes.

  • Businesses and business owners seeking to protect their assets from creditors, especially those in high-risk businesses (doctors, accountants, lawyers, manufacturers and architects).

  • Those wishing to supplement or enhance their business succession plans.

As with any business and tax planning tool, CPAs should take several other steps before implementing VEBAs. They must perform some due diligence and acquaint themselves with IRC sections 501(c)(9) and 419A(f)(6) and related cases. It is also important that they examine the various multiple-employer VEBAs and their sponsors and ask these questions:

  • Does the sponsor provide a comprehensive due-diligence package?

  • Is there a credible legal opinion that addresses the important aspects of the plan?

  • Does the sponsor follow ERISA guidelines, such as the $160,000 salary limitation when designing a benefit?

  • Does the sponsor have the legal and financial professionals on staff to handle the myriad compliance requirements?

  • Which organizations does the sponsor work with to set up VEBAs—CPA firms, law firms, financial institutions or state CPA societies?

When a CPA is satisfied he or she has a qualified sponsor and program, it is time to begin exploring the business and personal planning benefits of the VEBA program for specific clients.


The easiest way to see how a VEBA plan works is to analyze the following example.

XYZ Corp. has two key employees (Key 1 and Key 2) and five other eligible employees (E 1 to 5). Their age, sex and annual compensation are provided in the exhibit on page 40. An employer must consider this information in deciding how much it will contribute on a regular annual basis to fund plan benefits. In this example, the contribution is $100,000 annually. The employer must then calculate what multiple of compensation will provide a death benefit that will absorb the $100,000 contribution. In this case, the compensation multiple is 10. A participant who earns $20,000 annually is entitled to a death benefit equal to 10 times compensation, or $200,000. Currently, an employee with more than $160,000 of compensation will receive a benefit based only on $160,000. Thus, for Key 1 and Key 2 we use $160,000 of compensation. Each key employee will have $1,600,000 in death benefits under the plan. This calculation complies with the IRC section 505(b) nondiscrimination rules mentioned above. If the key employees wanted to receive a $2,400,000 death benefit, the plan would have to use a multiple of 15 times compensation for each employee.

Column E displays the cost allocations associated with providing these death benefits. The objective is to determine the most cost-efficient way for the employer to fund the benefits. The cost for E 5's benefit is the cost of a term insurance contract. Similarly, term insurance is used to provide death benefits on the lives of all employees but Key 1 and Key 2. This leaves 98% of the contribution to be used on the lives of Key 1 and Key 2. Cash value life insurance contracts will provide their death benefits. While at first glance this may seem somewhat discriminatory, the key employees own neither the contracts nor their cash values. All contracts are owned by and payable to the trustee for the benefit of all participants. Given normal corporate activities, it is likely some rank-and-file employees will leave the employer before the key employees. Thus, purchasing cash value contracts on employees who may leave is an inefficient use of funds.

In American Association of Christian Schools , 663 F. Supp 275, 87-2 USTC 9452 (MD Ala. 1987), aff'd 850 F. 2d 1510, 88-2 9452 (11th Circuit 1988), the court held that the cost of benefits is immaterial when testing for discrimination. Discrimination is measured by the proportionality of benefits provided. In the example, each participant's death benefit is equal to 10 times his or her compensation (subject to the compensation limits described above).

Column F shows the taxable income participants must report, often referred to as PS 58 costs. (Under IRC section 79, the life insurance provided to a participant under an employee benefit plan is considered a taxable benefit to them.) PS 58 costs are determined using a government chart or the term cost of the policy purchased, whichever is lower. The PS 58 cost is based on an employee's age and the amount of projected death benefits and represents its economic value to the participant. If an employee does not want to pay the tax on this economic benefit and elects not to participate in the plan or the death benefit, he or she can waive participation. Given the voluntary nature of the program, a similar waiver would result if the employee preferred not to take a medical exam, for example.

Each employee of XYZ will designate a beneficiary. If the employee dies while a plan participant, his or her named beneficiary will receive the death benefit income-tax-free. If the beneficiary designation is irrevocable and the three-year contemplation-of-death rule applies, the proceeds also will become estate-tax-free after three years. If this rule does not apply, the death benefit is excludable from the estate immediately, as the employee has no vested right or control.


If an employer finds it no longer can maintain a VEBA for any number of appropriate business reasons, it can end its participation. If a VEBA is terminated, all assets will be allocated to employees who are active participants in the plan on the termination date. The assets will be distributed to participants in proportion to their total salaries during their years of participation. Any funds paid to participants on termination will be taxable to them as ordinary income. Key employees often receive a larger percentage of the amounts allocated due to their higher compensation and their longer years of participation.


While nobody knows what the future holds for any employee benefit plan, VEBAs have 70 years of legislative history behind them. Because they meet the necessary ERISA and nondiscrimination requirements, VEBAs are widely used by business owners to provide benefits for themselves and their employees. A properly designed VEBA offers employers significant business, tax and estate planning benefits. CPAs should help eligible clients investigate the availability of an existing multiple-employer VEBA. Once the CPA has located a qualified program, the sponsor can use information provided by the client to design a proposal. Armed with this proposal, the client will be able to decide if a VEBA truly meets its long-term objectives.

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