Part III. — Internal Revenue Bulletin 2007-45

Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits

Notice 2007–83

The Internal Revenue Service (IRS) and Treasury Department are aware of certain trust arrangements claiming to be welfare benefit funds and involving cash value life insurance policies that are being promoted to and used by taxpayers to improperly claim federal income and employment tax benefits. This notice informs taxpayers and their representatives that the tax benefits claimed for these arrangements are not allowable for federal tax purposes. This notice also alerts taxpayers and their representatives that these transactions are tax avoidance transactions and identifies certain transactions using trust arrangements involving cash value life insurance policies, and substantially similar transactions, as listed transactions for purposes of § 1.6011–4(b)(2) of the Income Tax Regulations and §§ 6111 and 6112 of the Internal Revenue Code. This notice further alerts persons involved with these transactions of certain responsibilities that may arise from their involvement with these transactions.

Concurrently with this notice, the IRS is publishing Rev. Rul. 2007–65 (concluding that for purposes of deductions allowable to an employer under § 419, a welfare benefit fund’s qualified direct cost does not include premium amounts for cash value life insurance policies paid by the fund, whenever the fund is directly or indirectly a beneficiary under the policy within the meaning of § 264(a)), and Notice 2007–84 (describing trust arrangements involving purported welfare benefit funds that, in form, provide post-retirement medical and life insurance benefits to employees on a nondiscriminatory basis but, in operation, result in the owner or owners receiving all or a substantial portion of the post-retirement and other benefits, and all or a substantial portion of any assets distributed from the trust).

BACKGROUND

Promoted Arrangements

Trust arrangements utilizing cash value life insurance policies and purporting to provide welfare benefits to active employees are being promoted to small businesses and other closely held businesses as a way to provide cash and other property to the owners of the business on a tax-favored basis. The arrangements are sometimes referred to by persons advocating their use as “single employer plans” and sometimes as “419(e) plans.” Those advocates claim that the employers’ contributions to the trust are deductible under §§ 419 and 419A as qualified cost, but that there is not a corresponding inclusion in the owner’s income.

A promoted trust arrangement may be structured either as a taxable trust or a tax-exempt trust, i.e., a voluntary employees’ beneficiary association (VEBA) that has received a determination letter from the IRS that it is described in § 501(c)(9). The plan and the trust documents indicate that the plan provides benefits such as current death benefit protection, self-insured disability benefits, and/or self-insured severance benefits to covered employees (including those employees who are also owners of the business), and that the benefits are payable while the employee is actively employed by the employer. The employer’s contributions are often based on premiums charged for cash value life insurance policies. For example, contributions may be based on premiums that would be charged for whole life policies. As a result, the arrangements often require large employer contributions relative to the actual cost of the benefits currently provided under the plan.

Under these arrangements, the trustee uses the employer’s contributions to the trust to purchase life insurance policies. The trustee typically purchases cash value life insurance policies on the lives of the employees who are owners of the business (and sometimes other key employees), while purchasing term life insurance policies on the lives of the other employees covered under the plan.

It is anticipated that after a number of years the plan will be terminated and the cash value life insurance policies, cash, or

other property held by the trust will be distributed to the employees who are plan participants at the time of the termination. While a small amount may be distributed to employees who are not owners of the business, the timing of the plan termination and the methods used to allocate the remaining assets are structured so that the business owners and other key employees will receive, directly or indirectly, all or a substantial portion of the assets held by the trust.

Those advocating the use of these plans often claim that the employer is allowed a deduction under § 419(c)(3) for its contributions when the trustee uses those contributions to pay premiums on the cash value life insurance policies, while at the same time claiming that nothing is includible in the owner’s gross income as a result of the contributions (or, if amounts are includible, they are significantly less than the premiums paid on the cash value life insurance policies). They may also claim that nothing is includible in the income of the business owner or other key employee as a result of the transfer of a cash value life insurance policy from the trust to the employee, asserting that the employee has purchased the policy when, in fact, any amounts the owner or other key employee paid for the policy may be significantly less than the fair market value of the policy. Some of the plans are structured so that the owner or other key employee is the named owner of the life insurance policy from the plan’s inception, with the employee assigning all or a portion of the death proceeds to the trust. Advocates of these arrangements may claim that no income inclusion is required because there is no transfer of the policy itself from the trust to the employees.

Intent to Challenge Transactions

The IRS intends to challenge the claimed tax benefits for the above-described transactions for various reasons. Depending on the facts and circumstances of a particular arrangement, contributions to a purported welfare benefit fund on behalf of an employee who is a shareholder may properly be characterized as dividend income to the owner, the value of which is includible in the owner’s gross

2007–45 I.R.B. 960 November 5, 2007

LISTED TRANSACTIONS

Transactions Identified As Listed Transactions

Any transaction that has all of the following elements, and any transaction that is substantially similar to such a transaction, are identified as “listed transactions” for purposes of § 1.6011–4(b)(2) and §§ 6111 and 6112, effective October 17, 2007, the date this notice is released to the public.

