Pension medical account may reimburse another retiree group

Plain-English summary

A company had excess assets in a section 401(h) account used to pay medical costs for one grandfathered group of retirees. It proposed amending its plans so that the account could also reimburse qualifying health-insurance premiums for another group of retirees who were eligible for benefits under the same pension plan or had retired because of permanent disability. The IRS ruled that the proposed use would comply with section 401(h) and would not disqualify the pension plan. Contributions to the medical account plan would be excluded from retirees' income under section 106, and qualifying reimbursements would be excluded under section 105(b).

Ruling snapshot

• Question: Could a qualified pension plan's section 401(h) account reimburse eligible medical premiums for an additional retiree group without causing disqualification or taxable income?
• Outcome: Approved, based on the stated plan terms and representations.
• Key authorities: IRC §§ 105, 106, 401(a), and 401(h); Treas. Reg. § 1.401-14

Full text (IRS public release)

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Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201611003 Third Party Communication: None
Release Date: 3/11/2016 Date of Communication: Not Applicable
Index Number: 105.00-00, 106.00-00,
401.27-00 Person To Contact:
--------------------
----------------------- Telephone Number:
------------------------------ ---------------------
------------------------------------ Refer Reply To:
---------------------------------- CC:TEGE:EB:HW
------------------------------------------ PLR-121608-15
--------------------------------------------- Date: December 3, 2015

Legend:

Taxpayer = ----------------------------------

Parent Company = ------------------------------------

Retirement Plan A = --------------------------------------------

Retirement Plan B = ---------------------------------------------------------

Health Plan for Retirees = -------------------------------------------------------------------

Reimbursement Arrangement Plan = -------------------------------------------------------------------

Medical Account Plan = ------------------------------------------------------------------------------------

Year 1 = -------

Year 2 = -------

Year 3= -------

Year 4 = -------

Year 5= -------

Year 6 = -------
PLR-121608-15 2

Year 7 = -------

Year 8 = -------

Amount 1 = -------------------

Date 1: -------------------------

Dear ------------:

This letter responds to your -------------------ruling request, submitted by your authorized
representatives, as supplemented by correspondence dated ----------------------and --------
-----------------------, requesting rulings on the Federal tax consequences of a proposed
transaction under sections 105, 106, and 401(h) of the Internal Revenue Code (the
“Code”) and their accompanying regulations.

The following facts and representations are submitted under penalties of perjury in
support of your request:

Taxpayer was formed in Year 1 as a subsidiary of Parent Company. Prior to Taxpayer’s
creation, Parent Company maintained Retirement Plan A, a defined benefit plan
qualified under section 401(a) of the Code.

In Year 2, Retirement Plan A, sponsored by Parent Company, was amended to add a
retiree health account described in section 401(h). No employee contributions were
required to be made to the Retirement Plan A 401(h) account. Retirement Plan A
received a favorable determination letter from the Internal Revenue Service following
the amendment which added the 401(h) account.

In Years 3, 4, and 5, in accordance with a special transition rule set forth in Section
7311 of the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239), all of the
eligibility conditions for which Parent Company satisfied, Parent Company made direct
contributions to the Retirement Plan A 401(h) account of approximately Amount 1. At
no time did Parent Company transfer any assets from Retirement Plan A, including any
transfer of assets pursuant to section 420, to the Retirement Plan A 401(h) account.
Following Year 5, Parent Company made no further contributions to that 401(h)
account.

In Year 1, at the time Parent Company formed Taxpayer as a subsidiary, Taxpayer
adopted Retirement Plan B, identical in its terms to Retirement Plan A. At the same
time, a portion of the assets of Retirement Plan A were transferred from Retirement
Plan A to Retirement Plan B, including assets in the Retirement Plan A 401(h) account.
Since Taxpayer’s formation, no contributions have been made by Taxpayer to the
Retirement Plan B 401(h) account.
PLR-121608-15 3

In Year 6, Taxpayer became a separate, publicly-traded company. Thereafter,
Taxpayer continued to maintain Retirement Plan B, including the section 401(h)
account. No employee contributions were made to Retirement Plan B, and Taxpayer
has not made any additional contributions to the Retirement Plan B 401(h) account. All
retired employees of Taxpayer who are eligible to receive medical benefits under the
Retirement Plan B 401(h) account are eligible to receive retirement benefits under
Retirement Plan B, or are retired from employment with Taxpayer by reason of
permanent disability.

