Calculation of UBTI for Certain Exempt Organizations, 7110-7114 [2014-01625]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 79, Number 25 (Thursday, February 6, 2014)]
[Proposed Rules]
[Pages 7110-7114]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-01625]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-143874-10]
RIN 1545-BJ92


Calculation of UBTI for Certain Exempt Organizations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Withdrawal of notice of proposed rulemaking and notice of 
proposed rulemaking.

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SUMMARY: This document contains a new proposed regulation providing 
guidance on how certain organizations that provide employee benefits 
must calculate unrelated business taxable income (UBTI). This document 
also withdraws the notice of proposed rulemaking relating to UBTI that 
was published on February 4, 1986.

DATES: The notice of proposed rulemaking that was published on February 
4, 1986, at 51 FR 4391 is withdrawn as of February 6, 2014. Written or 
electronic comments and request for a public hearing must be received 
by May 7, 2014.

ADDRESSES: Send Submissions to: CC:PA:LPD:PR (REG-143874-10), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20224. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
143874-10), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at www.regulations.gov (IRS REG-143874-10).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulation, 
Dara Alderman or Janet Laufer at (202) 317-5500 (not a toll-free 
number); concerning submissions of comments and/or to request a 
hearing, Oluwafunmilayo (Fumni) Taylor at (202) 317-6901 (not a toll-
free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed Income Tax Regulations (26 CFR part 
1) under section 512(a) of the Code. Organizations that are otherwise 
exempt from tax under section 501(a) are subject to tax on their 
unrelated business taxable income (UBTI) under section 511(a). Section 
512(a) of the Code generally defines UBTI of exempt organizations and 
provides special rules for calculating UBTI for organizations described 
in section 501(c)(7) (social and recreational clubs), voluntary 
employees' beneficiary associations described in section 501(c)(9) 
(VEBAs), supplemental unemployment benefit trusts described in section 
501(c)(17) (SUBs), and group legal services organizations described in 
section 501(c)(20) (GLSOs).
    Section 512(a)(1) provides a general rule that UBTI is the gross 
income from any unrelated trade or business regularly carried on by the 
organization, less certain deductions. Under section 512(a)(3)(A), in 
the case of social and recreational clubs, VEBAs, SUBs, and GLSOs, UBTI 
is defined as gross income, less directly connected expenses, but 
excluding ``exempt function income.''
    Exempt function income is defined in section 512(a)(3)(B) as gross 
income from two sources. The first type of exempt function income is 
amounts paid by members as consideration for providing the members or 
their dependents or guests with goods,

[[Page 7111]]

facilities, or services in furtherance of the organization's exempt 
purposes. The second type of exempt function income is all income 
(other than an amount equal to the gross income derived from any 
unrelated trade or business regularly carried on by the organization 
computed as if the organization were subject to section 512(a)(1)) that 
is set aside: (1) For a charitable purpose specified in section 
170(c)(4); (2) in the case of a VEBA, SUB, or GLSO, to provide for the 
payment of life, sick, accident, or other benefits; or (3) for 
reasonable costs of administration directly connected with a purpose 
described in (1) or (2).
    Section 512(a)(3)(E) generally limits the amount that a VEBA, SUB, 
or GLSO may set aside as exempt function income to an amount that does 
not result in an amount of total assets in the VEBA, SUB, or GLSO at 
the end of the taxable year that exceeds the section 419A account limit 
for the taxable year. For this purpose, however, the account limit does 
not take into account any reserve under section 419A(c)(2)(A) for post-
retirement medical benefits.
    Section 512(a)(3)(E) was added to the Code under the Tax Reform Act 
of 1984, Public Law 98-369 (98 Stat. 598 (1984)). Congress enacted 
section 512(a)(3)(E) to limit the extent to which a VEBA, SUB, or 
GLSO's income is exempt from tax, noting that ``[p]resent law does not 
specifically limit the amount of income that can be set aside'' by a 
VEBA, SUB, or GLSO on a tax-free basis. H.R. Rep. No. 98-432, pt. 2, at 
1275.
    To implement section 512(a)(3)(E), Sec.  1.512(a)-5T was published 
in the Federal Register as TD 8073 on February 4,1986 (51 FR 4312), 
with an immediate effective date. A cross-referencing Notice of 
Proposed Rulemaking (the 1986 Proposed Regulation) was issued 
contemporaneously with the temporary regulation. Written comments were 
received on the 1986 Proposed Regulation, and a public hearing was held 
on June 26, 1986. The 1986 Proposed Regulation is hereby withdrawn and 
replaced by the new proposed regulation that is published in this 
document. Section 1.512(a)-5T will continue to apply until it is 
removed by a final rule published in the Federal Register. This new 
proposed regulation contains some changes to improve clarity and 
respond to comments received on the 1986 Proposed Regulation, but 
otherwise generally has the same effect as the 1986 Proposed Regulation 
and Sec.  1.512(a)-5T.