(1) The transaction involves a trust or other fund described in § 419(e)(3) that is purportedly a welfare benefit fund.

(2) For determining the portion of its contributions to the trust or other fund that are currently deductible the employer does not rely on the exception in § 419A(f)(5)(A) (regarding collectively bargained plans).

(3) The trust or other fund pays premiums (or amounts that are purported to be premiums) on one or more life insurance policies and, with respect to at least one of the policies, value is accumulated either:

(a) within the policy (for example, a cash value life insurance policy); or

(b) outside the policy (for example, in a side fund or through an agreement outside the policy allowing the policy to be converted to or exchanged for a policy which will, at some point in time, have accumulated value based on the purported premiums paid on the original policy).

(4) The employer has taken a deduction for any taxable year for its contributions to the fund with respect to benefits provided under the plan (other than post-retirement medical benefits, post-retirement life insurance benefits, and child care facilities) that is greater than the sum of the following amounts:

(a) With respect to any uninsured benefits provided under the plan,

(i) an amount equal to claims that were both incurred and paid during the taxable year; plus

(ii) the limited reserves allowable under § 419A(c)(1) or (c)(3), as applicable; plus

(iii) amounts paid during the taxable year to satisfy claims incurred in a prior taxable year (but only to the extent that no deduction was taken for such amounts in a prior year); plus

income, and for which amounts are not deductible by the corporation. See Neona- tology Associates v. Commissioner, 299 F.3d 221 (3d Cir. 2002). Depending on the facts and circumstances of a particular arrangement, the arrangement may properly be characterized as a plan deferring the receipt of compensation for purposes of § 404(a)(5), resulting in the application of the rules under § 404(a)(5) governing the timing of any otherwise available deductions. See Wellons v. Com- missioner, 31 F.3d 569 (7th Cir. 1994). In addition, an arrangement may properly be characterized as a nonqualified deferred compensation plan for purposes of § 409A. Application of § 409A may result in immediate inclusion of income and additional taxes to the employee, as well as income tax withholding liabilities to the employer. The facts and circumstances of a particular arrangement may result in it coming within the definition of a split-dollar life insurance arrangement, so that the tax consequences to the employer and the employees are subject to the rules governing those types of arrangements, including potentially § 409A. Under the economic benefit regime of the split-dollar life insurance arrangement rules set forth in § 1.61–22, the employee must include in income the full value of the economic benefits provided to the employee under the arrangement for the taxable year without a corresponding employer deduction.

If, based on the facts and circumstances, an arrangement described above is properly characterized as a welfare benefit fund for purposes of §§ 419 and 419A (rather than a dividend arrangement, a plan deferring the receipt of compensation, or a split-dollar life insurance arrangement), an employer is allowed a deduction for contributions to the trust or other welfare benefit fund only to the extent allowed under §§ 419 and 419A. Under §§ 419 and 419A, no deduction is allowed with respect to premiums paid for life insurance coverage provided to current employees if the welfare benefit fund or the employer is directly or indirectly a beneficiary under the life insurance policy within the meaning of § 264(a). In the promoted arrangements discussed above, the trust typically retains rights in the life insurance policies and is directly or indirectly

a beneficiary under the policies, so that no deduction is allowed with respect to the life insurance premiums. See Situation 1 in Rev. Rul. 2007–65. Further, any deduction with respect to uninsured benefits (for example, uninsured medical, disability, or severance benefits) is not based on the premiums paid on the life insurance policies, but is generally limited to claims incurred and paid during the year. ¹ See Situation 2 in Rev. Rul. 2007–65. Thus, contrary to the claims made by persons advocating the use of the arrangements discussed above, premiums on cash value life insurance policies paid through the trust are not a justification for claiming a deduction under §§ 419 and 419A.

Moreover, in appropriate cases, the IRS intends to challenge the value claimed by the taxpayer for property distributed from the trust, including cash value life insurance policies.

The above conclusions apply whether the trust used to provide the plan benefits is a taxable trust or a VEBA. While the trust may have received a determination letter stating the trust is exempt under § 501(c)(9), a letter of this type does not address the tax deductibility of contributions to the trust with respect to the employer nor the income inclusion with respect to the employees.