In Year 7, the Retirement Plan B 401(h) account was closed to new entrants. In Year 8,
Retirement Plan B was frozen and newly-hired employees were not eligible to
participate in it.

Continuously since becoming a separate, publicly-traded company in Year 6, Taxpayer
has maintained a traditional, major medical plan for its retirees under its Health Plan for
Retirees. For a certain group of retirees (the “Grandfathered Group”), Taxpayer was
obligated to maintain such medical benefits pursuant to the transactions that resulted in
Taxpayer becoming a separate, publicly-traded company.

Commencing in Year 6, Taxpayer has used the Retirement Plan B 401(h) account to
pay a portion of the monthly medical plan premiums under the Health Plan for Retirees
for members of the Grandfathered Group, their spouses, and certain of their
dependents up to age 65. For Taxpayer’s eligible retirees in the Grandfathered Group
who turn age 65, and are enrolled in Medicare, the 401(h) account is used to provide
reimbursement for premiums for Medicare and certain individual health insurance under
the Reimbursement Arrangement Plan. The Reimbursement Arrangement Plan is an
“employer-payment” plan (not a health reimbursement arrangement) that reimburses
premiums for Medicare and certain individual health insurance (and not any other
section 213(d) expenses) for those individuals who are in the Grandfathered Group,
over age 65, and enrolled in Medicare.

In Year 7, at the same time that the 401(h) account was closed to new entrants,
Taxpayer adopted the Medical Account Plan, which is a retiree-only health
reimbursement account established in accordance with section 105 and unconnected to
Retirement Plan B, its 401(h) account, or the Reimbursement Arrangement Plan. The
Medical Account Plan is for the benefit of eligible retirees and totally disabled former
employees not included in the Grandfathered Group (the “Non-Grandfathered Group”)
who are eligible for the traditional, major medical plan for retirees that Taxpayer
maintains.

Prior to age 65, former employees in the Non-Grandfathered Group are eligible to
purchase coverage for themselves, their spouse, and their eligible dependents under
PLR-121608-15 4

the Health Plan for Retirees, but receive no premium subsidy. No amount in the
Retirement Plan B 401(h) account is used to provide any benefit to this group.

After age 65, amounts credited to a member of the Non-Grandfathered Group’s Medical
Account Plan (which is a notional account) can be used to pay the premiums for the
traditional, major medical plan for retirees sponsored by Taxpayer or to purchase
coverage on the open market. The Retirement Plan B 401(h) account is not used to
provide any of the amounts credited under the Medical Account Plan. Taxpayer is under
no obligation, contractual or otherwise, to provide any benefit to the Non-Grandfathered
Group under the Medical Account Plan.

On Date 1, at the time Retirement Plan B was frozen, the Health Plan for Retirees,
Reimbursement Arrangement Plan, and Medical Account Plan were closed to new
entrants who did not meet certain age and service requirements prior to Date 1, or who
had not become disabled prior to such date. Individuals falling into this category are
referred to here as the “Excluded Group.”

Although Taxpayer has made no contributions to the Retirement Plan B 401(h) account
at any time after Year 6, the account has assets in excess of all current and reasonably
anticipated future obligations to members of the Grandfathered Group. Taxpayer
therefore proposes the following transaction (“Proposed Transaction”): Taxpayer will
use the Retirement Plan B 401(h) account to also reimburse members of the Non-
Grandfathered Group for premiums that are considered “sickness, accident,
hospitalization, [or] medical expenses” under section 401(h) and Treas. Reg. § 1.401-
14, eligible for reimbursement under the terms of the Medical Account Plan, and
incurred by eligible individuals who meet the requirements to be considered “retired
employees, their spouses, or their dependents” under section 401(h) of the Code and/or
Treas. Reg. § 1.401-14.