Explanation of Provisions

Covered Entity

    This new proposed regulation uses the uniform term ``Covered 
Entity'' to describe VEBAs and SUBs subject to the UBTI computation 
rules of section 512(a)(3).\1\ For taxable years beginning after June 
30, 1992, GLSOs are no longer exempt as section 501(c)(20) 
organizations. See section 120(e). Therefore, a GLSO is no longer a 
Covered Entity. Effective July 1, 1992, a GLSO could, if it otherwise 
qualified, request a ruling or determination modifying the basis for 
its exemption from section 501(c)(20) to section 501(c)(9).
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    \1\ While section 501(c)(7) organizations are also subject to 
the UBTI computation rules of section 512(a)(3), this proposed 
regulation addresses only computations for VEBAs and SUBs.
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Limitation on Amounts Set Aside for Exempt Purposes

    The 1986 Proposed Regulation and Sec.  1.512(a)-5T provide that 
under section 512(a)(3)(E)(i), a Covered Entity's UBTI is generally the 
lesser of two amounts: (1) The investment income of the Covered Entity 
for the taxable year (excluding member contributions), or (2) the 
excess of the total amount set aside as of the close of the taxable 
year (including member contributions and excluding certain long-term 
assets) over the qualified asset account limit (calculated without 
regard to the otherwise permitted reserve for post-retirement medical 
benefits) for the taxable year. In the view of the Treasury Department 
and the IRS, this means that UBTI is calculated based on the extent to 
which the assets of a Covered Entity at the end of the year exceed the 
section 512 limitation, regardless of whether income was allocated to 
payment of benefits during the course of the year.
    In CNG Transmission Mgmt. VEBA v. U.S., 588 F.3d 1376 (Fed. Cir. 
2009), aff'g, 84 Fed. Cl. 327 (2008), the Federal Circuit Court of 
Appeals decided in favor of the IRS on this issue. The Court said that 
the ``language of section 512(a)(3)(E) is clear and unambiguous,'' and 
that a VEBA ``may not avoid the limitation on exempt function income in 
[section] 512(a)(3)(E)(i) merely by allocating investment income toward 
the payment of welfare benefits during the course of the tax year.'' 
CNG, 558 F.3d at 1379, 1377-78; accord Northrop Corp. Employee 
Insurance Benefit Plans Master Trust v. U.S., 99 Fed. Cl. 1 (2011), 
aff'd, 467 Fed. Appx. 886 (Fed. Cir. April 10, 2012), cert. denied, 
(Dec. 3, 2012).
    Notwithstanding the view of the Treasury Department and the IRS and 
support for that view in the foregoing cases, one court has applied a 
different interpretation. In Sherwin-Williams Co. Employee Health Plan 
Trust v. Comm'r, 330 F.3d 449 (6th Cir. 2003), rev'g, 115 T.C. 440 
(2000), the Sixth Circuit Court of Appeals held that investment income 
that the taxpayer VEBA earmarked and claimed was spent before year-end 
on reasonable costs of administration was not subject to the section 
512(a)(3)(E) limit on exempt function income.\2\ The Treasury 
Department and the IRS believe that the decision in Sherwin-Williams is 
contrary to the statute, the legislative history of section 
512(a)(3)(E), Sec.  1.512(a)-5T, and the 1986 Proposed Regulation, and 
have determined that it is appropriate to issue this proposed 
regulation clarifying the proper way to make the calculation.\3\ If the 
final regulation follows the approach taken in this proposed 
regulation, the IRS will no longer recognize the precedential effect of 
Sherwin-Williams in the Sixth Circuit.
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    \2\ As noted by the Federal Circuit in CNG, Sherwin-Williams can 
be viewed as distinguishable on its facts because the government 
there agreed to a stipulation that the investment income at issue 
had been spent on administrative costs, and in CNG there was not an 
equivalent stipulation. The Treasury Department and the IRS believe 
that the stipulation in Sherwin-Williams is not a distinction that 
should have affected the outcome. Specifically, the Treasury 
Department and the IRS believe that regardless of whether investment 
income is earmarked for (or otherwise traceable to) the payment of 
program benefits and administrative expenses during the year, the 
formula set forth in the 1986 Proposed Regulation and Sec.  
1.512(a)-5T, as well as the new proposed regulation, operates the 
same way.
    \3\ The IRS's interpretation is set forth in its non-
acquiescence to the Sherwin-Williams decision (AOD 2005-02, 2005-35 
I.R.B. 422). In AOD 2005-02, the IRS recognized the precedential 
effect of the decision to cases appealable to the Sixth Circuit and 
indicated that it would follow Sherwin-Williams with respect to 
cases within that circuit if the opinion cannot be meaningfully 
distinguished.
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    This new proposed regulation retains the formula set forth in the 
1986 Proposed Regulation and Sec.  1.512(a)-5T but modifies and 
clarifies the description and adds examples. This new proposed 
regulation specifically states that any investment income a Covered 
Entity earns during the taxable year is subject to unrelated business 
income tax (UBIT) to the extent the Covered Entity's year-end assets 
exceed the account limit, and clarifies that this rule applies 
regardless of how that income is used.
    To further improve clarity, this new proposed regulation slightly 
modifies language from the prior version of Q&A-3, separates it into a 
new Q&A-2 and -3, and adds examples.
    This new proposed regulation also reflects the rule under section

