The opinion
115 T.C. No. 33
UNITED STATES TAX COURT
SHERWIN-WILLIAMS COMPANY EMPLOYEE HEALTH PLAN TRUST, KEY TRUST
COMPANY OF OHIO, TRUSTEE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21333-97. Filed November 9, 2000.
Trust (T), a tax-exempt voluntary employees’
beneficiary association described in sec. 501(c)(9),
I.R.C., set aside for each year at issue a certain
amount of investment income to provide for the payment
of reasonable costs of administration directly con-
nected with providing for the payment of health care
benefits (amount of investment income at issue).
Held: In determining for each year at issue the
unrelated business taxable income (UBTI) of T under
sec. 512(a)(3)(A), I.R.C., the amount of investment
income at issue is subject to the limitation prescribed
by sec. 512(a)(3)(E)(i), I.R.C. Held, further, in
calculating for each year at issue the limitation
prescribed by sec. 512(a)(3)(E)(i), I.R.C., the amount
of assets that T set aside to provide for the payment
of health care benefits, including reasonable costs of
administration directly connected with providing for
the payment of such benefits, is not to be reduced by
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the amount of the reserve described in sec.
419A(c)(2)(A), I.R.C., for post-retirement medical
benefits. Held, further, because of the limitation
prescribed by sec. 512(a)(3)(E)(i), I.R.C., in deter-
mining for each year at issue the UBTI of T under sec.
512(a)(3)(A), I.R.C., the amount of investment income
at issue may not be excluded as exempt function income.
Michael T. Cummins and Robert K. Olson, for petitioner.
Mark L. Hulse, for respondent.
OPINION1
CHIECHI, Judge: Respondent determined the following defi-
ciencies in the Federal income tax (tax) of The Sherwin-Williams
Company Employee Health Plan Trust (Trust):
Year Deficiency
1991 $489,941
1992 339,924
The issues for decision are:
(1) In determining for each year at issue the unrelated
business taxable income (UBTI) of the Trust under section
512(a)(3)(A),2 is the amount of investment income that the Trust
1
Unless otherwise indicated, our Opinion pertains to 1991
and 1992, the years at issue.
2
All section references are to the Internal Revenue Code
(Code) in effect for the years at issue. All Rule references are
to the Tax Court Rules of Practice and Procedure.
- 3 -
set aside3 to provide for the payment of reasonable costs of
administration directly connected with providing for the payment
of health care benefits subject to the limitation prescribed by
section 512(a)(3)(E)(i)? We hold that it is.
(2) In calculating for each year at issue the limitation
prescribed by section 512(a)(3)(E)(i), is the amount of assets
that the Trust set aside to provide for the payment of health
care benefits, including reasonable costs of administration
directly connected with providing for the payment of such bene-
fits, to be reduced by the amount of the reserve described in
section 419A(c)(2)(A) for post-retirement medical benefits
(reserve for post-retirement medical benefits)? We hold that it
is not.
Background
This case was submitted fully stipulated. The facts that
have been stipulated are so found except as stated herein.
At the time of the filing of the petition, the Trust’s
address was in care of its trustee, Key Trust Company of Ohio,
N.A. (Trustee), in Cleveland, Ohio.
On December 30, 1987, The Sherwin-Williams Company (Sherwin-
Williams) established the Trust to fund health care benefits for
participants in The Sherwin-Williams health care plan (Sherwin-
3
All references herein to an amount set aside are to an
amount set aside within the meaning of sec. 512(a)(3)(B).
- 4 -
Williams health care plan participants). On September 27, 1988,
the Commissioner of Internal Revenue determined that the Trust
was exempt from tax because it qualified as a voluntary employ-
ees’ beneficiary association described in section 501(c)(9). The
Trust maintained that qualification during the years at issue.
(We shall refer to a tax-exempt voluntary employees’ beneficiary
association described in section 501(c)(9) as a VEBA.)
The Trust agreement establishing the Trust provided in
pertinent part:
8.2 Payment of Benefits. * * * Any Trust Fund income
not used in the year in which it was earned to
provide life, sickness, accident or other benefits
described in Section 501(c)(9) of the Code and the
regulations thereunder or to pay reasonable admin-
istrative costs associated with the delivery of
those benefits shall be set aside to provide for
the payment of the benefits and benefit costs
described in Section 512(a)(3)(B)(ii) of the Code
and limited by Section 512(a)(3)(E) of the Code in
the immediately following year. * * *
The Trust derived its income from (1) member contributions
from Sherwin-Williams and Sherwin-Williams health care plan
participants and (2) investment income. The Trust set aside, and
subsequently expended, income to provide for the payment of
health care benefits and reasonable costs of administration
directly connected with providing for the payment of such bene-
fits. The amounts of income that the Trust set aside to provide
for the payment of reasonable costs of administration directly
connected with providing for the payment of health care benefits
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equaled $1,580,455 for 1991 and $1,853,529 for 1992.4
The amounts of assets that the Trust set aside as of the
close of the years at issue to provide for the payment of health
care benefits and reasonable costs of administration directly
connected with providing for the payment of such benefits were
$41,975,366 and $45,637,659, respectively.
