Nondiscrimination In Action Part V: Voluntary Employees’ Beneficiary Associations (“VEBAs”)

Part I: Nondiscrimination for VEBAs

VEBA as a Tax-exempt Entity. A VEBA is a tax-exempt entity (usually a trust) as defined under §501(c)(9) of the IRC. A VEBA operates as a tax-advantaged funding vehicle for providing qualified employee benefits (e.g., medical, dental, prescription drug, accident and life insurance benefits) to its members or their dependents. If a VEBA is established properly, employer contributions are deductible when contributed, earnings generally grow tax-free, and money withdrawn to cover medical expenses is not taxed.

Plan Asset Rule. In limited circumstances, §403 of the Employee Retirement Income Security Act of 1974 (“ERISA”) requires “plan assets” to be held in a VEBA or another type of trust. Health plans have assets when participants make contributions or employers decide to set aside funds to meet plan obligations. However, employee contributions withheld in connection with a cafeteria plan are exempt from this trust requirement. Also, insurance policies are not required to be held in trust. If a trust is required under ERISA, a VEBA will satisfy this requirement.

Collectively Bargained Populations. Employers may also be required to establish a VEBA to fund large retiree health liabilities due to a collective bargaining agreement with a union, bankruptcy reorganization or a class action suit.

Benefiting the Employer, Employees, and Retirees. VEBAs may also be established, without obligation, because the arrangement is beneficial to the employer, employees, and retirees.

Tax-exempt Status. A VEBA that is part of an employer plan is tax-exempt if the classification of employees who are eligible for benefits, and the benefits offered, do not discriminate in favor of highly compensated employees (“HCEs”). However, benefits may represent a uniform percentage of employees’ compensation, if the rate is equal among all employees. Details on these nondiscrimination requirements are found in IRC §505.

Nondiscrimination Requirement. The nondiscrimination requirements were enacted to ensure that HCEs are not favored over other employees. In general, plans must be nondiscriminatory as to eligibility and benefits. Both tests must be satisfied or the VEBA will not be exempt from taxation.

Highly Compensated Employees versus Key Employees. Only discrimination in favor of HCEs is prohibited. Coverage for each class of benefits under the plan must be provided to a classification of employees that is not discriminatory in favor of employees who are HCEs, and as to each class of benefits, such benefits cannot discriminate in favor of HCEs. Eligibility for benefits also may not be subject to conditions or limitations that have the effect of entitling officers, shareholders, or highly compensated employees of an employer contributing to the VEBA to benefits that are disproportionate in relation to benefits to which other members of the association are entitled. Whether the selection or administration of objective conditions has the effect of providing disproportionate benefits to officers, shareholders, or highly compensated employees generally is to be determined on the basis of all the facts and circumstances.

Defining a Highly Compensated Employee. HCEs for nondiscrimination purposes under IRC §505 are defined using the standards for determining highly compensated employees under IRC §414(q), which are 5% owners and those employees earning compensation in excess of IRC §414(q)(1)(B) threshold amount during the prior plan year (for 2024, $150,000 based on the 2023 threshold amount); and if election made by the employer, employees who were in the top-20% paid group for the prior year.

Prohibition Against Private Inurement. The prohibition against disproportionate benefits is part of the broader prohibition against private inurement under a VEBA. If a VEBA provides a disproportionate benefit, that benefit is not treated as a benefit and instead, is treated as private inurement of the assets of the VEBA.

Reasonable and Objective Criteria. The same types of reasonable and objective criteria that may be used to limit benefits under the general nondiscrimination rules also may be applied under the disproportionate benefit rule. Thus, differences in benefits among non-HCEs are irrelevant.

Part II: Prohibition Against Private Inurement

Payment of Benefits Permitted. No part of the net earnings of a VEBA may “inure to the benefit” of any individual, other than through the payment of permitted benefits. Whether prohibited inurement has occurred, generally is determined based on all the facts and circumstances, including the following:

• The disposition of property to, or performance of services for, a person for less than market value (or cost, if greater);
• The payment of unreasonable compensation to trustees or employees of the VEBA;
• The purchase of insurance or services for amounts in excess of their fair market value from a company in which a trustee, officer, or other fiduciary of the VEBA has an interest; and/or
• The provision of disproportionate benefits to any member.

Prohibited Transaction Rules. The rule against prohibited inurement is distinct from the prohibited transaction rules that apply under ERISA §406. For a VEBA established in connection with an ERISA plan, the prohibited transaction rules also apply to a transaction or arrangement that constitutes prohibited inurement under the VEBA rules.

Part III: Relationship to Other Nondiscrimination Requirements

Ordering Rules. IRC §505 provides an ordering rule for situations where the VEBA and the benefit plan to which it relates are also subject to nondiscrimination requirements in another section of the IRC.  In this case, as long as it meets those nondiscrimination requirements, it will automatically satisfy the nondiscrimination requirements in IRC §505.

Part IV: Questions & Additional Support

Additional Support

To obtain additional support for performance of these and other nondiscrimination related requirements, as mandated by the Internal Revenue Code, please reach out to your local service colleague or your client advisor. The Baldwin Group maintains an extensive suite of support solutions and advisory guidance capabilities respecting an employer plan sponsor’s performance of its IRS nondiscrimination related compliance assuredness activities. The Baldwin Regulatory Compliance Collaborative (the “BRCC”) also offers a carefully curated range of consultative and advisory support solutions related to the administration of US-based employee benefit plans, program, and other offerings.