New law overturns 2006 IRS ruling; improves VEBA Death Benefits

Last month, President Obama signed legislation that will fund the federal government – through September 2016 – and extend certain expiring tax provisions. The Protecting Americans from Tax Hikes (PATH) Act, which was enacted effective December 18, 2015, includes an amendment to Section 105(j) of the Internal Revenue Code that prevents the forfeiture of death benefits by allowing the taxable reimbursement of medical expenses for designated beneficiaries such as adult children, siblings, parents and others.

Section 105(j) allows for certain funded HRAs, sponsored by a State retirement system, to provide reimbursements to designated beneficiaries (other than the Participant’s spouse and tax dependents) without jeopardizing the tax advantages of the Plan. The PATH Act expands the types of Plans to which Section 105(j) applies to include HRAs sponsored by any State or political subdivision that is funded through a Section 115 trust* or a Voluntary Employee Beneficiary Association (VEBA) trust.

As amended, Section 105(j) provides that benefits provided to Participants and tax dependents will not be included in income “solely because such plan, on or before January 1, 2008, provides for reimbursements of health care expenses of a deceased employee’s beneficiary.” Accordingly, only those Clients who had adopted a funded HRA and provided reimbursements to designated beneficiaries on or prior to January 1, 2008, would be able to take advantage of the special designated beneficiary rule.**

Note: This change does not authorize cash distributions to designated beneficiaries or the participant’s estate; the law authorizes only “reimbursements of health care expenses of a deceased employee’s beneficiary.

Rick Allen, TASC’s Executive Vice President of Public Sector & Strategic Markets, was heavily involved throughout the process, spending years advocating for this change. “Although a small part of the overall (2,000 page) bill, this fix is a huge victory for VEBA Plan Participants,” said Rick, who has more than 25 years of employee benefits advisory and consulting experience working with public and private sector employers across the United States.

For those groups that wish to take advantage of the amendment to Section 105, TASC will follow up in the near future with a more detailed communication (including next steps – if any).

*An HRA that is funded through a Section 115 would not be able to take advantage of this special rule unless the employer has obtained a private letter ruling from the IRS that the trust’s income is not includable in gross income under Section 115.

**The impact of the reference to January 1, 2008, is not entirely clear; those employers opting for the more aggressive interpretation of the statute, are encouraged to consult legal/tax counsel in order to determine whether the new rule applies to their Plan.