The Trust’s account limit, as defined in section 419A(c),
for its qualified asset account, as defined in section 419A(a),
was $64,615,9365 for 1991 and $84,192,933 for 1992. The forego-
ing account limits for 1991 and 1992 included $53,313,236 and
$71,602,395, respectively, attributable to a reserve for post-
retirement medical benefits.
The Trust filed Forms 990, Return of Organization Exempt
From Income Tax (Form 990), and Forms 990-T, Exempt Organization
Business Income Tax Return (Form 990-T), in which it reported as
unrelated business income $1,851,399 and $1,155,793 of investment
4
The costs for 1992 ($1,853,529) were paid first from in-
vestment income for that year.
5
The parties stipulated that the Trust’s account limit for
1991, as defined in sec. 419A(c), was $65,652,991. However, that
stipulation is contrary to the record in this case. The record
establishes, and we have found, that that account limit was
$64,615,936. We may, and we shall in this instance, disregard a
stipulation between the parties where the stipulation is clearly
contrary to the facts established by the record. See Cal-Maine
Foods, Inc. v. Commissioner, 93 T.C. 181, 195 (1989).
- 6 -
income for 1991 and 1992, respectively.6 In its Forms 990-T for
1991 and 1992, the Trust claimed as deductions directly connected
with its unrelated business income (1) “Compensation of officers,
directors, and trustees” in the amounts of $1,456,954 and
$1,618,779, respectively, and (2) “Other deductions” in the
amounts of $156,084 and $287,450, respectively. Of the foregoing
total deductions claimed in the Trust’s Forms 990-T for 1991 and
1992, $1,580,455 and $1,853,529, respectively, constitute reason-
able costs of administration directly connected with providing
for the payment of health care benefits for which the Trust set
aside income within the meaning of section 512(a)(3)(B).7
The instructions to Forms 990-T stated in pertinent part:
Sections 501(c)(7), (9), (17), and (20) organiza-
tions will not be taxed on income set aside for:
1. Religious, charitable, scientific, literary, or
educational purposes, or for the prevention of cruelty
to children or animals;
2. The payment of life, sick, accident, or other
benefits by a section 501(c)(9), (17), or (20) organi-
zation. The amount allowed as a set-aside may not
exceed a limit determined using section 419A. See
sections 419A and 512(a)(3)(E) for details;
3. Reasonable administration costs directly con-
nected with 1 and 2 above.
6
The Trust reported in Forms 990 additional investment
income of $232,202 and $405,095 for 1991 and 1992, respectively,
which the Trust did not treat as unrelated business income in
those forms or in Forms 990-T for those years.
7
See supra note 4.
- 7 -
In the notice of deficiency (notice) issued to the Trust,
respondent determined that, in calculating its UBTI, the Trust
erroneously deducted in Forms 990-T for 1991 and 1992
(1) $1,424,371 and $1,588,555, respectively, as “Compensation of
officers, directors, and trustees” and (2) $156,084 and $264,974,
respectively, as “Other deductions”. Respondent made those
determinations because the Trust failed to establish that those
disallowed amounts constitute expenses directly related to, and
therefore deductible from, its investment income that it reported
as unrelated business income in Forms 990-T (i.e., $1,851,399 for
1991 and $1,155,793 for 1992).8
Discussion
On brief, the Trustee abandons the position that the Trust
took in Forms 990-T for 1991 and 1992 that, in calculating its
UBTI, it is entitled to deduct from unrelated business gross
income (1) “Compensation of officers, directors, and trustees” in
the amounts of $1,456,954 and $1,618,779, respectively, and
(2) “Other deductions” in the amounts of $156,084 and $287,450,
respectively. Instead, the Trustee argues on brief that
$1,580,455 of the Trust’s income for 19919 and $1,853,529 of the
8
Respondent made no determinations in the notice regarding
the amounts of unrelated business income that the Trust reported
in Forms 990-T for the years at issue.
9
The Trustee makes no argument about the balance of the
investment income (i.e., $270,944) that the Trust reported as
(continued...)
- 8 -
Trust’s income for 199210 constitute exempt function income, as
defined in section 512(a)(3)(B), and that such amounts of income
are excluded from the calculation of its UBTI under section
512(a)(3)(A). It is respondent’s position that, because of the
limitation prescribed by section 512(a)(3)(E)(i), the amounts of
investment income that the Trust reported as unrelated business
income in Forms 990-T for the years at issue are not excluded
from the calculation of the Trust’s UBTI.11 Petitioner bears the
9
(...continued)
unrelated business income in its Form 990-T for 1991. We find
that petitioner has failed to show that such remaining amount of
investment income for 1991 (1) constitutes exempt function
income, as defined in sec. 512(a)(3)(B), or (2) otherwise is not
subject to the tax on UBTI imposed by sec. 511(a).
10
On brief, the Trustee acknowledges that for 1992 not only
its investment income but also certain of its other income was
set aside, and subsequently expended, for $1,853,529 of reason-
able costs of administration directly connected with providing
for the payment of health care benefits. The Trustee further
acknowledges that it reported in Form 990-T for 1992 only
$1,155,793 of its investment income for that year as unrelated
business income. Respondent made no determination in the notice
that the Trust’s remaining investment income for 1992 (i.e.,
$405,095), which the Trust did not treat as unrelated business
income in Form 990 and Form 990-T for that year, should be
included in calculating the Trust’s UBTI for that year. We
conclude that the only amount of the Trust’s income for 1992 that
is at issue in this case is $1,155,793 of investment income that
the Trust reported as unrelated business income in Form 990 and
Form 990-T for that year. Our references hereinafter to the
amount at issue for 1992 shall be to the correct amount at issue
for 1992, and not to the amount (i.e., $1,853,529) that the
Trustee claims on brief is at issue for that year.