[[Page 7112]]

512(a)(3)(B) that the UBTI of a Covered Entity includes UBTI derived by 
the Covered Entity from any unrelated trade or business (as defined in 
section 513) regularly carried on by it, computed as if the 
organization were subject to section 512(a)(1).
    In addition, this new proposed regulation reflects the special rule 
under section 512(a)(3)(E)(iii). Accordingly, a Covered Entity is not 
subject to the limitation under section 512(a)(3)(E) if substantially 
all of the contributions to the Covered Entity are made by employers 
who were tax exempt throughout the five-year taxable period ending with 
the taxable year in which the contributions are made.

Special Rules Relating to Sections 419A(f)(5) and 419A(f)(6)

    Some commenters on the 1986 Proposed Regulation requested that the 
regulations explicitly provide that the special account limits under 
section 419A(f)(5) for collectively bargained plans be used in 
determining the set aside limits under section 512. The 1986 Proposed 
Regulation contained a rule that references Sec.  1.419A-2T for special 
rules relating to collectively bargained welfare benefit funds. The 
Treasury Department and the IRS are actively working on regulations 
under section 419A(f)(5) relating to collectively-bargained welfare 
benefit funds and believe it is appropriate to address issues related 
to collectively bargained welfare benefit funds in that project.
    A number of commenters suggested that a VEBA that is part of a 10 
or more employer plan described in section 419A(f)(6) should be 
exempted from the UBTI rules under section 512. However, after the 1986 
Proposed Regulation and Sec.  1.512(a)-5T were published, the Technical 
Corrections to the Tax Reform Act of 1984, which was part of the Tax 
Reform Act of 1986, Public Law 99-514, added language to section 
512(a)(3)(E)(i) that specifically subjects 10 or more employer plans to 
the set aside limit described in that section . See section 
1851(a)(10)(A) of Public Law 99-514. Consistent with this change in the 
law, this new proposed regulation provides that a Covered Entity that 
is part of a 10 or more employer plan is subject to the set aside 
limit, and that the account limit is determined as if the plan is not 
subject to the exception under section 419A(f)(6).