The IRS has previously identified certain other transactions that claim to be welfare benefit funds as listed transactions, concluding that the tax benefits claimed to be generated by these transactions are not allowable for federal income tax purposes. Notice 2003–24, 2003–1 C.B. 853, describes certain transactions purporting to meet the exception under § 419A(f)(5) for collectively bargained plans and identifies those and substantially similar transactions as listed transactions, and Notice 95–34, 1995–1 C.B. 309, describes transactions that purport to meet the 10-or-more employer plan exception under § 419A(f)(6). The transactions described in Notice 95–34 and substantially similar transactions have also been identified as listed transactions. See Notice 2004–67, 2004–2 C.B. 600.

1 Limited deductions are allowable under §§ 419 and 419A for additions to certain reserves, including a reserve for claims incurred but unpaid as of the close of a taxable year.

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action in this notice also. It should be noted that, independent of their classification as “listed transactions” for purposes of § 1.6011–4(b)(2) and §§ 6111 and 6112, transactions that are the same as, or substantially similar to, the transaction identified in this notice may already be subject to the requirements of §§ 6011, 6111, 6112, or the regulations thereunder. Persons required to disclose these transactions under § 1.6011–4 and who fail to do so may be subject to the penalty under § 6707A. ³ Persons required to disclose or register these transactions under § 6111 who have failed to do so may be subject to the penalty under § 6707(a). Persons required to maintain lists of investors under § 6112 who fail to do so (or who fail to provide such lists when requested by the IRS) may be subject to the penalty under § 6708(a).

In addition, the IRS may impose other penalties on persons involved in this transaction or substantially similar transactions (including the accuracy-related penalty under § 6662 or 6662A) and, as applicable, on persons who participate in the promotion or reporting of this transaction or substantially similar transactions (including the return preparer penalty under § 6694, the promoter penalty under § 6700, and the aiding and abetting penalty under § 6701).

Further, under § 6501(c)(10), the period of limitations on assessment may be extended beyond the general three-year period of limitations for persons required to disclose transactions under § 1.6011–4 who fail to do so. See Rev. Proc. 2005–26, 2005–1 C.B. 965. The IRS and the Treasury Department recognize that some taxpayers may have filed tax returns taking the position that they were entitled to the purported tax benefits of the types of transactions described in this notice. These taxpayers should consult with a tax advisor to ensure that their transactions are disclosed properly and to take appropriate corrective action.

DRAFTING INFORMATION

The principal authors of this notice are Larry Isaacs of the Employee Plans, Tax Exempt and Government Entities Division and Betty Clary of the Office

(iv) amounts paid during the taxable year or a prior taxable year for administrative expenses with respect to uninsured benefits and that are properly allocable to the taxable year (but only to the extent that no deduction was taken for such amounts in a prior year).

(b) With respect to any insured benefits provided under the plan,

(i) insurance premiums paid during the taxable year that are properly allocable to the taxable year (other than premiums paid with respect to a policy described in (3)(a) or (b) above); plus

(ii) insurance premiums paid in prior taxable years that are properly allocable to the taxable year (other than premiums paid with respect to a policy described in (3)(a) or (b) above); plus

(iii) amounts paid during the taxable year or a prior taxable year for administrative expenses with respect to insured benefits and that are properly allocable to the taxable year (but only to the extent that no deduction was taken for such amounts in a prior year).

(c) For taxable years ending prior to November 5, 2007, with respect to life insurance benefits provided through policies described in (3)(a) and (b) above, the greater of the following amounts: ²

(i) in the case of an employer with a taxable year that is the calendar year, the aggregate amounts reported by the employer as the cost of insurance with respect to such policies on the employees’ Forms W–2 (or Forms 1099) for that year, plus an amount equal to the amounts that would have been reportable on the employees’ Forms W–2 for that year, but for the exclusion under section 79 (relating to the cost of up to $50,000 of coverage); or, in the case of an employer with a taxable year other than the calendar year, the portions of the aggregate amounts reported by the employer on the Forms W–2 (or Forms 1099) as described in (i), above, (or that would have been reported absent the exclusion under § 79) that are properly allocable to the employer’s taxable year; and

(ii) with respect to each employee insured under a cash value life insurance policy, the aggregate cost of insurance charged under the policy or policies with

respect to the amount of current life insurance coverage provided to the employee under the plan (but limited to the product of the current life insurance coverage under the plan multiplied by the current year’s mortality rate provided in the higher of the 1980 or 2001 CSO Table).

(d) The additional reserve, if any, under § 419A(c)(6) (relating to medical benefits provided through a plan maintained by a bona fide association), but only to the extent amounts are not already included above in this paragraph (4), and only to the extent that no deduction was taken for such amounts in a prior taxable year.