11
Respondent also advances arguments on brief as to why
respondent’s determinations in the notice should be sustained.
However, as noted above, the Trustee no longer contests those
(continued...)
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burden of establishing that its position is correct. See Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Before addressing the issues presented, we set forth the
pertinent statutory provisions implicated by those issues.12
Although section 501(a) exempts a VEBA from tax, section 501(b)
subjects a tax-exempt VEBA to tax to the extent provided in
sections 511 through 515 relating to the tax on UBTI. Section
511(a) imposes a tax for each taxable year on the UBTI of a VEBA,
as defined in section 512.
Section 512(a)(1) provides the following general definition
of UBTI:
(1) General rule.–-Except as otherwise provided in
this subsection, the term “unrelated business taxable
income” means the gross income derived by any organiza-
tion from any unrelated trade or business (as defined
in section 513) regularly carried on by it, less the
deductions allowed by this chapter which are directly
connected with the carrying on of such trade or busi-
ness, both computed with the modifications provided in
subsection (b).
Section 512(a)(3) provides the following special rules in
defining the UBTI of a VEBA described in section 501(c)(9):
(3) Special rules applicable to organizations
described in paragraph (7), (9), (17), or (20) of
section 501(c).--
11
(...continued)
determinations.
12
Although the statutory provisions set forth below apply
not only to a VEBA but also to certain other organizations, our
discussion generally is limited to the application of those
provisions to a VEBA.
- 10 -
(A) General rule.–-In the case of an organi-
zation described in paragraph (7), (9), (17), or
(20) of section 501(c), the term “unrelated busi-
ness taxable income” means the gross income (ex-
cluding any exempt function income), less the
deductions allowed by this chapter which are di-
rectly connected with the production of the gross
income (excluding exempt function income) * * *.
(B) Exempt function income.–-For purposes of
subparagraph (A), the term “exempt function in-
come” means the gross income from dues, fees,
charges, or similar amounts paid by members of the
organization as consideration for providing such
members or their dependents or guests goods, fa-
cilities, or services in furtherance of the pur-
poses constituting the basis for the exemption of
the organization to which such income is paid.
Such term also means all income (other than an
amount equal to the gross income derived from any
unrelated trade or business regularly carried on
by such organization computed as if the organiza-
tion were subject to paragraph (1)), which is set
aside—-
(i) for a purpose specified in section
170(c)(4), or
(ii) in the case of an organization
described in paragraph (9) * * * of section
501(c), to provide for the payment of life,
sick, accident, or other benefits,
including reasonable costs of administration di-
rectly connected with a purpose described in
clause (i) or (ii). If during the taxable year,
an amount which is attributable to income so set
aside is used for a purpose other than that de-
scribed in clause (i) or (ii), such amount shall
be included, under subparagraph (A), in unrelated
business taxable income for the taxable year.
* * * * * * *
(E) Limitation on amount of setaside in the
case of organizations described in paragraph (9)
* * * of section 501(c).--
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(i) In general.–-In the case of any
organization described in paragraph (9) * * *
of section 501(c), a set-aside for any pur-
pose specified in clause (ii) of subparagraph
(B) may be taken into account under subpara-
graph (B) only to the extent that such set-
aside does not result in an amount of assets
set aside for such purpose in excess of the
account limit determined under section 419A
(without regard to subsection (f)(6) thereof)
for the taxable year (not taking into account
any reserve described in section
419A(c)(2)(A) for post-retirement medical
benefits).
The Trust as a VEBA that is funded by, inter alia, employer
contributions is subject to sections 41913 and 419A. Section
419A(a) provides:
SEC. 419A. QUALIFIED ASSET ACCOUNT; LIMITATION ON
ADDITIONS TO ACCOUNT.
(a) General Rule.–-For purposes of this subpart
and section 512, the term “qualified asset account”
means any account consisting of assets set aside to
provide for the payment of--
* * * * * * *
(2) medical benefits * * *
Section 419A(c) imposes an account limit on the Trust’s
qualified asset account, as defined in section 419A(a). Section
13
Sec. 419 prescribes rules governing the deductibility of
contributions paid or accrued by an employer to a welfare benefit
fund. The amount of such a deduction allowable under sec. 419 is
determined by reference to, inter alia, any addition to a quali-
fied asset account determined under sec. 419A(b). Sec. 419A(b)
provides that no addition to any qualified asset account may be
taken into account for purposes of sec. 419 to the extent such
addition results in the amount in such account exceeding the
account limit, as defined in sec. 419A(c).
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419A(c) provides:
SEC. 419A. QUALIFIED ASSET ACCOUNT; LIMITATION ON
ADDITIONS TO ACCOUNT.