Treatment of Existing Reserves

    A number of concerns were raised by commenters relating to the 
rules in the 1986 Proposed Regulation regarding existing reserves. For 
example, one commentator stated that the requirement that an employer 
must charge all post-retirement claims paid on or after July 18, 1984 
against any existing reserve as of July 18, 1984 (and earnings on 
existing reserves) is burdensome. However, this treatment of existing 
reserves is required under section 512(a)(3)(E)(ii)(III). Thus, this 
new proposed regulation retains the rules regarding existing reserves 
in the 1986 Proposed Regulation and adds a clarification to the 
example.

Proposed Effective Date

    This regulation is proposed to apply to taxable years ending on or 
after the date of publication of the final regulation.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to this regulation, and because the 
regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this regulation has 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Requests for Public Hearing

    Before this proposed regulation is adopted as a final regulation, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are timely submitted to the 
IRS. The Treasury Department and the IRS request comments on all 
aspects of the proposed rules. All comments will be available for 
public inspection and copying. A public hearing will be scheduled if 
requested in writing by any person that timely submits written or 
electronic comments. If a public hearing is scheduled, notice of the 
date, time, and place for the hearing will be published in the Federal 
Register.

Drafting Information

    The principal authors of this regulation are Dara Alderman and 
Janet Laufer, Office of Division Counsel/Associate Chief Counsel (Tax 
Exempt and Government Entities). However, other personnel from the 
Treasury Department and the IRS participated in the development of this 
regulation.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to be read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.512(a)-5 is added to read as follows:


Sec.  1.512(a)-5  Questions and answers relating to the unrelated 
business taxable income of organizations described in paragraphs (9) or 
(17) of section 501(c).

    Q-1. What does section 512(a)(3) provide with respect to 
organizations described in paragraphs (9) or (17) of section 501(c)?
    A-1. (a) In general, section 512(a)(3) provides rules for 
determining the unrelated business income tax of voluntary employees' 
beneficiary associations (VEBAs) and supplemental unemployment benefit 
trusts (SUBs). Under section 512(a)(3)(A), a Covered Entity's 
``unrelated business taxable income'' means all income except exempt 
function income. Under section 512(a)(3)(B), exempt function income 
includes income that is set aside for exempt purposes, as described in 
Q&A-2 of this section, subject to certain limits, as described in Q&A-3 
of this section.
    (b) For purposes of this section, a ``Covered Entity'' means a VEBA 
or a SUB.
    Q-2. What is exempt function income?
    A-2. (a) Under section 512(a)(3)(B), the exempt function income of 
a Covered Entity for a taxable year means the sum of--
    (1) amounts referred to in the first sentence of section 
512(a)(3)(B) that are paid by members of the Covered Entity and 
employer contributions to the Covered Entity (collectively ``member 
contributions''); and
    (2) other income of the Covered Entity (including earnings on 
member contributions) that is set aside for--
    (i) a purpose specified in section 170(c)(4) and reasonable costs 
of administration directly connected with such purpose, or
    (ii) subject to the limitation of section 512(a)(3)(E) (as 
described in Q&A-3 of this section), the payment of life, sick, 
accident, or other benefits and

[[Page 7113]]

