Calculation of UBTI for Certain Exempt Organizations, 67370-67375 [2019-26274]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 84, Number 237 (Tuesday, December 10, 2019)]
[Rules and Regulations]
[Pages 67370-67375]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-26274]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9886]
RIN 1545-BJ92


Calculation of UBTI for Certain Exempt Organizations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation and removal of temporary regulation.

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SUMMARY: This document contains a final regulation providing guidance 
on how certain organizations that provide employee benefits must 
calculate unrelated business taxable income (UBTI).

DATES: 
    Effective Date: This regulation is effective December 10, 2019.
    Applicability Date: This regulation applies to taxable years 
beginning on or after December 10, 2019. For rules that apply to 
earlier periods, see Sec.  1.512(a)-

[[Page 67371]]

5T as contained in 26 CFR part 1, revised April 1, 2019.

FOR FURTHER INFORMATION CONTACT: Jennifer Solomon or Janet Laufer at 
(202) 317-5500 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains final 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), and supplemental unemployment benefit trusts described in 
section 501(c)(17) (SUBs).
    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, and SUBs, 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, 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 or 
SUB, 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).
    As described in greater detail below, section 512(a)(3)(E) 
generally limits the amount that a VEBA or SUB may set aside as exempt 
function income to an amount that does not result in an amount of total 
assets in the VEBA or SUB at the end of the taxable year that exceeds 
the section 419A account limit for the taxable year. As specified in 
section 512(a)(3)(E)(i), for this purpose, 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's or SUB'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 or SUB 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 was withdrawn and 
replaced by a new proposed regulation (the 2014 proposed regulation) 
that was published in the Federal Register on February 6, 2014 (79 FR 
7110). The Treasury Department and the IRS received two comments on the 
2014 proposed regulation. No public hearing was held.
    The Treasury Department and the IRS have considered the comments 
received in response to the 2014 proposed regulation. This final 
regulation adopts the provisions of the 2014 proposed regulation with 
no modifications other than the following changes: (1) A change in the 
applicability date to taxable years beginning on or after the date of 
publication of this final regulation; (2) the addition of a clause 
modifying the definition of covered entity to include certain 
corporations described in section 501(c)(2), as provided in section 
512(a)(3)(C); (3) the addition of a clause which refers to the 
provision in section 512(a)(3)(D) addressing nonrecognition of gain in 
the case of sales of certain property; and (4) updates to the examples, 
formatting changes, and other minor changes in wording, which are 
nonsubstantive. The modifications to the definition of covered entity 
and the addition of the clause addressing nonrecognition of gain are 
described under the heading ``Summary of Comments and Explanation of 
Provisions.'' The temporary regulation is removed.

Summary of Comments and Explanation of Provisions

Covered Entity

    Consistent with the 2014 proposed regulation, this final 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, group legal services 
organizations (GLSOs) are no longer exempt as section 501(c)(20) 
organizations.\2\ See section 120(e). Therefore, a GLSO is no longer a 
Covered Entity.
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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 regulation 
addresses only computations for VEBAs and SUBs.
    \2\ The preamble of the 2014 proposed regulation referred to 
GLSOs. However, on December 19, 2014, the Tax Increase Prevention 
Act of 2014, Public Law 113-295 (128 Stat. 4010) repealed sections 
120 and 501(c)(20) regarding GLSOs as ``deadwood'' provisions.
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    The 2014 proposed regulation did not reflect the provision of 
section 512(a)(3)(C), which provides that section 512(a)(3)(A) applies 
to a corporation described in section 501(c)(2), the income of which is 
payable to an organization described in section 501(c)(7), (9), or 
(17), as if the corporation were the organization to which the income 
is payable. For this purpose, the corporation is treated as having 
exempt function income for a taxable year only if it files a 
consolidated return with the organization described in section 
501(c)(7), (9), or (17). In this final regulation, a clause has been 
added to clarify that the term ``Covered Entity'' includes a 
corporation described in section 501(c)(2) to the extent provided in 
section 512(a)(3)(C).