(c) Account Limit.–-For purposes of this section–-
(1) In general.–-Except as otherwise provided in
this subsection, the account limit for any qualified
asset account for any taxable year is the amount rea-
sonably and actuarially necessary to fund–-
(A) claims incurred but unpaid (as of the
close of such taxable year) for benefits referred
to in subsection (a), and
(B) administrative costs with respect to such
claims.
(2) Additional reserve for post-retirement medical
and life insurance benefits.–-The account limit for any
taxable year may include a reserve funded over the
working lives of the covered employees and actuarially
determined on a level basis (using assumptions that are
reasonable in the aggregate) as necessary for–-
(A) post-retirement medical benefits to be
provided to covered employees (determined on the
basis of current medical costs) * * *
We turn now to the initial dispute between the parties over
whether, in determining for each year at issue the Trust’s UBTI
under section 512(a)(3)(A), the amount of investment income at
issue that the Trust set aside (i.e., $1,580,455 for 1991 and
$1,155,793 for 199214) to provide for the payment of reasonable
costs of administration directly connected with providing for the
payment of health care benefits is subject to the limitation
prescribed by section 512(a)(3)(E)(i). It is the position of the
14
See supra notes 4, 8, and 10.
- 13 -
Trustee that that amount of investment income for each year at
issue is not subject to that limitation. That position rests
upon the contentions of the Trustee that the plain language of
section 512(a)(3)(B) identifies four independent sources or
components of exempt function income and that one of those
sources or components of exempt function income is reasonable
costs of administration directly connected with a purpose de-
scribed in section 512(a)(3)(B)(i) or (ii). The Trustee posits
that the four sources of exempt function income identified by
section 512(a)(3)(B) are:
(1) amounts paid by members of the association as
consideration for goods, facilities, or services;
(2) amounts set aside for a charitable purpose;
(3) amounts set aside for the payment of life, sick,
accident, or other benefits; and
(4) reasonable costs of administration directly con-
nected with components 2 and 3.
According to the Trustee, “It is apparent from the plain language
of the statute [section 512(a)(3)(B)] that reasonable costs of
administration are an independent basis of Exempt Function
Income.”
Proceeding from its premises that reasonable costs of
administration directly connected with a purpose described in
section 512(a)(3)(B)(i) or (ii) are one of the four independent
sources or components of exempt function income under section
512(a)(3)(B), the Trustee argues that the limitation in section
- 14 -
512(a)(3)(E)(i) is “plainly restricted to only set-asides for the
payment of benefits described in I.R.C. §512(a)(3)(B)(ii), and
thus, its application does not extend to Exempt Function Income
arising from member contributions, set-asides for charitable
purposes, or administrative costs.”
Respondent counters that reasonable costs of administration
directly connected with a purpose described in section
512(a)(3)(B)(i) or (ii) do not constitute an independent source
or component of exempt function income under section
512(a)(3)(B). In support of that position, respondent argues:
It is clear the statute [section 512(a)(3)(B)] is
written so that the reasonable cost of administration
phrase did not have to be written twice, that is once
after clause (i) and again after clause (ii). This is
a common drafting technique used throughout the Inter-
nal Revenue Code. * * *
Another way of describing exempt function income
is income set-aside [sic] for a purpose specified in
section 170(c)(4) including administrative costs di-
rectly connected with this purpose or, in the case of
an organization described in paragraph (9), (17), or
(20) of section 501(c), to provide for the payment of
life, sick, accident, or other benefits, including
reasonable costs of administration directly connected
with this purpose. This is the clear meaning of this
section [512(a)(3)(B)]. Accordingly, administrative
costs are a part of the benefit costs which may be set-
aside [sic] under clauses (i) and (ii) of I.R.C. §
512(a)(3)(B), not a separate component thereof.
We first address the premises of the Trustee’s position
under section 512(a)(3)(E)(i), namely, its contentions that the
plain language of section 512(a)(3)(B) identifies four sources or
components of exempt function income and that one of those
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sources or components of exempt function income is reasonable
costs of administration directly connected with a purpose de-
scribed in section 512(a)(3)(B)(i) or (ii). While we agree with
the Trustee that the language of section 512(a)(3)(B) is unambig-
uous, we conclude that the plain language of section 512(a)(3)(B)
rejects the Trustee’s contentions.
Section 512(a)(3)(B) unambiguously defines the term “exempt
function income” to mean gross income from two sources only.
Moreover, section 512(a)(3)(B) plainly does not treat reasonable
costs of administration directly connected with a purpose de-
scribed in section 512(a)(3)(B)(i) or (ii) as income or as a
source or component of income.
The first source of gross income from which exempt function
income may be derived is specified in the first sentence of
section 512(a)(3)(B) as “gross income from dues, fees, charges,
or similar amounts paid by members of the organization”. How-
ever, in order to qualify as exempt function income, such gross
income specified in the first sentence of section 512(a)(3)(B)
must be paid by the organization’s members “as consideration for
providing such members or their dependents or guests goods,
facilities, or services in furtherance of the purposes constitut-
ing the basis for the exemption of the organization to which such
income is paid.”
