Accounting, Funding and Tax Consequences

35% of the prior year's qualified direct costs (other than insurance premiums)

Under IRC Section 419A, where there is no actuarial determination of certain liabilities, the code permits safe harbor limits. For medical benefits, the safe harbor limit is 35% of the prior year's qualified direct costs (other than insurance premiums). Short-term disability is 17.5%, and unemployment or severance is 75% of the average of two selected prior years from the preceding seven.

17.5% of the prior year's qualified direct costs (other than insurance premiums)

Under the IRC Section 419A safe harbor provisions, the limit for short-term disability reserves is 17.5% of the prior year's qualified direct costs (other than insurance premiums). This compares to 35% for medical benefits and 75% for unemployment or severance benefits.

A separate account must be established for each key employee, and annual addition limitations of IRC Section 415 should include these separate accounts

Under IRC Section 419A, when key employees are provided a post-retirement medical or death benefit, a separate account is established for each key employee. The annual addition limitations of IRC Section 415 should include the separate accounts for key employees maintained in accordance with IRC Section 419A. Key employee is defined by IRC Section 416(i).

Collectively bargained plans, employee-pay-all plans, and jointly ventured plans (MEWAs)

IRC Section 419A does not apply to collectively bargained plans, employee-pay-all plans, or jointly ventured plans (MEWAs). These exceptions recognize the different nature and regulatory framework of these plan types.

All welfare benefit funds must be aggregated and treated as one fund, and certain related employers must be treated as one employer

Under IRC Section 419A aggregation rules, for certain purposes all welfare benefit funds are required to be aggregated and treated as one fund by the employer. In addition, certain related employers are required to be treated as one employer for certain purposes. This prevents employers from circumventing deduction limits by using multiple funds.

They are exempt from income tax, though unrelated business taxable income is taxable as current income

So long as a trust is qualified under IRC Section 501(c)(9), the ordinary income and gains of the trust are exempt from income tax. However, unrelated business taxable income is taxable as current income. There are also several instances where the trust's tax-exempt status may be lost.

Providing plan assets to a shareholder not as a benefit, providing non-qualified or disproportionate benefits, violating association status such as ceasing to be voluntary, or failing to keep required records

A qualified trust's tax-exempt status may be lost for several reasons, including providing plan assets to a shareholder or individual other than as a benefit, providing non-qualified benefits or disproportionate benefits, violating association status such as ceasing to be voluntary, or failing to keep required records.

At corporate income tax rates

If the plan sponsor is an association, income and gains from a non-qualified trust are taxed at corporate income tax rates. Otherwise, non-qualified trusts are taxed at individual income tax rates. This contrasts with qualified 501(c)(9) trusts whose income is generally tax-exempt.

Interest earnings on the 501(c)(9) trust are tax-exempt while those of the 419A trust are taxable, but the 501(c)(9) trust may be retroactively disqualified with tax consequences while the 419A trust cannot

The two trusts are the same tax-wise regarding allowable deduction to the employer and taxable income to participants. However, interest earnings on the 501(c)(9) qualified trust are tax-exempt while those of the 419A (unqualified) trust are taxable. The 501(c)(9) trust must abide by IRC Section 505 discrimination rules, and can be retroactively disqualified with tax consequences, which is not the case with the 419A trust.

Qualified trust: IRS Form 990; Nonqualified trust: IRS Form 1041

Each trust entity, being a taxpayer, has its own Employer Identification Number and must file an annual tax return. A qualified trust generally uses IRS Form 990, while a non-qualified trust generally uses IRS Form 1041.

Income from those tax-exempt securities may be exempt from federal income tax, but the trust's other income sources remain taxable and the trust must still comply with all applicable tax laws

While the use of tax-exempt securities (such as municipal bonds) can mitigate some of the taxable income for an unqualified trust, it does not fully solve the issue of the trust's overall taxability. The trust still needs to comply with all applicable tax laws, and its other income sources would still be subject to tax.

No, it does not apply to self-funded death benefits unless they are tied to a life insurance policy

IRC Section 79 applies exclusively to employer-provided group-term life insurance and is based on an actual life insurance policy. It does not apply to self-funded death benefits unless they are tied to a life insurance policy. Similarly, IRC Section 101 applies to death benefits paid through life insurance contracts and does not cover self-funded death benefits unless part of a policy issued by a life insurer.