Nonrecognition of Gain

    The 2014 proposed regulation did not reflect the provision of 
section 512(a)(3)(D) regarding nonrecognition of gain with respect to 
the sale of certain property. In this final regulation, a clause has 
been added to refer to that provision. Section 512(a)(3)(D) provides 
that, if property used directly in the performance of the exempt 
function of a Covered Entity is sold by the Covered Entity, and other 
property is purchased and used by the Covered Entity directly in the 
performance of its exempt function within a four-year period beginning 
one year before the date of the sale, and ending three years after the 
date of sale, gain (if any) from the sale is recognized only to the 
extent that the sales price of the old property exceeds the Covered 
Entity's cost of purchasing the other property.

[[Page 67372]]

Limitation on Amounts Set Aside for Exempt Purposes

    Section 512(a)(3)(E)(i) limits the amount of investment income a 
Covered Entity may treat as nontaxable exempt function income in any 
given year to the extent such income ``result[s] in'' a year-end 
account balance ``in excess of'' the modified section 419A account 
limit. An account overage can be considered the result of, or 
essentially caused by, investment income only by considering all 
investment income earned during the year. Thus, in order to give an 
appropriate meaning to the term ``result in'', the total amount of 
investment income earned during the year should be considered when 
calculating whether an excess exists at the end of the year.
    Certain taxpayers have taken a contrary position and asserted that 
investment income may be set aside and used separately before the end 
of a taxable year for current benefit payments and related 
administrative costs (collectively, ``benefit expenditures'') and 
thereby avoid the limit imposed by section 512(a)(3)(E)(i) on exempt 
function income. 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 
VEBA earmarked and claimed was spent before year-end on reasonable 
costs of administration was not subject to the section 512(a)(3)(E)(i) 
limit on exempt function income. In contrast, 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 rejected this argument. 
The Court stated that the ``language of section 512(a)(3)(E) is clear 
and unambiguous,'' and upheld the Court of Federal Claims' conclusion 
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).
    The Treasury Department and the IRS have concluded 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 and 2014 proposed regulations, and have determined that it is 
appropriate to issue this final regulation clarifying the proper 
calculation method.\3\ Specifically, the Treasury Department and the 
IRS disagree with the Sixth Circuit's conclusion that investment income 
may be set aside and used separately before the end of a taxable year 
to pay the reasonable costs of administering health care benefits and 
thereby avoid the limit imposed by section 512(a)(3)(E)(i) on exempt 
function income.\4\
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    \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 the decision in Sherwin-Williams with 
respect to cases within that circuit if the opinion could not be 
meaningfully distinguished.
    \4\ Notably, the Sixth Circuit opinion in Sherwin-Williams 
concluded that section 512(a)(3)(E)(i) supported the interpretation 
adopted by the court, not that the interpretation was based on the 
unambiguous terms of the statute or even the best reading of the 
statute. The Sixth Circuit also erroneously considered the 1986 
temporary regulation as consistent with that interpretation.
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    The fungible nature of money means that there is necessarily a 
connection between investment income that a Covered Entity earns during 
the year and the total amount of funds in the entity at year-end, even 
if the Covered Entity purports to apply all of that income to benefit 
expenditures. For example, a VEBA with a beginning balance of $1,000, 
investment income of $100, benefit expenditures of $3,000, and employer 
contributions of $3,000, will have a year-end balance of $1,100. This 
will be true regardless of whether the VEBA allocates the investment 
income to the benefit expenditures. Assume that the VEBA's year-end 
account limit under section 512(a)(3)(E)(i) is $1,010, so that there is 
an account overage of $90. Absent $90 of the investment income, the 
VEBA would have had a year-end account balance of $1,010 and no account 
overage. Thus, $90 of the investment income in the example ``result[s] 
in'' a year-end account balance ``in excess of'' the VEBA's year-end 
account limit and may not be set aside and excluded as exempt function 
income.
    The analysis that all investment income earned during a year should 
be considered in determining whether there is an account overage is 
consistent with the Joint Committee on Taxation's report with respect 
to the legislation that enacted section 512(a)(3)(E). This report 
indicated that investment income is subject to UBTI in ``an amount 
equal to the lesser of the income of the fund or the amount by which 
the assets in the fund exceed a specific limit on amounts set aside for 
exempt purposes.'' See Staff of the Joint Comm. on Taxation, 98th 
Cong., General Explanation of the Revenue Provisions of the Deficit 
Reduction Act of 1984, at 790 (Comm. Print 1984) (JCS-41-84). 
Accordingly, the Treasury Department and the IRS continue to interpret 
section 512(a)(3)(E)(i) to mean that whether a VEBA or SUB allocated 
its investment income (rather than other funds) to current year 
expenditures is irrelevant to the application of the set aside 
limitation.
    As discussed above, the statutory provisions are not dependent upon 
a determination as to whether particular sources of income were used 
for benefit expenditures in any particular year. Rather, the ``result 
in'' language of section 512(a)(3)(E)(i) means that amounts set aside 
for benefit expenditures are treated as exempt function income only to 
the extent the total amount set aside for such purposes as of the end 
of the year is equal to or less than ``the account limit determined 
under section 419A . . . for the taxable year (not taking into account 
any reserve described in section 419A(c)(2)(A) for post-retirement 
medical benefits).'' Accordingly, the final regulations reflect this 
rule, and, for taxable years to which these regulations apply, the IRS 
will apply this final regulation to cases arising in the Sixth Circuit.
    This final regulation retains the formula, description, and 
examples set forth in the 2014 proposed regulation. The 2014 proposed 
regulation retained the formula set forth in the 1986 proposed 
regulation and Sec.  1.512(a)-5T, but modified and clarified the 
description and added examples. Thus, consistent with the 2014 proposed 
regulation, this final 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.
    The IRS received two comments on the 2014 proposed regulation. One 
of the commenters asked that the proposed regulation be withdrawn on 
the basis that it is inconsistent with the statute, while the other 
commenter indicated his view that the position taken in the proposed 
regulation is a fair interpretation of the statute. With respect to the 
request that the 2014 proposed regulation be withdrawn, the Treasury 
Department and the IRS have concluded that the position in the 2014 
proposed regulation, and adopted in this final regulation, is not only 
consistent with the statute, but is correct