Taxpayer proposes to amend Retirement Plan B, including the terms under which it
established the 401(h) account, and the Medical Account Plan, to permit the Retirement
Plan B 401(h) account to make reimbursements for amounts credited to members of the
Non-Grandfathered Group’s Medical Account Plan (the “Proposed Amendment”). All
members of the Non-Grandfathered Group who receive the benefit of such
reimbursements from the Retirement Plan B 401(h) account are also eligible to receive
retirement benefits under Retirement Plan B, or have retired from employment with
Taxpayer by reason of permanent disability. No portion of the 401(h) account will be
used to provide any benefit or reimbursement to any member of the Excluded Group.

Taxpayer represents that:

(1) It does not have a contractual obligation to fund the Medical Account Plan and may
amend or terminate its retiree health plans at any time;
PLR-121608-15 5

(2) The Proposed Transaction will not affect benefits that are already being paid
through the Retirement Plan B 401(h) account;

(3) The Medical Account Plan is currently and, at all times following the implementation
of the Proposed Transaction, will remain unfunded and no retired employee will be
entitled to any amount under the Medical Account Plan in excess of premiums
requested to be reimbursed under the Retirement Plan B 401(h) account; and

(4) Until premium reimbursements are made under the Medical Account Plan, all
Medical Account Plan-related funds will remain in the Retirement Plan B 401(h)
account, and, in the event of termination of either Retirement Plan B or the Medical
Account Plan, all such amounts remaining in the 401(h) account after satisfaction of all
liabilities to provide medical benefits will be subject to 401(h) (including
section 401(h)(5) and the excise tax on reversions pursuant to section 4980).

RULINGS REQUESTED

Taxpayer requests a ruling that the Proposed Transaction:

(1) Will not violate section 401(h) and Treas. Reg. § 1.401-14 or otherwise cause
Retirement Plan B to lose it its tax-qualified status under section 401(a); and

(2) Will be excludable from the gross income of such “retired employees, their spouse,
or their dependents” under sections 105 and 106, as applicable.

LAW

Section 61(a)(1) of the Code and Treas. Reg. § 1.61-21(a)(3) provide that, except as
otherwise provided in Subtitle A, gross income includes compensation for services,
including fees, commissions, fringe benefits, and similar items.

Section 105(a) provides that, except as otherwise provided in this section, amounts
received by an employee through accident or health insurance for personal injuries or
sickness shall be included in gross income to the extent such amounts (1) are
attributable to contributions by the employer which were not includible in the gross
income of the employee, or (2) are paid by the employer.

Section 105(b) provides that, except in the case of amounts attributable to (and not in
excess of) deductions allowed under section 213 (relating to medical, etc., expenses)
for any prior taxable year, gross income does not include amounts referred to in
subsection (a) if such amounts are paid, directly or indirectly, to the taxpayer to
reimburse the taxpayer for expenses incurred by him for the medical care (as defined in
section 213(d)) of the taxpayer, his spouse, his dependents (as defined in section 152,
determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof), and any
PLR-121608-15 6

child (as defined in section 152(f)(1)) of the taxpayer who as of the end of the taxable
year has not attained age 27. Any child to whom section 152(e) applies shall be treated
as a dependent of both parents for purposes of this subsection.

Section 106 provides that gross income does not include contributions by the employer
to accident or health plans for compensation (through insurance or otherwise) to his
employees for personal injuries or sickness.

Section 401(a) describes requirements for a qualified trust that is created or organized
in the United States and forms part of a pension plan of an employer that is for the
exclusive benefit of the employer’s employees or their beneficiaries. Section 501(a)
provides in pertinent part that an organization described in section 401(a) is generally
exempt from income tax.

In pertinent part, section 401(h) provides that, under regulations prescribed by the
Secretary, and subject to the provisions of section 420, a pension or annuity plan may
provide for the payment of benefits for sickness, accident, hospitalization, and medical
expenses of retired employees, their spouses and their dependents, but only if—

    (1) such benefits are subordinate to the retirement benefits provided by the
  plan,
    (2) a separate account is established and maintained for such benefits,
    (3) the employer's contributions to such separate account are reasonable and
  ascertainable,
    (4) it is impossible, at any time prior to the satisfaction of all liabilities under the
  plan to provide such benefits, for any part of the corpus or income of such
  separate account to be (within the taxable year or thereafter) used for, or diverted
  to, any purpose other than the providing of such benefits, and
    (5) notwithstanding the provisions of subsection (a)(2), upon the satisfaction of
  all liabilities under the plan to provide such benefits, any amount remaining in
  such separate account must, under the terms of the plan, be returned to the
  employer.