reasonable costs of administration directly connected with such 
purpose.
    (b) The other income described in paragraph (a)(2) of this Q&A-2 
does not include the gross income derived from any unrelated trade or 
business (as defined in section 513) regularly carried on by the 
Covered Entity, computed as if the organization were subject to section 
512(a)(1).
    Q-3. What are the limits on the amount that may be set aside?
    A-3. (a) Pursuant to section 512(a)(3)(E)(i), and except as 
provided in paragraph (b) of this Q&A-3, the amount of investment 
income (as defined in paragraph (c)(1) of this Q&A-3) set aside by a 
Covered Entity as of the close of a taxable year of such Covered Entity 
to provide for the payment of life, sick, accident, or other benefits 
(and administrative costs associated with the provision of such 
benefits) is not taken into account for purposes of determining the 
amount of that income that constitutes ``exempt function income'' to 
the extent that the total amount of the assets of the Covered Entity at 
the end of the taxable year to provide for the payment of life, sick, 
accident, or other benefits (and related administrative costs) exceeds 
the applicable account limit for such taxable year of the Covered 
Entity (as described in paragraph (d) of this section). Accordingly, 
any investment income a Covered Entity earns during the taxable year is 
subject to unrelated business income tax to the extent the Covered 
Entity's year-end assets exceed the applicable account limit. This rule 
applies regardless of whether the Covered Entity spends or retains (or 
is deemed to spend or deemed to retain) that investment income during 
the course of the year. Thus, in addition to the unrelated business 
taxable income derived by a Covered Entity from any unrelated trade or 
business (as defined in section 513) regularly carried on by it, 
computed as if the organization were subject to section 512(a)(1), the 
unrelated business taxable income of a Covered Entity for a taxable 
year of such an organization includes the lesser of--
    (1) the investment income of the Covered Entity for the taxable 
year, or
    (2) the excess of the total amount of the assets of the Covered 
Entity (excluding amounts set aside for a purpose described in section 
170(c)(4)) as of the close of the taxable year over the applicable 
account limit for the taxable year.
    (b) In accordance with section 512(a)(3)(E)(iii), a Covered Entity 
is not subject to the limits described in this Q&A-3 if substantially 
all of the contributions to the Covered Entity are made by employers 
who were tax exempt throughout the five year taxable period ending with 
the taxable year in which the contributions are made.
    (c) For purposes of this section, a Covered Entity's ``investment 
income''--
    (1) means all income except--
    (i) member contributions described in paragraph (a)(1) of Q&A-2 of 
this section;
    (ii) income set aside as described in paragraph (a)(2)(i) of Q&A-2 
of this section; or
    (iii) income from any unrelated trade or business described in 
paragraph (b) of Q&A-2 of this section; and
    (2) includes gain realized by the Covered Entity on the sale or 
disposition of any asset during such year (other than gain on the sale 
or disposition of assets of an unrelated trade or business described in 
paragraph (b) of Q&A-2 of this section). The gain realized by a Covered 
Entity on the sale or disposition of an asset is equal to the amount 
realized by the organization over the basis of such asset in the hands 
of the organization reduced by any qualified direct costs attributable 
to such asset (under paragraphs (b), (c), and (d) of Q&A-6 of Sec.  
1.419A-1T).
    (d) In calculating the total amount of the assets of a Covered 
Entity as of the close of the taxable year, certain assets with useful 
lives extending substantially beyond the end of the taxable year (for 
example, buildings, and licenses) are not to be taken into account to 
the extent they are used in the provision of life, sick, accident, or 
other benefits. By contrast, cash and securities (and other similar 
investments) held by a Covered Entity are taken into account in 
calculating the total amount of the assets of a Covered Entity as of 
the close of the taxable year because they are used to pay welfare 
benefits, rather than merely used in the provision of such benefits.
    (e) The determination of the applicable account limit for purposes 
of this Q&A-3 is made under the rules of sections 419A(c) and 
419A(f)(7), except that a reserve for post-retirement medical benefits 
under section 419A(c)(2)(A) is not to be taken into account. See Sec.  
1.419A-2T for special rules relating to collectively bargained welfare 
benefit funds.
    (f) The limits of this Q&A-3 apply to a Covered Entity that is part 
of a 10 or more employer plan, as defined in section 419A(f)(6). For 
this purpose, the account limit is determined as if the plan is not 
subject to the exception under section 419A(f)(6).
    (g) Examples. The following examples illustrate the calculation of 
a VEBA's UBTI:

