Section 419 of the Internal Revenue Code allows employers to take deductions—within certain limits—for contributions made to a trust to fund welfare benefits for employees. In order to be considered a 419 plan, the plan must offer “welfare” benefits to employees and it must be a “funded” plan.
Welfare benefits are a general designation for any employer provided benefit which is not a pension or other retirement benefit. Examples include benefits paid in the event of sickness, accident, disability, death, or unemployment.
Funded plans are arrangements where the employer sets aside assets specifically dedicated to paying for benefits. In order for a plan to be funded, the assets must be placed in a trust, escrow,
or similar arrangement, where: (i) the assets can only be used for the benefit of employees or beneficiaries, and (ii) the assets cannot be returned to the employer.
Deductions for Funding a 419 Plan
If an arrangement meets the requirements set out in § 419, then an employer may take a deduction for plan contributions up to an amount equal to current year costs of the plan, plus an amount reasonably necessary to fund claims incurred but as yet unpaid, plus, in the case of post retirement benefits, an additional amount limited to what would be required actually to fund the promised benefit on a level basis over the “working lives” of participating employees.
Taxation of Assets During Funding Period
If the plan assets are set aside in a voluntary employee benefits association (“VEBA”), then, in general, any income earned on the assets while in the VEBA would be tax exempt. If assets are set aside in a trust, then any income earned by the assets will be taxed to the trust.
Taxation of Benefits When Paid
Welfare benefits are taxed upon receipt. Once benefits are paid out, the employee must recognize the benefit as ordinary income.
Non-Discrimination for Some 419 Plans
Benefits under a 419 plan may be subject to rules of non-discrimination. While some funded welfare benefits may be offered on a selective (discriminatory) basis, if a 419 plan offers post retirement benefits or is funded with a VEBA, the benefits must be made generally available and cannot discriminate in favor of highly compensated employees.