[[Page 67373]]

for the reasons set forth in this preamble.
    Both of the commenters expressed concern over the proposed 
applicability date in the 2014 proposed regulation because of its 
potential impact on VEBAs within the Sixth Circuit's jurisdiction. The 
2014 proposed regulation proposes that it will apply to taxable years 
ending on or after the date of publication of the final regulation. One 
commenter argued that the proposed applicability date would be unfair 
to VEBAs that are within the Sixth Circuit's jurisdiction because these 
VEBAs and their sponsors have been operating in good faith under a tax 
regime that a federal court of appeals held is the law. The commenter 
suggested that if the 2014 proposed regulation were finalized as 
proposed, the regulation should apply only with respect to taxable 
years beginning six months after the date the final regulation is 
published in the Federal Register, at least for VEBAs within the Sixth 
Circuit's jurisdiction.
    The other commenter stated that VEBAs that account for investment 
income in the manner approved by the Sixth Circuit have been operating 
in good faith and in accordance with a reasonable interpretation of the 
relevant Code provisions. The commenter expressed concern that if the 
regulation were finalized in the manner in which it was proposed, the 
investment income of those VEBAs would be retroactively taxed. The 
commenter therefore requested that the proposed applicability date be 
changed in the final regulation to the first taxable year beginning on 
or after the date of publication of the final regulation.
    Taking into account these comments, the Treasury Department and the 
IRS have decided to modify the applicability date, so that this final 
regulation applies to taxable years beginning on or after the date of 
publication of the final regulation (and so for VEBAs within the Sixth 
Circuit's jurisdiction, the position reflected in AOD 2005-02 would 
apply through the end of the VEBA's taxable year in which the final 
regulation is issued).