The death benefit is generally subject to income tax to the beneficiary unless the payment qualifies under a qualified plan under Section 401(a) for tax-deferred treatment

When a self-funded death benefit is paid directly from the employer's general assets without an insurance contract, it may not receive the same favorable tax treatment as an employer-sponsored life insurance policy. Generally, the death benefit will be subject to income tax under IRC Section 79 unless it qualifies as a qualified plan under Section 401(a), which provides tax-deferred treatment.

They have the same tax advantages as a fully insured plan because the trust is treated as an insurance company for this benefit

Self-funded death benefits have the same tax advantages as a fully insured plan if funded through an IRC Section 501(c)(9) trust. For tax purposes, such a trust is treated as an insurance company for this benefit, making the death benefits potentially tax-free to beneficiaries.

The excess or prefunded amounts are generally not taxable to participants, provided the participants do not constructively receive them

When an employer prefunds (contributes more than the amount needed to pay death benefits), the excess or prefunded amounts are generally not taxable to participants, provided the participants do not constructively receive them. Prefunding provides a more structured, long-term approach with investment growth and smoother cash flow management.

Taxable distributions, not employer contributions toward insurance costs

In a pay-as-you-go funded VEBA death benefit plan, since employers do not make advance contributions, payments made to cover death benefits are considered taxable distributions, not employer contributions toward insurance costs. This method offers greater flexibility but doesn't allow for investment growth to reduce future contributions.

The disability benefits are generally taxable to the employee

When the employer pays the premiums for disability insurance as part of an employer-sponsored plan or fringe benefit, the disability benefits are generally taxable to the employee. This is because the employee received a tax-free benefit (employer-paid premiums), so the resulting benefits are taxable.

The benefits are generally tax-free

When an employee pays the premiums for disability insurance using after-tax dollars, the benefits received are generally tax-free. This is because the employee has already paid tax on the premiums, and there is no further tax obligation when the benefits are received.

60% is taxable (the employer-paid portion) and 40% is tax-free (the employee-paid portion)

When both the employer and employee contribute to disability premiums, the IRS requires proportional allocation. If the employer pays 60% and the employee pays 40% with after-tax dollars, then 60% of the disability benefits will be taxable (reflecting the employer's contribution) and 40% will be tax-free (reflecting the employee's after-tax contribution).

A three-year look-back rule, where pre-tax participant contributions under a Section 125 plan are deemed employer contributions

In self-funded contributory disability plans where funding is split, the ratios are based upon a three-year look-back rule. Pre-tax participant contributions made under a Section 125 premium conversion plan are deemed to be employer contributions for this purpose.

Whether the participant has a 100% employer-paid plan (based on year three alone) or a 67/33 employer/employee plan (based on the three-year look-back average)

This appears to be an unresolved issue in the tax code. When a plan was 50/50 in years one and two and becomes 100% employer-paid in year three, it is unclear whether the participant has a 100% employer-paid plan or a 67/33 plan based on the three-year look-back rule.

All of the following: payroll deduction from taxable income, imputation of income via Form 1099, or grossing-up of participant's pay

Three situations should be deemed participant-paid for disability purposes: (1) payroll deduction from the participant's taxable income, (2) imputation of income to the participant by means of an IRS Form 1099, and (3) grossing-up of the participant's pay to enable them to make after-tax disability contributions without a change in take-home pay.

Participant contributions are allocated to disability first and medical second

It is common practice in a self-funded health care plan with disability and medical benefits that are contributory regarding participant coverage to allocate participant contributions for disability first and for medical second. This strategy maximizes the tax-free portion of disability benefits, since employee-paid disability benefits are received tax-free.

100% of the disqualified benefits

Harsh punitive taxes are assessed against an employer for providing a disqualified benefit. The tax is 100% of the disqualified benefits. This is one of the most severe tax penalties in the employee benefits area.

Permitting any portion of the fund to revert to the benefit of the employer, even if the fund's liabilities are 100% satisfied

Disqualified benefits include: giving a key employee a post-retirement medical or death benefit except through a separate account as required by IRC Section 419A(d), giving a medical or death benefit to a highly compensated employee under a discriminatory plan, and permitting any portion of the fund to revert to the benefit of the employer, even if the liabilities of the fund are 100% satisfied.