Participation in the Listed Transactions

Whether a taxpayer has participated in the listed transaction described in this notice will be determined under § 1.6011–4(c)(3)(i)(A). However, an individual who is not the employer will be treated as a participant for a taxable year if, and only if the individual owns, directly or indirectly, 20 percent or more of an entity, other than a C corporation, that is a participant in the listed transaction for the taxable year. For this purpose, indirect ownership is determined under rules similar to the rules of § 318 but without regard to the family attribution rules of § 318(a)(1).

Disclosure, List Maintenance, and Registration Requirements; Penalties; Other Considerations

In general, if a taxpayer has participated in a listed transaction, the rules of § 1.6011–4(e) determine when a disclosure statement must be filed by the taxpayer. However, if, under § 1.6011–4(e), a taxpayer is required to file a disclosure statement with respect to the listed transaction described in this notice after October 17, 2007, and prior to January 15, 2008, that disclosure statement will be considered to be timely filed if the taxpayer alternatively files the disclosure statement with the Office of Tax Shelter Analysis (OTSA) by January 15, 2008.

Some transactions described in Notice 95–34 and substantially similar transactions may be identified as a listed trans

2 For taxable years ending on or after November 5, 2007, the amount under this (4)(c) is zero.

3 Section 6707A applies to returns and statements due after October 22, 2004. See Notice 2005–11, 2005–1 C.B. 493. The amount of the penalty under § 6707A with respect to a listed transaction is $100,000 in the case of a natural person and $200,000 in any other case.

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uses the employer’s contributions to purchase cash value life insurance policies on the lives of employees who are owners of the business and, sometimes, on the lives of other key employees.

The amount of the employer’s deduction for contributions to one of these plans is often based on a calculation of a reserve associated with each of the plan participants. However, the calculation may be based on an unreasonable assumption that all of the covered employees will eventually receive post-retirement benefits under the plan, or may be based on other actuarial assumptions that either are not reasonable or are not permitted to be reflected in the reserve calculations for purposes of §§ 419 and 419A.

Under some arrangements, the plan documents may indicate that post-retirement benefits will be provided on a nondiscriminatory basis when, in fact, only a few employees (primarily the employees who are also owners of the business) will ever receive those benefits. To the extent a trust holds excess assets not needed to pay the original benefits, the owner will also receive a substantial portion of those assets. Under some arrangements, this will be accomplished through the use of “loans” to the owners. For some arrangements, the plan will be amended to provide benefits other than the plan’s original post-retirement medical or life insurance benefits. For others, the plan will be terminated prior to the payment of the post-retirement benefits and the timing of the termination and the methods used to allocate the remaining assets are structured so that the owners and other key employees will receive, directly or indirectly, all or a substantial portion of the assets held by the trust.

Persons advocating the use of these plans claim that the employer’s contributions for the post-retirement medical and life benefits are deductible under §§ 419 and 419A as additions to a qualified asset account. They may also claim that owners or other key employees receive the economic benefits from the contributions with little or no income inclusion.

LAW

Sections 419 and 419A prescribe limits on the amount of deductions for contributions paid or accrued by an employer

of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this notice, contact Mr. Isaacs at RetirementPlanQuestions@irs.gov or Ms. Clary at (202) 622–6080 (not a toll-free call).

Trust Arrangements Purporting to Provide Nondiscriminatory Post-Retirement Medical and Life Insurance Benefits

Notice 2007–84

Sections 419 and 419A of the Internal Revenue Code set forth rules under which employers are permitted to make currently deductible contributions to welfare benefit funds in order to provide their retirees with medical and life insurance benefits. Businesses often maintain welfare benefit funds that comport with the intent of §§ 419 and 419A and do in fact provide meaningful medical and life insurance benefits to retirees on a nondiscriminatory basis, and make substantial contributions to those welfare benefit funds that are fully deductible. Such welfare benefit funds are outside the scope of this notice.

This notice addresses certain trust arrangements that are being promoted to and used by small businesses to avoid federal income and employment taxes. The arrangements described in this notice involve purported welfare benefit funds that, in form, provide post-retirement medical and life insurance benefits to employees on a nondiscriminatory basis, but that, in operation, will primarily benefit the owners or other key employees of the businesses. This notice alerts taxpayers and their representatives that the tax treatment of these arrangements may vary from the claimed tax treatment. The Internal Revenue Service (IRS) may issue further guidance to address these arrangements, and taxpayers should not assume that the guidance will be applied prospectively only.

Concurrently with this notice, the IRS is publishing Notice 2007–83, this Bulletin, which identifies as listed transactions certain transactions involving purported welfare benefit fund arrangements using cash

value life insurance policies. The fact that an arrangement is described in this notice does not preclude it from also being a listed transaction under Notice 2007–83 where the arrangement provides benefits to active employees as well as to retired employees.

