Employee benefits by and for employees – that’s the idea behind organizations described under section 501(c)(9) of the Internal Revenue Code. Under 501(c)(9), voluntary employee benefits associations (“VEBAs”) receive exemption from federal income tax. Individuals sharing a common “employment-related bond” may pool resources to establish qualified benefit programs for employee members. For employees interested in having a greater voice in shaping their benefit programs, the 501(c)(9) may provide that opportunity.
Benefits for those sharing an employment-related bond
As the acronym suggests, VEBAs are groups of employees who voluntarily associate for the common purpose of providing benefits to those in the association. The principal underlying exemption here is similar to that of Section 501(c)(7) social clubs. Namely, through individuals’ common bond of shared employment, they may voluntarily contribute their post-tax earnings to provide for certain benefits without paying a second level of tax on the money they contribute to such organization. To qualify as a 501(c)(9), the following requirements must be met:
(a) The organization is an association of employees;
(b) Participation in the association is voluntary;
(c) The purpose of the organization is to provide for the payment of life, sick, accident, or other benefits to its members or their dependents or designated beneficiaries, and substantially all of its operations are in furtherance of providing such benefits; and
(d) No part of the net earnings of the organization inures, other than by payment of the benefits referred to in (c), to the benefit of any private shareholder or individual.
Significantly, the treasury regulations do not allow sole proprietors, partnerships, or self-employed individuals to create a VEBA. The individuals must be employees and share an “employment-related bond.” For example, employees of one or more employers engaged in the same line of business in the same geographic locale have an employment-related bond. Because a VEBA must be voluntary, organizations that provide for membership automatically with employment to a specific employer do not qualify, nor do organizations that arise out of collective bargaining agreements that mandate participation.
The Right Kind of Benefits
Benefits permitted under c(9) may not be just any kind of benefits. Rather, VEBAs may only provide employees with benefits similar to a life, sickness, or accident benefit. Here is one real-life example: Some time ago, a group of policemen in Canton, Ohio formed a VEBA under section 501(c)(9) to provide benefits to policemen in that city. The association’s main purposes were “to promote a fraternal spirit among its members, and to extend moral and material aid to them (and to their dependents) upon their death or retirement from the police force.” To fulfill that mission, the association paid a “dividend” to police officers who retired after twenty years of service, or to their families if the police officer died while working for the department. The average payment was around $4,500. Collectively, annual payments for this benefit amounted to about 85% of the association’s expenses.
Despite the commendable intentions of the association, the IRS revoked the association’s exemption under Section 501(c)(9). The IRS argued that section 501(c)(9) provides tax exemption only for “voluntary employees' beneficiary associations providing for the payment of life, sick, accident, or other benefits to the members of such association or their dependents.” According to the IRS, the dividends paid by the police organization to retiring or deceased officers were not in line with descriptions contemplated by 501(c)(9). The Sixth Circuit of the United States Court of Appeals agreed. In particular, the court noted that the Treasury Regulations define qualifying benefits as follows: “A benefit is similar to a life, sick, or accident benefit,” if:
(a) the benefit “is intended to safeguard or improve the health of a member or a member's dependents,” or
(b) the benefit “protects against a contingency that interrupts or impairs a member's earning power.”
The police organization’s benefits were more like a pension or deferred compensation benefits, which did not qualify under Section 501(c)(9) despite the organization’s noble intentions.
The above case illustrates that complying with 501(c)(9) requires careful planning. The rules governing qualifying and non-qualifying benefits for 501(c)(9) organizations are highly nuanced. Individuals seeking to form a 501(c)(9) should consult with qualified legal counsel to ensure that benefits being contemplated for the organization are permissible under the regulations. For further information about 501(c)(9) VEBAs or other tax-exempt organizations, please contact one of our attorneys at 312.626.1600 or firstname.lastname@example.org, or visit us on the web at www.wagenmakerlaw.com.