    Example 1 (a) Employer X establishes a VEBA as of January 1, 
2013, through which it provides health benefits to active employees. 
The plan year is the calendar year. The VEBA has no employee 
contributions or member dues, receives no income from an unrelated 
trade or business regularly carried on by the VEBA, and has no 
income set aside for a purpose specified in section 170(c)(4). The 
VEBA's investment income in 2013 is $1,000. As of December 31, 2013, 
the applicable account limit under section 512(a)(3)(E)(i) is $5,000 
and the total amount of assets is $7,000.
    (b) The UBTI for 2013 is $1,000. This is because the UBTI is the 
lesser of (1) the investment income for the year ($1,000) and (2) 
the excess of the VEBA assets over the account limit at the end of 
the year ($7,000 over $5,000, or $2,000).
    Example 2 (a) The facts are the same as in Example 1, except 
that the VEBA's applicable account limit under section 
512(a)(3)(E)(i) as of December 31, 2013, is $6,500.
    (b) The UBTI for 2013 is $500. This is because the UBTI for 2013 
is the lesser of (1) the investment income for the year ($1,000) and 
(2) the excess of the VEBA assets over the account limit at the end 
of the year ($7,000 over $6,500, or $500).
    Example 3 (a) Employer Y contributes to a VEBA through which Y 
provides health benefits to active and retired employees. The plan 
year is the calendar year. At the end of 2012, there was no 
carryover of excess contributions within the meaning of section 
419(d), the balance in the VEBA was $25,000, the Incurred but Unpaid 
(IBU) claims reserve was $6,000, the reserve for post-retirement 
medical benefits (PRMB) (computed in accordance with section 
419A(c)(2)) was $19,000, and there were no existing reserves within 
the meaning of section 512(a)(3)(E)(ii). During 2013, the VEBA 
received $70,000 in employer contributions and $5,000 in investment 
income, paid $72,000 in benefit payments and $7,000 in 
administrative expenses, and received no income from an unrelated 
trade or business regularly carried on by the VEBA. All the 2013 
benefit payments are with respect to active employees and the IBU 
claims reserve (that is, the account limit under section 419A(c)(1)) 
at the end of 2013 was $7,200. The reserve for PRMB at the end of 
2013 was $20,000. All amounts designated as ``administrative 
expenses'' are expenses incurred in connection with the 
administration of the employee health benefits. ``Investment 
income'' is net of administrative costs incurred in the production 
of the investment income (for example, investment management and/or 
brokerage fees). Only employers contributed to the VEBA (that is, 
there were no employee contributions or member dues/fees). The VEBA 
did not set aside any income for the a purpose specified in section 
170(c)(4).
    (b) The total amount of assets of the VEBA at the end of 2013 is 
$21,000 (that is, $25,000 beginning of year balance + $70,000

[[Page 7114]]

contributions + $5,000 investment income - ($72,000 in benefit 
payments + $7,000 in administrative expenses)).
    (c) The applicable account limit under section 512(a)(3)(E)(i) 
(that is, the account limit under section 419A(c), excluding the 
reserve for post retirement medical benefits) is the IBU claims 
reserve ($7,200).
    (d) The total amount of assets of the VEBA as of the close of 
the year ($21,000) exceeds the applicable account limit ($7,200) by 
$13,800.
    (e) The unrelated business taxable income is $5,000 (that is, 
the lesser of investment income ($5,000) and the excess of the 
amount of assets of the VEBA as of the close of the taxable year 
over the applicable account limit ($13,800)).
    Example 4 (a) The facts are the same as in Example 3 except that 
the 2012 year-end balance was $15,000.
    (b) The total amount of assets in the VEBA at the end of 2013 is 
$11,000 (that is, $15,000 beginning of year balance + $70,000 
contributions + $5,000 investment income - ($72,000 in benefit 
payments + $7,000 in administrative expenses)).
    (c) The applicable account limit under section 512(a)(3)(E)(i) 
remains $7,200.
    (d) The total amount of assets of the VEBA as of the close of 
the year ($11,000) exceeds the applicable account limit ($7,200) by 
$3,800.
    (e) The unrelated business taxable income is $3,800 (that is, 
the lesser of investment income ($5,000) and the excess of the total 
amount of assets of the VEBA at the close of the taxable year over 
the applicable account limit ($3,800)).