The IRS has previously identified certain other transactions that claim to be welfare benefit funds as listed transactions. Notice 2003–24, 2003–1 C.B. 853, describes certain transactions purporting to meet the exception under § 419A(f)(5) of the Internal Revenue Code for collectively bargained plans. Notice 95–34, 1995–1 C.B. 309, describes transactions that purport to meet the 10-or-more employer plan exception under § 419A(f)(6). Notice 2004–67, 2004–2 C.B. 600, includes transactions described in Notice 2003–24 and Notice 95–34, as well as substantially similar transactions, as listed transactions.

BACKGROUND

Promoted trust arrangements claiming to provide nondiscriminatory post-retirement medical benefits and post-retirement life insurance benefits have recently come to the attention of the IRS. These arrangements, among others, may be referred to by persons advocating the use of the plans as “single employer plans” or “419(e) plans.” These purported welfare benefit arrangements are usually sold to small businesses and other closely held businesses as a way to provide post-retirement medical benefits, post-retirement life insurance, and cash and other property to the owners or other key employees of the business on a tax-favored basis through the use of a trust. Those advocating the use of these plans usually assert that the contributions are tax-deductible, but with no corresponding inclusion by the owner or other key employee. Some of these arrangements involve plans that previously had claimed to be 10-or-more employer plans under § 419A(f)(6); some others were established to receive policies transferred from terminating plans that claimed to be 10-or-more employer plans.

A promoted arrangement may involve either a taxable trust or a tax-exempt trust, i.e., a voluntary employees’ beneficiary association (VEBA) that has received a determination letter from the IRS that it is described in § 501(c)(9). The trust frequently

November 5, 2007 963 2007–45 I.R.B.

treated as amounts received through accident or health insurance. Thus, the plan must exist primarily for the benefit of employees, as opposed to shareholders. See, e.g., Larkin v. Commissioner, 48 T.C. 629 (1967), aff’d, 394 F.2d 494 (1 ^st Cir. 1968) (holding that the plan was merely a device to use corporate earnings to meet the anticipated medical needs of the shareholders).

Section 4976(a) imposes on an employer an excise tax in the amount of 100 percent of the amount of any disqualified benefit provided with respect to a welfare benefit fund maintained by the employer. Under § 4976(b)(1), a “disqualified benefit” means (i) any post-retirement medical benefit or life insurance benefit provided with respect to a key employee if a separate account is required to be established for the key employee under § 419A(d) and the payment is not from that employee’s account; (ii) any post-retirement medical benefit or life insurance benefit provided with respect to an individual in whose favor discrimination is prohibited unless the plan meets the requirements of § 505(b) with respect to the benefit (whether or not the § 505(b) requirements apply to the plan); and (iii) any portion of a welfare benefit fund reverting to the benefit of the employer.

INTENT TO CHALLENGE ARRANGEMENTS

The IRS may challenge the claimed tax benefits for the above-described arrangements for various reasons. Depending on the facts and circumstances of a particular arrangement, contributions to a purported welfare benefit arrangement on behalf of an employee who is an owner may properly be characterized as dividends or as non-qualified deferred compensation subject to § 404(a)(5) or 409A (or both), or the arrangement may be subject to the rules for split-dollar life insurance arrangements. See Notice 2007–83.

If, based on the facts and circumstances, an arrangement described above is properly characterized as a welfare benefit fund, an employer’s deductions for contributions to the welfare benefit trust or other fund are subject to the rules of §§ 419 and 419A. Under those rules, deductions for post-retirement medical and life benefits are subject to a number of limitations and requirements, including

to a welfare benefit fund. A welfare benefit fund generally consists of a taxable or exempt trust, corporation, or other organization that is part of a plan of an employer through which the employer provides welfare benefits to employees or their beneficiaries. Under § 419, the employer’s contributions to a welfare benefit fund are deductible only if they would otherwise be deductible under Chapter 1 of the Code, and the amount of the deduction is limited to the welfare benefit fund’s qualified cost for the taxable year.

One component of qualified cost is a fund’s qualified direct cost for the year, which is the amount (including administrative expenses) that would have been allowable as a deduction to the employer with respect to the benefits provided during the year if those benefits had been provided directly by the employer, and the employer had used the cash receipts and disbursements method of accounting. A second component of qualified cost is any addition to a qualified asset account for the taxable year, but only to the extent the addition does not exceed specified limits. Further, the qualified cost for the taxable year is reduced by the fund’s after-tax income for the year.