The second source of gross income from which exempt function
- 16 -
income may be derived is specified in the second sentence of
section 512(a)(3)(B) as all other income (except an amount equal
to the gross income derived from any unrelated trade or
business15 regularly carried on by such organization and computed
as if the organization were subject to section 512(a)(1)). (For
convenience, we shall sometimes refer to the second source of
exempt function income specified in the second sentence of
section 512(a)(3)(B) as non-member income.) However, in order to
qualify as exempt function income, such non-member income speci-
fied in the second sentence of section 512(a)(3)(B) must be set
aside for a purpose described in section 512(a)(3)(B)(i) or (ii),
including reasonable costs of administration directly connected
with any such purpose.
The phrase that appears at the end of the second sentence of
section 512(a)(3)(B), i.e., “including reasonable costs of
administration directly connected with a purpose described in
clause (i) or (ii)”, unambiguously pertains to and modifies both
section 512(a)(3)(B)(i) and (ii). That phrase plainly treats
non-member income (1) set aside to provide for the payment of
reasonable costs of administration directly connected with a
purpose described in section 512(a)(3)(B)(i) as set aside for a
15
Sec. 513(a) defines the term “unrelated trade or business”
to mean, in general, any trade or business of the tax-exempt
organization the conduct of which is not substantially related to
the exercise or performance by such organization of its exempt
purposes.
- 17 -
purpose described in that section and (2) set aside to provide
for the payment of reasonable costs of administration directly
connected with a purpose described in section 512(a)(3)(B)(ii) as
set aside for a purpose described in that section.16
To support its position that reasonable costs of administra-
tion directly connected with a purpose described in section
512(a)(3)(B)(i) or (ii) qualify as one of the four independent
sources or components of exempt function income under section
512(a)(3)(B), the Trustee relies not only on the language of
section 512(a)(3)(B), but also on the following statement in Phi
Delta Theta Fraternity v. Commissioner, 887 F.2d 1302, 1307 (6th
Cir. 1989), affg. 90 T.C. 1033 (1988): “Section 512(a)(3)(B),
however, does allow reasonable costs actually spent in adminis-
tering a tax-exempt activity to be included in ‘exempt function
income.’” We find the Trustee’s reliance on that statement to be
misplaced. The United States Court of Appeals for the Sixth
16
We need not resort to the legislative history of sec.
512(a)(3)(B) to determine the meaning of the phrase in question
that appears at the end of the second sentence of that section.
That is because the terms of that statutory provision are unam-
biguous, and there are no exceptional circumstances warranting
our turning to that legislative history for guidance. See
Burlington N. R.R. Co. v. Oklahoma Tax Commn., 481 U.S. 454, 461
(1987); Fernandez v. Commissioner, 114 T.C. 324, 329-330 (2000).
Nonetheless, it is noteworthy that, consistent with its plain
language, the legislative history of sec. 512(a)(3)(B) provides
that income will be treated as set aside for benefits specified
in that section where it is set aside and used not only for the
payment of those benefits but also for the payment of reasonable
costs of administration of providing those benefits. See S.
Rept. 91-552 (1969), at 72, 1969-3 C.B. 470.
- 18 -
Circuit (Court of Appeals), the Court to which an appeal in the
instant case would normally lie, did not decide in Phi Delta
Theta Fraternity the issues under section 512(a)(3) that are
presented here.17 Moreover, the foregoing statement in Phi
Delta Theta Fraternity on which the Trustee relies in the instant
case is dictum. Finally, even if the statement in Phi Delta
Theta Fraternity were not dictum, we do not find that that
17
The taxpayer in Phi Delta Theta Fraternity v. Commis-
sioner, 887 F.2d 1302 (6th Cir. 1989), affg. 90 T.C. 1033 (1988),
was a national college fraternity (fraternity) that was exempt
from tax as an organization described in sec. 501(c)(7). The
ultimate issue before the Court of Appeals was whether the
investment income of the fraternity qualified as exempt function
income for purposes of sec. 512(a)(3)(A) and (B). In resolving
that issue, the Court considered two questions: (1) Whether
there was a proper set aside by the fraternity within the meaning
of sec. 512(a)(3)(B); and (2) even if there was no proper set
aside within the meaning of that section, whether the fraternity
spent income on exempt purposes, and, if it did, whether that
income therefore qualified as exempt function income. Although
those questions are not presented here, it is noteworthy that in
resolving those matters the Court of Appeals in Phi Delta Theta
Fraternity quoted portions of sec. 512(a)(3)(B) as applicable to
the sec. 501(c)(7) fraternity involved in that case, as follows:
Such term [exempt function income] also means all
income * * * which is set aside–-
(i) for a purpose specified in section 170(c)(4)
* * * including reasonable costs of administration
directly connected with a purpose described in clause
(i) or (ii). * * *
Phi Delta Theta Fraternity v. Commissioner, supra at 1305. Thus,
the Court of Appeals recognized in Phi Delta Theta Fraternity
that the phrase “including reasonable costs of administration
directly connected with a purpose described in clause (i) or
(ii)” does not stand alone, but pertains to and modifies sec.
512(a)(3)(B)(i) as well as sec. 512(a)(3)(B)(ii).
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statement supports the Trustee’s position here that one of the
four independent sources or components of exempt function income
under section 512(a)(3)(B) is reasonable costs of administration
directly connected with a purpose described in section
512(a)(3)(B)(i) or (ii).