    Q-4. What is the effective date of the amendments to section 
512(a)(3) and what transition rules apply to ``existing reserves for 
post-retirement medical or life insurance benefits''?
    A-4. (a) The amendments to section 512(a)(3), made by the Tax 
Reform Act of 1984, apply to income earned by a Covered Entity after 
December 31, 1985, in the taxable years of such an organization ending 
after such date.
    (b) Section 512(a)(3)(E)(ii)(I) provides that income that is 
attributable to ``existing reserves for post-retirement medical or life 
insurance benefits'' will not be treated as unrelated business taxable 
income. This includes income that is either directly or indirectly 
attributable to existing reserves. An ``existing reserve for post-
retirement medical or life insurance benefits'' (as defined in section 
512(a)(3)(E)(ii)(II)) is the total amount of assets actually set aside 
by a Covered Entity on July 18, 1984 (calculated in the manner set 
forth in Q&A-3 of this section, and adjusted under paragraph (c) of 
Q&A-11 of Sec.  1.419-1T), reduced by employer contributions to the 
fund on or before such date to the extent such contributions are not 
deductible for the taxable year of the employer containing July 18, 
1984, and for any prior taxable year of the employer, for purposes of 
providing such post-retirement benefits. For purposes of the preceding 
sentence only, an amount that was not actually set aside on July 18, 
1984, will be treated as having been actually set aside on such date 
if--
    (1) such amount was incurred by the employer (without regard to 
section 461(h)) as of the close of the last taxable year of the Covered 
Entity ending before July 18, 1984, and
    (2) such amount was actually contributed to the Covered Entity 
within 8\1/2\ months following the close of such taxable year.
    (c) In addition, section 512(a)(3)(E)(ii)(I) applies to existing 
reserves for such post-retirement benefits only to the extent that such 
``existing reserves'' do not exceed the amount that could be 
accumulated under the principles set forth in Revenue Rulings 69-382, 
1969-2 CB 28; 69-478, 1969-2 CB 29; and 73-599, 1973-2 CB 40. Thus, 
amounts attributable to any such excess ``existing reserves'' are not 
within this transition rule even though they were actually set aside on 
July 18, 1984. See Sec.  601.601(d)(2)(ii)(b).
    (d) All post-retirement medical or life insurance benefits (or 
other benefits to the extent paid with amounts set aside to provide 
post-retirement medical or life insurance benefits) provided after July 
18, 1984 (whether or not the employer has maintained a reserve or fund 
for such benefits) are to be charged, first, against the ``existing 
reserves'' within this transition rule (including amounts attributable 
to ``existing reserves'' within this transition rule) for post-
retirement medical benefits or for post-retirement life insurance 
benefits (as the case may be) and, second, against all other amounts. 
For this purpose, the qualified direct cost of an asset with a useful 
life extending substantially beyond the end of the taxable year (as 
determined under Q&A-6 of Sec.  1.419-1T) will be treated as a benefit 
provided and thus charged against the ``existing reserve'' based on the 
extent to which such asset is used in the provision of post-retirement 
medical benefits or post-retirement life insurance benefits (as the 
case may be). All plans of an employer providing post-retirement 
medical benefits are to be treated as one plan for purposes of section 
512(a)(3)(E)(ii)(III), and all plans of an employer providing post-
retirement life insurance benefits are to be treated as one plan for 
purposes of section 512(a)(3)(E)(ii)(III).
    (e) In calculating the unrelated business taxable income of a 
Covered Entity for a taxable year of such organization, the total 
income of the Covered Entity for the taxable year is reduced by the 
income attributable to ``existing reserves'' within the transition rule 
before such income is compared to the excess of the total amount of the 
assets of the Covered Entity as of the close of the taxable year over 
the applicable account limit for the taxable year.
    (f) The following example illustrates the calculation of a VEBA's 
UBTI:

    Example. Assume that the total income of a VEBA for a taxable 
year is $1,000, and that the excess of the total amount of the 
assets of the VEBA as of the close of the taxable year over the 
applicable account limit is $600. Assume also that of the $1,000 of 
total income, $540 is attributable to ``existing reserves'' within 
the transition rule of section 512(a)(3)(E)(ii)(I). The unrelated 
business taxable income of this VEBA for the taxable year is equal 
to the lesser of the following two amounts: (1) The total income of 
the VEBA for the taxable year, reduced by the extent to which such 
income is attributable to ``existing reserves'' within the meaning 
of the transition rule ($1,000 - $540 = $460); or (2) the excess of 
the total amount of the assets of the VEBA as of the close of the 
taxable year over the applicable account limit ($600). Thus, the 
unrelated business income of this VEBA for the taxable year is $460.

    Q-5. What is the effective/applicability date of this section?
    A-5. Except as otherwise provided in this paragraph, this section 
is applicable to taxable years ending on or after the date of 
publication of the final regulation. For rules that apply to earlier 
periods, see 26 CFR 1.512(a)-5T (revised as of April 1, 2013).

John M. Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2014-01625 Filed 2-5-14; 8:45 am]
BILLING CODE 4830-01-P