Effective/Applicability Date

    This regulation is effective on December 10, 2019. The regulation 
applies to taxable years beginning on or after December 10, 2019. For 
rules that apply to earlier periods, see Sec.  1.512(a)-5T as contained 
in 26 CFR part 1, revised April 1, 2019.

Special Analyses

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Department of the Treasury and the Office of 
Management and Budget regarding review of tax regulations. Because this 
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, the notice of proposed 
rulemaking preceding this regulation was submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Drafting Information

    The principal authors of this regulation are Jennifer Solomon and 
Janet Laufer, Office of Associate Chief Counsel (Employee Benefits, 
Exempt Organizations, and Employment Taxes). 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.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

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

    Authority:  26 U.S.C. 7805, unless otherwise noted.
* * * * *

0
Par. 2. Section 1.512(a)-55 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).

    (a)(1) Q-1. What does section 512(a)(3) provide with respect to 
organizations described in paragraphs (9) or (17) of section 501(c)?
    (2) A-1. (i) 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'' (UBTI) 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 paragraph (b) of this section, subject to certain limits, 
as described in paragraph (c) of this section.
    (ii) For purposes of this section, a ``Covered Entity'' means a 
VEBA or a SUB, and, to the extent provided in section 512(a)(3)(C), a 
corporation described in section 501(c)(2).
    (b)(1) Q-2. What is exempt function income?
    (2) A-2. (i) Under section 512(a)(3)(B), the exempt function income 
of a Covered Entity for a taxable year means the sum of--
    (A) 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'');
    (B) Other income of the Covered Entity (including earnings on 
member contributions) that is set aside for a purpose specified in 
section 170(c)(4) and reasonable costs of administration directly 
connected with such purpose; and
    (C) Other income of the Covered Entity (including earnings on 
member contributions) that, subject to the limitation of section 
512(a)(3)(E) (as described in paragraph (c) of this section), is set 
aside for the payment of life, sick, accident, or other benefits and 
reasonable costs of administration directly connected with such 
purpose.
    (ii) The other income described in paragraphs (b)(2)(i)(B) and (C) 
of this section 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).
    (c)(1) Q-3. What are the limits on the amount that may be set 
aside?
    (2) A-3. (i) Pursuant to section 512(a)(3)(E)(i), and except as 
provided in paragraph (c)(2)(ii) of this section, the amount of 
investment income (as defined in paragraph (c)(2)(iii) of this section) 
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 set aside 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 (c)(2)(iv) of this

[[Page 67374]]

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. The rule in this paragraph (c)(2) 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--
    (A) The investment income of the Covered Entity for the taxable 
year; and
    (B) The excess (if any) of--
    (1) 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
    (2) The applicable account limit for the taxable year.
    (ii) In accordance with section 512(a)(3)(E)(iii), a Covered Entity 
is not subject to the limits described in this paragraph (c) 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.
    (iii) For purposes of this section, a Covered Entity's ``investment 
income''--
    (A) Means all income except--
    (1) Member contributions described in paragraph (b)(2)(i)(A) of 
this section;
    (2) Income set aside as described in paragraph (b)(2)(i)(B) of this 
section; or
    (3) Income from any unrelated trade or business described in 
paragraph (b)(2)(ii) of this section; and
    (B) 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)(2)(ii) of this section), except to the extent provided in 
section 512(a)(3)(D).
    (C) For purposes of paragraph (c)(2)(iii)(B) 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).
    (iv) 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 may be used to pay welfare 
benefits, rather than merely used in the provision of such benefits.
    (v) The determination of the applicable account limit for purposes 
of this paragraph (c) 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.
    (vi) The limits of this paragraph (c) apply to a Covered Entity 
that is part of a 10 or more employer plan, as defined in section 
419A(f)(6). For purposes of this paragraph (c), the account limit is 
determined as if the plan is not subject to the exception under section 
419A(f)(6).
    (vii) The following examples illustrate the calculation of a VEBA's 
UBTI.