In further support of its position that reasonable costs of
administration directly connected with a purpose described in
section 512(a)(3)(B)(i) or (ii) qualify as one of the four
independent sources or components of exempt function income under
section 512(a)(3)(B), the Trustee relies on the instructions to
Forms 990-T for the years at issue. Those instructions provided
in pertinent part:
Sections 501(c)(7), (9), (17), and (20) organiza-
tions will not be taxed on income set aside for:
1. Religious, charitable, scientific, literary, or
educational purposes, or for the prevention of cruelty
to children or animals;
2. The payment of life, sick, accident, or other
benefits by a section 501(c)(9), (17), or (20) organi-
zation. The amount allowed as a set-aside may not
exceed a limit determined using section 419A. See
sections 419A and 512(a)(3)(E) for details;
3. Reasonable administration costs directly con-
nected with 1 and 2 above.
We acknowledge that the foregoing instructions to Forms 990-
T are not as clearly stated as section 512(a)(3)(B) is. Nonethe-
less, we find those instructions to be consistent with the plain
language of section 512(a)(3)(B). We have held that section
- 20 -
512(a)(3)(B) plainly treats non-member income set aside for
reasonable costs of administration directly connected (1) with a
purpose described in section 512(a)(B)(3)(i) as set aside for a
purpose described in that section and (2) with a purpose de-
scribed in section 512(a)(3)(B)(ii) as set aside for a purpose
described in that section.
In any event, we are not bound by the instructions to Forms
990-T for the years at issue. The authoritative sources of tax
law are statutes, regulations, and judicial decisions, and not
informal instructions published by the Internal Revenue Service.
See Casa de La Jolla Park, Inc. v. Commissioner, 94 T.C. 384, 396
(1990). We find the Trustee’s reliance on the instructions to
Forms 990-T for the years at issue to be misplaced.
We hold that section 512(a)(3)(B) treats non-member income
set aside to provide for the payment of reasonable costs of
administration directly connected with a purpose described in
section 512(a)(3)(B)(ii) as non-member income set aside for a
purpose described in section 512(a)(3(B)(ii).
The Trustee’s contentions that section 512(a)(3)(B) identi-
fies four independent sources or components of exempt function
income and that one of those sources or components is reasonable
costs of administration directly connected with a purpose de-
scribed in section 512(a)(3)(B)(i) or (ii) constitute the pre-
mises on which the Trustee constructs its argument that non-
- 21 -
member investment income set aside by the Trust for the payment
of reasonable costs of administration directly connected with a
purpose described in section 512(a)(3)(B)(ii) is not subject to
the limitation prescribed by section 512(a)(3)(E)(i). We have
rejected those contentions, and therefore those premises are not
valid. We further reject the Trustee’s argument that the limita-
tion prescribed by section 512(a)(3)(E)(i) does not apply to the
non-member investment income at issue that the Trust set aside to
provide for the payment of reasonable costs of administration
directly connected with a purpose described in section
512(a)(3)(B)(ii).18
As a VEBA described in section 501(c)(9), a set-aside by the
Trust of non-member income for a purpose described in section
512(a)(3)(B)(ii) is to be taken into account as exempt function
income under section 512(a)(3)(B) only to the extent that such
18
It is noteworthy that the Trust agreement establishing the
Trust provided that such costs are subject to the limitation
prescribed by sec. 512(a)(3)(E)(i). That Trust agreement pro-
vided in pertinent part:
8.2 Payment of Benefits. * * * Any Trust Fund income
not used in the year in which it was earned to
provide life, sickness, accident or other benefits
described in Section 501(c)(9) of the Code and the
regulations thereunder or to pay reasonable admin-
istrative costs associated with the delivery of
those benefits shall be set aside to provide for
the payment of the benefits and benefit costs
described in Section 512(a)(3)(B)(ii) of the Code
and limited by Section 512(a)(3)(E) of the Code in
the immediately following year. * * * [Emphasis
added.]
- 22 -
set aside does not exceed the limitation prescribed by section
512(a)(3)(E)(i). See sec. 512(a)(3)(E)(i). We have held that
the plain language of section 512(a)(3)(B) treats non-member
income set aside to provide for the payment of reasonable costs
of administration directly connected with a purpose described in
section 512(a)(3)(B)(ii) as set aside for a purpose described in
that section. We further hold that “a set-aside for any purpose
specified in clause (ii) of subparagraph (B)” of section
512(a)(3) to which the limitation prescribed by section
512(a)(3)(E)(i) applies is a set-aside to provide for the payment
of life, sick, accident, or other benefits and reasonable costs
of administration directly connected with providing for the
payment of such benefits. We also hold that the limitation
prescribed by section 512(a)(3)(E)(i) applies to the amounts of
non-member income at issue that the Trust set aside to provide
for the payment of reasonable costs of administration directly
connected with providing for the payment of health care benefits.
The Trustee advances an alternative argument in the event
that the Court were to hold, as we have, that the limitation
prescribed by section 512(a)(3)(E)(i) applies to the amounts of
non-member income at issue. According to the Trustee’s alterna-
tive argument, in calculating for each year at issue the limita-
tion prescribed by section 512(a)(3)(E)(i), the plain language of
that section requires that not only the Trust’s account limit
- 23 -
determined under section 419A, but also the amount of assets set
aside by the Trust, be reduced by the amount of the reserve for
post-retirement medical benefits described in section
419A(c)(2)(A).