Treas. Reg. § 1.401-14(a) provides that, under section 401(h), a qualified pension or
annuity plan may make provision for the payment of sickness, accident, hospitalization,
and medical expenses for retired employees, their spouses, and their dependents. The
term "medical benefits described in section 401(h)" is used in this section to describe
such payments.

Treas. Reg. § 1.401-14(b)(1) provides that, under section 401(h), a qualified pension or
annuity plan may provide for the payment of medical benefits described in section
401(h) only for retired employees, their spouses, or their dependents. To be "retired" for
purposes of eligibility to receive medical benefits described in section 401(h), an
employee must be eligible to receive retirement benefits provided under the pension
PLR-121608-15 7

plan, or else be retired by an employer providing such medical benefits by reason of
permanent disability. For purposes of the preceding sentence, an employee is not
considered to be eligible to receive retirement benefits provided under the plan if he is
still employed by the employer and a separation from employment is a condition to
receiving the retirement benefits.

In Rev. Rul. 2002-41, 2002-2 C.B. 75, an employer sponsors a health reimbursement
arrangement (HRA) that is paid for solely by the employer and not through salary
reduction contributions. The HRA reimburses substantiated medical care expenses (as
defined in section 213(d)) of participating employees and their spouses and dependents
(as defined in section 152) up to a maximum annual reimbursement amount. Unused
amounts from one coverage period are carried forward to subsequent coverage periods.
Participating employees have no right to receive cash or any other benefit in lieu of
medical expense reimbursements. In Situation 2 of Rev. Rul. 2002-41, the maximum
reimbursement amount under the HRA that is not applied to reimburse medical care
expenses before an employee retires or otherwise terminates employment continues to
be available after retirement or termination for any medical care expense incurred by
the former employee or the former employee's spouse and dependents. The ruling
concludes that coverage and reimbursements made under the HRA are excludable from
the gross income of participating employees under sections 106 and 105.

Notice 2002-45, 2002-2 C.B. 93, describes the tax treatment of HRAs. The notice
explains that a tax-favored HRA is an arrangement that (1) is paid for solely by the
employer and not pursuant to a salary reduction election or otherwise under a section
125 cafeteria plan; (2) reimburses the employee for medical care expenses (as defined
in section 213(d)) incurred by the employee or by the employee's spouse or
dependents; and (3) provides reimbursements up to a maximum dollar amount with any
unused portion of that amount at the end of the coverage period carried forward to
subsequent coverage periods.

CONCLUSION

Based on the facts and representations provided by Taxpayer, the use of the
Retirement Plan B 401(h) account to reimburse premiums of eligible retirees in the Non-
Grandfathered Group will not violate section 401(h) and Treas. Reg. § 1.401-14 or
otherwise cause Retirement Plan B to lose it its tax-qualified status under section
401(a). In addition, contributions from the Retirement Plan B 401(h) account to the
Medical Account Plan are excludable from a retired employee’s gross income under
section 106 of the Code. Furthermore, amounts received by retired employees, their
spouses, and their eligible dependents for medical care are excluded from the gross
income of the retired employees, if such amounts are paid directly or indirectly to the
retired employees to reimburse them for expenses incurred for the medical care of
themselves, their spouses, and their dependents under section 105(b).
PLR-121608-15 8

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

These rulings are based on the assumption that Retirement Plan A and Retirement Plan
B are qualified under section 401(a). The rulings contained in this letter are based upon
information and representations submitted by Taxpayer and accompanied by a
penalties of perjury statement executed by an appropriate party. While this office has
not verified any of the material submitted in support of the request for rulings, it is
subject to verification on examination.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.

If you have any questions concerning this letter, please contact --------------------,
Attorney, at ---------------------.

                                    Sincerely,

                                    /S/

                                    Janet A. Laufer
                                    Senior Technician Reviewer
                                    Health & Welfare Branch
                                    Office of Associate Chief Counsel
                                    (Tax Exempt & Government Entities)

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