$100 per day, or $200 per day if more than one qualified beneficiary is affected

The punitive tax for a COBRA infraction is $100 per day during the noncompliance period with respect to each qualified beneficiary, or $200 per day if more than one qualified beneficiary is affected. There is a maximum tax per year of the lesser of (a) 10% of the employer's self-funded health plan costs or (b) $500,000.

25% of the expenses of the plan, and government entities are exempt

The punitive tax for a nonconforming health care plan is 25% of the expenses of an employer, a self-employed person, or a VEBA that sponsors the plan. Nonconformity results from violating certain provisions such as COBRA, HIPAA, or similar federal regulations. Government entities are exempt from this penalty.

10% of the employer's self-funded health plan costs or $500,000

The maximum punitive tax per year for a COBRA infraction is the lesser of (a) 10% of the employer's self-funded health plan costs or (b) $500,000. This cap provides some limit on employer exposure while still maintaining a significant incentive for compliance.

IRC Sections 105 and 106

HRAs are employer-funded arrangements that reimburse employees for qualified medical expenses not covered by insurance. They are governed by IRC Sections 105 (exclusion of benefits) and 106 (exclusion of employer contributions). Employer contributions are tax-deductible, and reimbursements are tax-free for employees if used for qualified expenses.

The individual must be covered by a high-deductible health plan (HDHP) and not be covered by any other non-HDHP health plan

To establish and contribute to an HSA under IRC Section 223, an individual must: be covered by a HDHP, not be covered by any other health plan that is not an HDHP, not be enrolled in Medicare, and not be claimed as a dependent on another person's tax return.

Contributions are tax-deductible (or pre-tax), earnings grow tax-free, and distributions for qualified medical expenses are not taxable

HSAs offer a triple tax advantage: contributions made by the individual are tax-deductible (even without itemizing), interest or investment earnings on HSA funds grow tax-free, and distributions used for qualified medical expenses are not taxable. This makes HSAs one of the most tax-advantaged savings vehicles available.

The withdrawal is subject to ordinary income tax plus a 20% penalty

Withdrawals from an HSA for non-qualified expenses are subject to ordinary income tax and a 20% penalty. This penalty is waived for individuals aged 65 or older, or if the account holder is disabled or deceased. HSAs are owned by the individual and remain with the account holder even if they change jobs or retire.

The contributions must be treated as taxable income to the employee and are subject to employment taxes

Employer HSA contributions are generally excluded from the employee's gross income and not subject to employment taxes. However, if the employer does not reasonably believe that the HSA contributions are excludable (e.g., the employee does not have an HDHP or is covered by disqualifying non-HDHP coverage), then contributions must be treated as taxable income to the employee and are subject to employment taxes.

IRC Section 125; employees set aside pre-tax dollars to pay for eligible health care expenses, reducing their taxable income

Flexible Spending Arrangements (FSAs) are governed by IRC Section 125, which provides a tax inducement for a participant to reduce gross pay in exchange for employer-provided benefits. FSAs allow employees to set aside pre-tax dollars to pay for eligible health care expenses, reducing their taxable income.

ICHRAs have no annual contribution limits but contributions must be uniform across employee classes, and employees must be enrolled in individual health insurance or Medicare

Individual Coverage Health Reimbursement Arrangements (ICHRAs) have no annual contribution limits, but contributions must be uniform across employee classes. Employees must be enrolled in individual health insurance or Medicare to participate, and reimbursements are tax-free for employees and tax-deductible for employers.

IRC Section 9831(c); they can reimburse dental, vision, or other excepted benefits and short-term health insurance premiums

Excepted Benefit HRAs (EBHRAs) are governed by IRC Section 9831(c) and provide limited reimbursements for specific 'excepted' benefits such as dental, vision, or short-term health insurance, without requiring enrollment in a group health plan. The annual contribution limit for 2024 is $2,100.

A written plan is not required for tax purposes, but the plan must be understood and definitive, written or not

While a written health care plan is an ERISA requirement, it is not a requirement for tax purposes. However, the IRS holds that the plan must be understood and definitive, written or not. A written agreement or established practice will suffice, and board minutes and accounting entries are good evidence that a plan exists.