The parties agree that (1) the Trust’s respective account
limits, determined under section 419A(c), were $64,615,936 and
$84,192,933 for 1991 and 1992; (2) those account limits for those
years included $53,313,236 and $71,602,395, respectively, attrib-
utable to a reserve for post-retirement medical benefits; (3) the
amounts of assets that the Trust set aside (i.e., the total asset
balances reported by the Trust in Forms 990) for 1991 and 1992
were $41,975,366 and $45,637,659, respectively; and (4) (a) for
1991 $7,342,383 and $34,632,983 of the amount of assets so set
aside were allocable to (i) incurred but unpaid health benefit
claims and reasonable costs directly connected with such claims
and (ii) the reserve for post-retirement medical benefits,
respectively, and (b) for 1992 $6,824,833 and $38,812,826 of the
amount of assets so set aside were allocable to (i) incurred but
unpaid health benefit claims and reasonable costs directly
connected with such claims and (ii) the reserve for post-retire-
ment medical benefits, respectively. If the limitation pre-
scribed by section 512(a)(3)(E)(i) were to be calculated in the
manner advocated by the Trustee, the amount of assets set aside
by the Trust as of the close of each year at issue would not
- 24 -
exceed that limitation. In that event, the amount of investment
income at issue that the Trust set aside to provide for the
payment of reasonable costs of administration directly connected
with providing for the payment of health care benefits would
constitute exempt function income that is excluded under section
512(a)(3)(A) from the calculation of the Trust’s UBTI.
It is the position of respondent that, in calculating for
each year at issue the limitation prescribed by section
512(a)(3)(E)(i), only the account limit determined under section
419A, and not the amount of assets set aside by the Trust, must
be reduced by the reserve for post-retirement medical benefits
described in section 419A(c)(2)(A).
Although we have quoted section 512(a)(3)(E)(i) above, for
convenience we restate it here in addressing the contentions of
the parties with respect to the Trustee’s alternative argument.
Section 512(a)(3)(E)(i) provides:
(E) Limitation on amount of setaside in the case
of organizations described in paragraph (9), (17), or
(20) of section 501(c).--
(i) In general.–-In the case of any organiza-
tion described in paragraph (9), (17), or (20) of
section 501(c), a set-aside for any purpose speci-
fied in clause (ii) of subparagraph (B) may be
taken into account under subparagraph (B) only to
the extent that such set-aside does not result in
an amount of assets set aside for such purpose in
excess of the account limit determined under sec-
tion 419A (without regard to subsection (f)(6)
thereof) for the taxable year (not taking into
account any reserve described in section
419A(c)(2)(A) for post-retirement medical bene-
- 25 -
fits).
We find the Trustee’s interpretation of section
512(a)(3)(E)(i) (viz., the parenthetical phrase “(not taking into
account any reserve described in section 419A(c)(2)(A) for post-
retirement medical benefits)” modifies both “an amount of assets
set aside” and “the account limit determined under section 419A”
referred to in section 512(a)(3)(E)(i)) to be a strained and
unreasonable interpretation. We reject that interpretation. We
conclude that the parenthetical phrase appearing at the end of
section 512(a)(3)(E)(i), as reasonably and properly construed,
modifies only “the account limit determined under section 419(A)”
referred to in section 512(a)(3)(E)(i). Our construction is
supported by the temporary regulations under section
512(a)(3)(E)(i).
Section 1.512(a)-5T, Q&A-3(a), Temporary Income Tax Regs.,
51 Fed. Reg. 4332 (Feb. 4, 1986), as amended by 51 Fed. Reg.
11303 (Apr. 2, 1986) (Q&A-3(a)), provides in pertinent part:
Q-3: What amount of income may a VEBA, SUB or
GLSO set aside for exempt purposes?
A-3: (a) Pursuant to section 512(a)(3)(E)(i), the
amounts set aside in a VEBA, SUB, or GLSO (including a
VEBA, SUB, or GLSO that is part of a 10 or more em-
ployer plan, as defined in section 419A(f)(6)(B)) as of
the close of a taxable year of such VEBA, SUB, or GLSO
to provide for the payment of life, sick, accident, or
other benefits may not be taken into account for pur-
poses of determining “exempt function income” to the
extent that such amounts exceed the qualified asset
account limit, determined under sections 419A(c) and
419A(f)(7), for such taxable year of the VEBA, SUB, or
- 26 -
GLSO. In calculating the qualified asset account limit
for this purpose, a reserve for post-retirement medical
benefits under section 419A(c)(2)(A) is not to be taken
into account. [Emphasis added.]
Q&A-3(a) plainly provides that, for purposes of determining
the limitation prescribed by section 512(a)(3)(E)(i), a reserve
for post-retirement medical benefits described in section
419A(c)(2)(A) is not to be taken into account in “calculating the
qualified asset account limit”. Q&A-3(a) does not indicate that,
for those purposes, such a reserve is not to be taken into
account in calculating the amount of assets set aside as of the
close of a taxable year.