Under § 419A(a), the term “qualified asset account” means any account consisting of assets set aside to provide for the payment of disability benefits, medical benefits, supplemental unemployment benefits or severance pay benefits, or life insurance benefits. Sections 419A(b) and 419A(c)(1) generally limit the additions to a qualified asset account to an amount that is reasonably and actuarially necessary to fund claims incurred but unpaid (as of the close of the taxable year) for the benefits referred to above, plus administrative costs with respect to those claims.

Section 419A(c)(2) allows additional limited reserves for post-retirement medical and post-retirement life insurance benefits. The reserves must be funded over the working lives of the covered employees and must be actuarially determined on a level basis using assumptions that are reasonable in the aggregate as necessary for the post-retirement benefits to be provided to the covered employees. For purposes of § 419A(c)(2), contributions to a reserve are deductible under § 419A only if the contributions are intended to actually accumulate for the purpose of funding the

post-retirement benefits. General Signal Corporation v. Commissioner, 142 F.2d 546 (2d Cir. 1998). Under § 419A(c)(2)(A), the reserve for post-retirement medical benefits is further limited by the requirement that it be determined on the basis of current medical costs. In addition, for post-retirement life insurance the maximum insurance coverage that can be taken into account with respect to any covered employee is $50,000 of coverage. Moreover, in the case of post-retirement benefits for or on behalf of a key employee (as defined in § 416(i)(1)), § 419A(d) requires that a separate account be established for any medical or life insurance benefits provided with respect to the key employee, and any medical or life insurance benefits provided with respect to the key employee after retirement may only be paid from the separate account. Under § 419A(e)(1), in order for reserves for post-retirement medical and life insurance benefits to be taken into account the plan must meet the nondiscrimination requirements of § 505(b) with respect to those benefits (even if those requirements do not otherwise apply to the plan).

A plan meets the nondiscrimination requirements of § 505(b) only if (i) each class of benefits under the plan is provided under a classification of employees which is set forth in the plan and which is found by the Secretary not to be discriminatory in favor of employees who are highly compensated individuals, and (ii) in the case of each class of benefits, such benefits do not discriminate in favor of employees who are highly compensated individuals. Under § 505(b)(3), in the case of any benefit for which another section of the Code provides nondiscrimination rules ( e.g., § 105(h) in the case of a self-insured medical reimbursement plan), those rules apply instead with respect to the benefit. Under §§ 105(h)(8) and 414(t), all employees who are treated as employed by a single employer under the rules of § 414(b), (c), or (m) are treated as employed by a single employer for purposes of §§ 105(h), 79, and 505. Sections 104(a)(3) and 105(b), (c), and (d) exclude from gross income certain amounts received by an employee through accident and health insurance. Section 105(e) provides that for purposes of §§ 104 and 105, amounts received through an “accident and health plan for employees” are

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the use of reasonable actuarial assumptions, the requirement that the plan meet the nondiscrimination requirements of § 505(b) (determined after application of the rules of § 414(b), (c), and (m)), a prohibition against considering future increases in medical costs, and a limit on the reserves for post-retirement life insurance benefits to the reserves that would apply with respect to $50,000 of coverage. Moreover, in order to obtain a deduction for reserves for post-retirement medical or life benefits, the taxpayer cannot get a deduction unless the employer actually intends to use the contributions for that purpose.

The tax benefit rule may require that some or all of the deductions taken by the employer in earlier years be included in its income in a later year in which an event occurs that is fundamentally inconsistent with the premise on which the deductions were initially based. (For a further discussion of the tax benefit rule, see Hillsboro National Bank v. Commissioner, 460 U.S. 370 (1983)). Further, the IRS intends to challenge the claimed value of property distributed from a trust, including life insurance policies, whenever the property has not been properly valued by the taxpayer.

Finally, based on the facts and circumstances of a particular arrangement, some or all of the benefits or distributions provided to or for the benefit of employees who are also owners or other key employees may be disqualified benefits for purposes of § 4976 subjecting the employer to a 100% excise tax.

Taxpayers should be aware that the IRS may impose penalties on persons involved in these arrangements or similar arrangements (including the accuracy-related penalty under § 6662) and, as applicable, on persons who participate in the promotion or reporting of these arrangements or similar arrangements (including the return preparer penalty under § 6694, the promoter penalty under § 6700, and the aiding and abetting penalty under § 6701).

The above rules apply whether the trust used to provide benefits under the arrangement is a taxable trust or a VEBA. While the trust may have received a determination letter stating the trust is exempt under § 501(c)(9), a letter of this type does not address the tax deductibility of contributions to the trust with respect to the em

ployer, nor the income inclusion with respect to the employees.

DRAFTING INFORMATION

The principal authors of this notice are Larry Isaacs of the Employee Plans, Tax Exempt and Government Entities Division and Betty Clary of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this notice, contact Mr. Isaacs at RetirementPlanQuestions@irs.gov or Ms. Clary at (202) 622–6080 (not a toll-free call).

