Rev. Rul. 73-599

Advice has been requested as to the Federal income tax consequences of a revision of the taxpayer's group life and health insurance program for both active and retired lives where the amount of the "retired lives reserve" maintained by an insurance company will be transferred to and henceforth be maintained by a trust that qualifies for exemption under section 501(c)(9) of the Internal Revenue Code of 1954.

The taxpayer, an industrial corporation, files its returns on a calendar year basis using an accrual method of accounting. It has a program whereby life insurance and hospital, surgical, and other medical benefits are provided for certain of its active and retired employees. These benefits are provided for by group term insurance contracts issued to the taxpayer by an insurance company. The premiums called for by the contract are paid by the taxpayer to the insurance company and a deduction therefor is claimed by the taxpayer thus reducing its income subject to tax. A portion of such premiums is allocated by the insurance company to a "retired lives reserve" established and maintained by it for the purpose of accumulating a fund that would be used to pay all or a portion of the cost of continuing coverage for the retired employees. However, under the provisions of the contract, the taxpayer has the option to discontinue coverage for its retired employees under that insurance contract. Upon exercise of the option the balance in the reserve, after all charges thereto have been made, would be available for the declaration of a dividend on the policy by the insurance company to the taxpayer.

The taxpayer revised its employees' insurance benefits program so that insurance coverage would henceforth be provided for all its active and retired employees. To accomplish this it established a trust that qualifies for exemption under section 501(c)(9) of the Code. The taxpayer exercised its option under the group insurance contracts of which it was the named insured and directed that the amount accumulated in the retired lives reserve attributable to its contract be transferred to the trust. The amount transferred will thereafter be held and maintained by the trust for the sole purpose of providing insurance coverage for retired employees who are covered under the program so long as any active or retired employee covered by the revised program remains alive. As eligible employees retire the trustee will use such amounts either to pay premiums for insurance coverage to which the retired employees are entitled or, alternatively, to provide such benefits directly from the trust fund. The trust will become the named insured of new group insurance contracts and premiums called for by the new contracts will be paid by the trust.

In determining the amount of the taxpayer's contributions to the trust under the revised program, the amounts allocated to the fund for continuing post retirement coverage will not be greater than that which would be required, on an actuarial basis, to fairly allocate the cost of insurance coverage provided for retired employees over the working lives of such covered employees.

Section 1.162-10 of the Income Tax Regulations provides, in part, that amounts paid or accrued within the taxable year for a sickness, accident, hospitalization, medical expense, or similar benefit plan, are deductible under section 162(a) of the Code if they are ordinary and necessary expenses of the trade or business.

Rev. Rul. 69-478, 1969-2 C.B. 29, holds that a corporation's nonrefundable contribution to an employee's trust to provide group health and life insurance for both active and retired employees is deductible under section 162 of the Code, when contributions are actuarially determined and made by the employer on a level basis so that at the time of an employee's retirement there is enough money in the fund to enable the trustee to continue to make the premium payments on the contracted insurance.

Rev. Rul. 69-382, 1969-2 C.B. 28, holds, in part, that for taxable years ending on or before June 17, 1969, premiums paid or incurred by an employer policyholder under contracts providing group term life and health and accident coverage for its active and retired employees are deductible in full even though a portion of the premium is credited to a retired lives reserve if (1) the balance in the reserve is held by the insurance company solely for the purpose of providing insurance coverage on active or retired lives so long as any active or retired employees remain alive, and (2) the amount added to the retired lives reserve is not greater than an amount which would be required to fairly allocate the cost of the insurance coverage provided over the working lives of the employees involved. Further, that Revenue Ruling holds, in pertinent part, that these conclusions would be applicable to future years provided that the employer policyholder forthwith amends the contract to provide that it has no right to recapture any portion of the reserve so long as any active or retired employee remains alive.

Based on the stated facts, it is held that the taxpayer exercised its option to terminate coverage under its insurance policies, at which time it had the right to receive the balance accumulated in the retired lives reserve. Payment was directed to be made to the trust pursuant to that right. Therefore, the accumulated balance in such reserve, made up to in part by premiums paid by the taxpayer and deducted by it in reduction of its taxes and, in part, by interest increments added by the insurance company, shall be includible in the gross income of the taxpayer under section 61 of the Code for the taxable year in which its right to receive such balance becomes fixed notwithstanding that, at its request, the insurance company transferred such balance to the section 501(c)(9) trust. In those cases in which the tax benefit rule under section 111 applies, it is also held that the rule is only applicable to that part of the balance that was accumulated out of premiums. The rule has no application to that part of the accumulated balance that is the interest increments.

It is further held that annual contributions by the taxpayer to the fund maintained by the trustee for retired lives will constitute business expenses deductible under section 162 of the Code in the taxable year paid or incurred only to the extent that such contributions are actuarially determined and made on a level basis. Therefore, out of the entire amount transferred from the insurance company to the trust, which amount is held for retired lives, the taxpayer may have that portion that is actuarially determined and made on a level basis represent its otherwise payable annual contribution to the fund and only to that extent will it constitute a deduction under section 162 in the year of transfer. The excess, if any, of the amount transferred to the trust over the amount that represents its contribution to the fund for the year of transfer, shall constitute a prepayment of future annual contributions to the fund. Such prepayment may represent the taxpayers' future annual contributions to the fund and in future taxable years, if determined on an actuarial basis, will constitute a deduction under section 162.