Our interpretation regarding the parenthetical phrase
appearing at the end of section 512(a)(3)(E)(i) also is supported
by the General Explanation of the Revenue Provisions of the
Deficit Reduction Act of 1984 that was prepared by the Staff of
the Joint Committee on Internal Revenue Taxation (General Expla-
nation). Congress enacted section 512(a)(3)(E)(i) into the Code
as part of the Deficit Reduction Act of 1984. See Deficit
Reduction Act of 1984, Pub. L. 98-369, sec. 511(b), 98 Stat. 860.
The General Explanation provides in pertinent part with respect
to section 512(a)(3)(E)(i):
The [Deficit Reduction] Act [of 1984] provides a
specific annual limit on the amount of income of a tax-
exempt VEBA * * * that may be considered a permissible
set aside. Under the Act, the amount of such an orga-
nization’s income for a year that may be considered set
aside as exempt function income is generally not to
increase the total amount that is set aside to an
- 27 -
amount in excess of the account limit for the taxable
year determined under the deduction limits provided by
the Act (sec. 419A(c) and (f)). The limit on the set-
aside is intended to apply to more-than-10-employer
VEBAs which are exempt from the deduction limitations.
* * *
In general, the rules applicable in computing the
account limit under the deduction rules [section 419],
such as the special reserve limits for collectively
bargained plans, also are applicable in determining the
set-aside allowed for purposes of the unrelated busi-
ness income tax. However, for purposes of determining
the limit on the set aside, the account limit is not to
include any amount with respect to reserves to provide
post-retirement medical benefits. The limit on the
amount set aside as exempt function income does not
include a reserve for post-retirement medical benefits
because, in view of the advance deductions provided to
employers for these benefits, it was determined that
the allowance of such a tax-exempt reserve would pro-
vide an unnecessary tax incentive with respect to these
benefits. [Footnote ref. omitted; emphasis added.]
Staff of Joint Comm. on Taxation, General Explanation of the
Revenue Provisions of the Deficit Reduction Act of 1984, at 791
(J. Comm. Print 1984).
The General Explanation plainly provides that, in determin-
ing the limitation prescribed by section 512(a)(3)(E)(i), a
reserve for post-retirement medical benefits is not to be taken
into account in determining the account limit. The General
Explanation does not indicate that, in making that determination,
such a reserve is not to be taken into account in calculating the
amount of assets set aside at the close of a taxable year.19
19
If we were to accept the Trustee’s alternative position
that for each year at issue not only the account limit, as
(continued...)
- 28 -
We hold that, in calculating for each year at issue the
limitation prescribed by section 512(a)(3)(E)(i), that section
does not require that the amount of assets that the Trust set
aside as of the close of each such year be reduced by the amount
of the reserve for post-retirement medical benefits. The parties
agree that for each year at issue the amount of assets that the
Trust set aside to provide for the payment of health care bene-
fits, including reasonable costs of administration directly
connected with providing for the payment of such benefits,
exceeded the account limit, as defined in section 419A(c),
determined without regard to section 419A(f)(6) and without
taking into account the reserve for post-retirement medical
benefits described in section 419A(c)(2)(A). We hold that, in
determining for each year at issue the UBTI of the Trust under
section 512(a)(3)(A), the amount of investment income at issue
that the Trust set aside to provide for the payment of reasonable
costs of administration directly connected with providing for the
payment of health care benefits may not be excluded as exempt
19
(...continued)
defined in sec. 419A(c), but also the amount of assets set aside
by the Trust are to be determined without regard to the reserve
for post-retirement medical benefits, we would undermine the
reason set forth in the General Explanation why Congress decided
to require the account limit to exclude any amount with respect
to such a reserve in determining the limitation prescribed by
sec. 512(a)(3)(E)(i). See Staff of Joint Comm. on Taxation,
General Explanation of the Revenue Provisions of the Deficit
Reduction Act of 1984, at 791 (J. Comm. Print 1984).
- 29 -
function income.
We have considered all of the contentions and arguments of
the Trustee that are not discussed herein, and we find them to be
without merit and/or irrelevant.20
To reflect the foregoing,
Decision will be entered for
respondent.
20
We shall briefly address one of those arguments. The
Trustee argues that the Trust’s investment income at issue is not
subject to the unrelated business income tax because the invest-
ment income of a VEBA described in sec. 501(c)(9) “is not taxable
if spent in furtherance of its exempt purpose.” In support of
that argument, the Trustee relies on certain legislative history
of the Tax Reform Act of 1969 which enacted sec. 512(a)(3)(A) and
(B) into the Code. The Trustee’s reliance on that legislative
history is misplaced. When Congress enacted sec. 512(a)(3)(A)
and (B) in 1969, it placed no specific limitation on the amount
of income that may be set aside by a VEBA. See Tax Reform Act of
1969, Pub. L. 91-172, sec. 121(b), 83 Stat. 537. However, in
1984 Congress decided to impose a limitation on the amount of
income that may be set aside when it enacted sec. 512(a)(3)(E)(i)
into the Code. See Deficit Reduction Act of 1984, Pub. L. 98-
369, sec. 511(b), 98 Stat. 860; H. Conf. Rept. 98-861, at 1161-
1163 (1984), 1984-3 C.B. (Vol. 2) 415-417; see also Staff of
Joint Comm. on Taxation, General Explanation of the Revenue
Provisions of the Deficit Reduction Act of 1984, at 790-791 (J.
Comm. Print 1984).