Form 8918 — Section 6111 Disclosures

Notice 2007–85

This notice provides guidance to material advisors required to file a disclosure statement by October 31, 2007, under § 301.6111–3 of the Procedure and Administration Regulations.

BACKGROUND

On August 3, 2007, the Internal Revenue Service and Treasury Department published final regulations under § 301.6111–3 in the Federal Register (72 FR 43157) providing the rules relating to the disclosure of reportable transactions by material advisors under section 6111 of the Internal Revenue Code. See T.D. 9351, 2007–38 I.R.B. 616. In general, these regulations apply to transactions with respect to which a material advisor makes a tax statement on or after August 3, 2007. However, these regulations apply to transactions of interest entered into on or after November 2, 2006, with respect to which a material advisor makes a tax statement on or after November 2, 2006.

The regulations provide that each material advisor, with respect to any reportable transaction, must file a return as described in § 301.6111–3(d). Section 301.6111–3(d) provides that each material advisor required to file a disclosure statement under § 301.6111–3 must file a completed Form 8918, “ Material Advi- sor Disclosure Statement ” (or successor form). The Form 8918 must be filed with

the Office of Tax Shelter Analysis (OTSA) by the last day of the calendar month that follows the end of the calendar quarter in which the advisor became a material advisor with respect to the reportable transaction or in which the circumstances necessitating an amended disclosure occur.

Prior to the publication of the final regulations, material advisors were required to disclose reportable transactions on Form 8264, “ Application for Registration of a Tax Shelter .” Notice 2004–80, 2004–2 C.B. 963, and Notice 2005–22, 2005–1 C.B. 756, described the manner in which the Form 8264 was to be completed.

INTERIM PROVISION

The next due date for disclosures by material advisors is October 31, 2007. As of the date of release of this notice, Form 8918 has not yet been published. The IRS anticipates that the Form 8918 will be published soon.

Due to the unavailability of Form 8918, a material advisor required to file a completed Form 8918 by October 31, 2007, will be treated as satisfying the disclosure requirement of § 301.6111–3(d) if the material advisor files Form 8264 instead. If Form 8918 is published on or before October 31, 2007, material advisors may choose to use either Form 8918 or Form 8264 for disclosures required to be filed by October 31, 2007. For disclosures required to be filed after October 31, 2007, material advisors must use Form 8918 (or successor form) unless instructed otherwise by the IRS. Reportable transactions disclosed on the Form 8264 should be disclosed in the manner described in Notice 2004–80 and Notice 2005–22.

EFFECTIVE DATE

This notice is effective October 16, 2007, the date this notice was released to the public.

DRAFTING INFORMATION

The principal author of this notice is Charles D. Wien of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this notice, contact Charles D. Wien at 202–622–3070 (not a toll-free call).

November 5, 2007 965 2007–45 I.R.B.

2008 Limitations Adjusted As Provided in Section 415(d), etc. ¹

Notice 2007–87

Section 415 of the Internal Revenue Code (the Code) provides for dollar limitations on benefits and contributions under qualified retirement plans. Section 415 also requires that the Commissioner annually adjust these limits for cost-of-living increases. Other limitations applicable to deferred compensation plans are also affected by these adjustments. Many of the limitations will change for 2008 because the increase in the cost-of-living index met the statutory thresholds that trigger their adjustment. However, for others, the limitation will remain unchanged. For example, the limitation under § 402(g)(1) on the exclusion for elective deferrals described in § 402(g)(3) remains unchanged at $15,500. This limitation affects elective deferrals to section 401(k) plans and to the Federal Government’s Thrift Savings Plan, among other plans.

Cost-of-Living limits for 2008

Effective January 1, 2008, the limitation on the annual benefit under a defined benefit plan under § 415(b)(1)(A) is increased from $180,000 to $185,000. For participants who separated from service before January 1, 2008, the limitation for defined benefit plans under § 415(b)(1)(B) is computed by multiplying the participant’s compensation limitation, as adjusted through 2007, by 1.0236.

The limitation for defined contribution plans under § 415(c)(1)(A) is increased from $45,000 to $46,000.

The Code provides that various other dollar amounts are to be adjusted at the same time and in the same manner as the dollar limitation of § 415(b)(1)(A). These dollar amounts and the adjusted amounts are as follows:

The limitation under § 402(g)(1) on the exclusion for elective deferrals described in § 402(g)(3) remains unchanged at $15,500.

The annual compensation limit under §§ 401(a)(17), 404(l), 408(k)(3)(C),

1 Based on News Release IR–2007–171 dated October 18, 2007.

and 408(k)(6)(D)(ii) is increased from $225,000 to $230,000.