     (A) Example 1. (1) Employer X establishes a VEBA as of January 
1, 2015, 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 2020 is $1,000. As of 
December 31, 2020, the applicable account limit under section 
512(a)(3)(E)(i) is $5,000 and the total amount of assets of the VEBA 
is $7,000.
    (2) The VEBA's UBTI for 2020 is $1,000. This is because the UBTI 
is the lesser of the investment income for the year ($1,000) and the 
excess of the VEBA assets over the account limit at the end of the 
year ($7,000 over $5,000, or $2,000).
    (B) Example 2. (1) The facts are the same as in the example in 
paragraph (c)(2)(vii)(A) of this section (Example 1), except that 
the VEBA's applicable account limit under section 512(a)(3)(E)(i) as 
of December 31, 2020, is $6,500.
    (2) The VEBA's UBTI for 2020 is $500. This is because the UBTI 
for 2020 is the lesser of the investment income for the year 
($1,000) and the excess of the VEBA assets over the account limit at 
the end of the year ($7,000 over $6,500, or $500).
    (C) Example 3. (1) 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 2020, 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 2021, the VEBA 
receives $70,000 in employer contributions and $5,000 in investment 
income, pays $72,000 in benefit payments and $7,000 in 
administrative expenses, and receives no income from an unrelated 
trade or business regularly carried on by the VEBA. All the 2021 
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 2021 was $7,200. The reserve for PRMB at the end of 
2021 is $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 
does not set aside any income for the purpose specified in section 
170(c)(4).
    (2) The total amount of assets of the VEBA at the end of 2021 is 
$21,000 (that is, $25,000 beginning of year balance + $70,000 
contributions + $5,000 investment income-($72,000 in benefit 
payments + $7,000 in administrative expenses)).
    (3) 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).
    (4) 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.
    (5) The unrelated business taxable income of the VEBA 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)).
    (D) Example 4. (1) The facts are the same as in the example in 
paragraph (c)(2)(vii)(C) of this section (Example 3) except that the 
2020 year-end balance was $15,000.
    (2) The total amount of assets in the VEBA at the end of 2021 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)).
    (3) The applicable account limit under section 512(a)(3)(E)(i) 
remains $7,200.
    (4) 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.
    (5) The VEBA's unrelated business taxable income is $3,800 (that 
is, the lesser of investment income ($5,000) and the excess of

[[Page 67375]]

the total amount of assets of the VEBA at the close of the taxable 
year over the applicable account limit ($3,800)).

    (d)(1) 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''?
    (2) A-4. (i) 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.
    (ii) 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 paragraph (c) 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 including 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 
the amount was--
    (A) 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
    (B) Actually contributed to the Covered Entity within 8 \1/2\ 
months following the close of such taxable year.
    (iii) 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 the transition rule of section 512(a)(3)(E)(ii)(I) even though 
they were actually set aside on July 18, 1984. See Sec.  
601.601(d)(2)(ii)(b) of this chapter.
    (iv) 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 the transition rule of section 512(a)(3)(E)(ii)(I) 
(including amounts attributable to ``existing reserves'' within the 
transition rule of section 512(a)(3)(E)(ii)(I) for post-retirement 
medical benefits or for post-retirement life insurance benefits (as the 
case may be)) and, second, against all other amounts. For purposes of 
this paragraph (d)(2)(iv), 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).
    (v) 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 
of section 512(a)(3)(E)(ii)(I) 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.
    (vi) The following example illustrates the calculation of UBTI for 
a VEBA that has existing reserves.

    (A) 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 $460, 
determined as 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 of section 
512(a)(3)(E)(ii)(I) ($1,000-$540 = $460); and
    (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).

    (B) [Reserved]
    (e)(1) Q-5. What is the applicability date of this section?
    (2) A-5. Except as otherwise provided in this paragraph (e)(2), 
this section is applicable to taxable years beginning on or after 
December 10, 2019. For rules that apply to earlier periods, see Sec.  
1.512(a)-5T, as contained in 26 CFR part 1, revised April 1, 2019.


Sec.  1.512(a)-5T  [Removed]

0
Par. 3. Section 1.512(a)-5T is removed.

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
    Approved: November 19, 2019.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2019-26274 Filed 12-9-19; 8:45 am]
BILLING CODE 4830-01-P