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LIFE INSURANCE VEBA TAKES A HIT

July 31, 2002

An appeals court has upheld the IRS in striking down the use of a VEBA (Voluntary Employee Beneficiary Association) to provide tax-free benefits to highly compensated executives. The case (Neonatology Associates, PA, CA-3, #01-2862, 7/29/02) involves a setup where a professional medical corporation attempted to deduct contributions to a VEBA to buy life insurance. The contributions were far in excess of the cost of coverage, creating cash reserves that the doctors could purportedly withdraw tax-free.

The appeals court sustained the Tax Court ruling that the doctors’ corporation could only deduct payments up to the cost of term life coverage. The cost of term coverage was a small fraction of the amount contributed. The approximately $1,000,000 in excess of the cost of term insurance was treated as dividends -- non-deductible to the corporation, but taxable to the doctors. The doctors were also hit with penalties; the court ruled that the doctors could not reasonably rely on tax representations made by the insurance sellers who promoted the plan.

We hope to discuss this case more in a future Tax Update. In the meantime, approach VEBA life insurance schemes with the same respect you would give to wealth-generation opportunities on unsolicited faxes from Nigeria.

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