The dollar limitation under § 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan is increased from $145,000 to $150,000.

The dollar amount under § 409(o)(1)(C)(ii) for determining the maximum account balance in an employee stock ownership plan subject to a 5-year distribution period is increased from $915,000 to $935,000, while the dollar amount used to determine the lengthening of the 5-year distribution period is increased from $180,000 to $185,000.

The limitation used in the definition of highly compensated employee under § 414(q)(1)(B) is increased from $100,000 to $105,000.

The dollar limitation under § 414(v)(2)(B)(i) for catch-up contributions to an applicable employer plan other than a plan described in § 401(k)(11) or 408(p) for individuals aged 50 or over remains unchanged at $5,000. The dollar limitation under § 414(v)(2)(B)(ii) for catch-up contributions to an applicable employer plan described in § 401(k)(11) or 408(p) for individuals aged 50 or over remains unchanged at $2,500.

The annual compensation limitation under § 401(a)(17) for eligible participants in certain governmental plans that, under the plan as in effect on July 1, 1993, allowed cost-of-living adjustments to the compensation limitation under the plan under § 401(a)(17) to be taken into account, is increased from $335,000 to $345,000.

The compensation amount under § 408(k)(2)(C) regarding simplified employee pensions (SEPs) remains unchanged at $500.

The limitation under § 408(p)(2)(E) regarding SIMPLE retirement accounts remains unchanged at $10,500.

The limitation on deferrals under § 457(e)(15) concerning deferred compensation plans of state and local governments and tax-exempt organizations remains unchanged at $15,500.

The compensation amounts under § 1.61–21(f)(5)(i) of the Income Tax

Regulations concerning the definition of “control employee” for fringe benefit valuation purposes remains unchanged at $90,000. The compensation amount under § 1.61–21(f)(5)(iii) is increased from $180,000 to $185,000. The Code also provides that several pension-related amounts are to be adjusted using the cost-of-living adjustment under § 1(f)(3). These dollar amounts and the adjustments are as follows:

The adjusted gross income limitation under § 25B(b)(1)(A) for determining the retirement savings contribution credit for taxpayers filing a joint return is increased from $31,000 to $32,000; the limitation under § 25B(b)(1)(B) is increased from $34,000 to $34,500; and the limitation under § 25B(b)(1)(C) and (D) is increased from $52,000 to $53,000.

The adjusted gross income limitation under § 25B(b)(1)(A) for determining the retirement savings contribution credit for taxpayers filing as head of household is increased from $23,250 to $24,000; the limitation under § 25B(b)(1)(B) is increased from $25,500 to $25,875; and the limitation under § 25B(b)(1)(C) and (D) is increased from $39,000 to $39,750.

The adjusted gross income limitation under § 25B(b)(1)(A) for determining the retirement savings contribution credit for all other taxpayers is increased from $15,500 to $16,000; the limitation under § 25B(b)(1)(B) is increased from $17,000 to $17,250; and the limitation under § 25B(b)(1)(C) and (D) is increased from $26,000 to $26,500.

The applicable dollar amount under § 219(g)(3)(B)(i) for determining the deductible amount of an IRA contribution for taxpayers who are active participants filing a joint return or as a qualifying widow(er) is increased from $83,000 to $85,000. The applicable dollar amount under § 219(g)(3)(B)(ii) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $52,000 to $53,000. The applicable dollar amount under § 219(g)(7)(A) for a taxpayer who is not an active participant but whose

2007–45 I.R.B. 966 November 5, 2007

item thereof), or (ii) the allocation to a partner under the agreement of income, gain, loss, deduction, or credit (or item thereof) lacks substantial economic effect.

Section 1.704–1(b)(4)(ii) provides that allocations of tax credits and tax credit recapture (except for § 38 property) are not reflected by adjustments to the partners’ capital accounts. Thus, these allocations cannot have economic effect under § 1.704–1(b)(2)(ii)( b )( 1 ), and the tax credits and tax credit recapture must be allocated in accordance with the partners’ interests in the partnership as of the time the tax credit or credit recapture arises. If a partnership expenditure (whether or not deductible) that gives rise to a tax credit in a partnership taxable year also gives rise to valid allocations of partnership loss or deduction (or other downward capital account adjustments) for the year, then the partners’ interests in the partnership with respect to the credit (or the cost giving rise to it) are in the same proportion as the partners’ respective distributive shares of the loss or deduction (and adjustments). See § 1.704–1(b)(5), Example 11. Section 1.704–1(b)(4)(ii) further provides that identical principles apply in determining the partners’ interests in the partnership regarding tax credits, such as the credit under § 45, that arise from receipts of the partnership (whether or not taxable).