No, an act of goodwill did not establish a plan; there must be an established practice or definitive arrangement

Helping out an employee with medical expenses as an act of goodwill did not establish a plan for tax purposes. However, where an employer lacks notification or an established practice, a plan does not exist. Conversely, an established practice (such as regularly using a company plane to transport employees for medical care) can constitute a plan.

Yes, the IRS will recognize a one-participant plan as valid for tax purposes, even if the employee is a key employee

The IRS will recognize a one-participant plan as a valid plan for tax purposes, even if such employee was a key employee. Additionally, a self-funded plan of two participant-shareholders providing a $2,000 maximum benefit was held to be a plan for tax purposes.

Health care services incurred prior to the effective date of the plan are typically not eligible for reimbursement or exclusion from income

The effective date of a health care plan may be critical for tax purposes. Health care services incurred prior to the effective date of the plan are typically not eligible for reimbursement or exclusion from income, even if the plan later becomes effective and provides coverage for similar services.

Dependents gain tenure beyond the death of the employee and continue receiving tax advantages

Tax advantages apply only to employees and code-defined dependents. Such dependents gain tenure beyond the death of the employee. Employment status continues if health care coverage is extended by collective bargaining, retiree coverage, or severance agreement.

The IRS does not recognize domestic partnerships as marriages; domestic partners cannot file using a married filing status and certain tax benefits available to married couples may not apply

For federal tax purposes, the IRS does not recognize domestic partnerships as marriages. Consequently, individuals in domestic partnerships are not considered married and cannot file federal tax returns using a married filing status. Additionally, certain tax benefits available to married couples may not apply to domestic partners.

Behavioral control, financial control, and relationship of the parties

The IRS uses the common law test focusing on three overarching factors: (1) behavioral control - whether the company controls what and how the worker performs, (2) financial control - whether the worker can realize profit or loss and who provides tools/materials, and (3) relationship of the parties - whether there are written contracts, employee-type benefits, and expectation of a continuing relationship.

On IRS Form 1099, because independent contractors are not treated as employees for tax purposes

If independent contractors receive benefits through a self-funded health care plan, the economic value of those benefits must be reported on IRS Form 1099, as independent contractors are not treated as employees for tax purposes. Additionally, including too many independent contractors in a plan may risk its qualification as an employee benefit plan under ERISA.

As self-employed, consistent with the tax code's treatment of Sub-S owners with more than 2% ownership

The tax code provides that a Sub-S owner is to be treated as self-employed for tax purposes. Only a Sub-S owner with less than 2% ownership should be treated as a common law employee. For S corporation shareholders, health insurance premiums are included in wages but are deducted above the line on their individual tax return.

Yes, so long as they are not key players to the firm

Even though the sole proprietor is a self-employed person for tax purposes, the proprietor's spouse and dependents may be deemed the dependents of a common law participant so long as they are not key players to the firm. This provides a tax advantage for family members of sole proprietors.

They are deductible as if the MEWA were an insurance company, allowing for greater flexibility in funding levels compared to single-employer plans

Under IRC Section 419A(f)(6), contributions made by participating employers to a MEWA are deductible as if the MEWA were an insurance company. This provision allows for greater flexibility in funding levels compared to single-employer plans, which may face stricter limits on deductible contributions. Excess contributions may be carried forward to future tax years.

Prohibition of experience rating, so premiums or contributions are not adjusted based on any single employer's claims history

Congress designed MEWAs with safeguards including the use of third-party trustees for asset management (so no single employer has disproportionate control) and the prohibition of experience rating. Experience rating prohibition means premiums or contributions are not adjusted based on any single employer's claims history, ensuring equitable contributions among all participants.

Miniature insurance companies, with proper asset management and adherence to regulatory guidelines

MEWAs are designed to function similarly to miniature insurance companies, with clear fiduciary responsibilities for trustees, proper asset management, and adherence to regulatory guidelines. Congress aimed to prevent dominance by a single employer, eliminate incentives for overfunding to gain tax advantages, and reduce the risk of underfunding.

Only the highly compensated employees; benefits received by non-highly compensated participants may be excluded even if the plan is discriminatory

If a self-funded health care reimbursement plan is found to be discriminatory, amounts constituting excess reimbursements must be included in the gross income of the highly compensated employees. Benefits received by participants who are not highly compensated may be excluded even if the plan is discriminatory.