When Benefit Concepts Inc. of New York, a $2-million-a-year business-planning and consulting firm in New York City, decided to buy a vacation home for its employees, it narrowed its choices to two. "It was either a beach place in the Hamptons," says Daniel E. Carpenter, the company's president, "or a ski place near Stowe."

The skiers won.

In late January, the company had plans to purchase a $30,000, chalet-style condominium in the Green Mountains of Vermont. But the deed won't be made out to the corporation. It will bear the name of the company's Voluntary Employees' Beneficiary Association (VEBA).

As described under section 501 (c)(9) of the Internal Revenue Code, a VEBA is a vehicle (generally a trust) that pays for employees' fringe benefits after a corporation deposits sufficient money to cover these costs. The primary reason a company would choose to pay for these benefits through a separate entity is that contributions to a VEBA (assuming that certain standards set forth in the Internal Revenue Service regulations have been complied with) are fully deductible in the year that they are made. And that, obviously, helps a corporation trim its tax liabilities.

Through a VEBA, health and disability insurance can be covered (see INC., May 1983, page 182). So can vacation facilities -- even though the IRS isn't crazy about the idea. Its problem with recreation VEBAs is that some businesses abuse them. Owners of small corporations sometimes purchase condominiums through their companies' VEBA trusts, then refuse to share the facilities equally with their employees -- as the regulations require.

"The IRS feels that [the vacation-home VEBA] is a scam, and, in some cases, they're right," says Nancy Keppelman, an associate in the Detroit law firm of Miller, Canfield, Paddock & Stone. "We've heard rumors," she adds, "that the IRS is starting to come down hard in this area."

The IRS denies that it has singled out vacation-home VEBAs for special scrutiny, or that having a recreation VEBA will trigger a tax audit. So, consultants argue, corporations should use VEBAs whenever it is feasible. "If you do it right," says Barry R. Schotz, president of Creative Compensation Inc., a benefits consulting firm in La Jolla, Calif., "if you don't get greedy, the IRS will help you, because they have a stake in this, too, from a social point of view. A healthier employee is going to be less of a drain on the social programs."

The practice of providing workers with vacation benefits is not new. In 1915, the New York Waist and Dress Makers' Union, Local 25 of the International Ladies' Garment Workers' Union, rented a house in Pine Hill, N.Y., for the use of its members. The idea caught on, and, in 1919, the union made the arrangement permanent. It acquired the 1,000-acre Old Forest Park Hotel Resort in the Pocono Mountains in Pennsylvania, where the present ILGWU Forest Park Unity House now stands.

The concept of VEBAs also dates back to the early part of this century. "The original concept was a pass-the-hat situation when a fellow employee died," says Harlan M. Ten Pas of the Chicago accounting firm of Checkers, Simon & Rosner. "Then, in 1928, Congress came out with a statement that said a voluntary employees' beneficiary association could qualify as a tax-exempt entity. That's when it all started."

Oddly enough, small business didn't get around to making use of the technique until 1980, when the IRS finally issued regulations governing VEBAs. A VEBA, according to those rules, must be administered by its members, by an independent trustee, or, in some circumstances, by a corporation. It all depends on the type of fringe benefits provided. For instance, a corporation may control the VEBA if the benefits supplied are among those sanctioned by the Employee Retirement Income Security Act of 1974 (ERISA). If the fringes provided are not on the list of benefits that are covered by an Employee Welfare Benefit Plan under ERISA, members of the VEBA or independent trustees must be in charge. Among the fringe benefits covered by ERISA are medical, dental, life, and disability insurance.

Included in the list of benefits not specifically authorized are recreation facilities. But companies with recreation facilities can still manage their VEBAs, says Nancy Keppelman. To do so, they must expand their trusts to include one or more of the approved benefits. "Our position," Keppelman notes, "is that if you have, along with your recreation facility, something in the VEBA that is covered by ERISA, you'll probably be okay with the Internal Revenue Service."

Generally, participation in a VEBA is voluntary, but companies can require employees to belong, the IRS says, as long as the employees "incur no detriment." Christopher Frey, a resort-development consultant in Waitsfield, Vt., explains what that means: "The regulations cite deductions from pay as such a detriment. An employer may not impose a membership upon an employee by voluntarily withholding on his salary and paying over to a trust."

Membership in a VEBA is generally limited to former and present employees and their dependents (principally, spouses and children who are minors or students). Trustees, administrators of the VEBA, and similar "nonemployee insiders" can participate, too, but such persons can make up no more than 10% of the VEBA's total membership. "Not all members need to be employees in the strict sense," Frey points out. "For example, the proprietor of a business whose employees are members could participate."

Membership in a company's VEBA can be restricted by geographic area, length of service, or the worker's status as a full or part-time employee. Workers participating in a VEBA also can be required to pass a minimum health test (to make sure they are physically able to make use of company-sponsored recreation facilities). But in no way can the VEBA disproportionately favor the company s officers, shareholders, and other highly paid employees.

The principal reason companies choose to make VEBAs the owners of their vacation homes is the effect on taxable income. Take the case of Benefit Concepts. It will deposit $30,000, the purchase price of the Stowe condominium, in its VEBA at the end of its fiscal year, entitling it to a $30,000 deduction on its 1983 tax return. If the corporation had planned to purchase the property in its name, rather than through the VEBA, it could not have deducted the full purchase price in one lump sum but would have had to depreciate the property over 15 years.

And this isn't the only selling point. A VEBA can charge its members a fee to pay for upkeep on a vacation home, so the facility can be self-sustaining after it is acquired. "We're definitely going to be utilizing mandatory contributions by the employees," says Carpenter of Benefit Concepts. "It won't be substantial -- $50 or so a month, nothing prohibitive. If you're going to be using the facility, you should have to pay some of the freight."

Also, assets placed in a VEBA can't be attached by creditors of the employer, and interest earned on funds accumulating in the trust is exempt from income taxation. Suppose Benefit Concepts's VEBA earned $1,000 in interest in 1983. Since the trust is tax-exempt, the entire amount would go to pay fringe-benefit costs, such as upkeep on the condominium. "That means," says Larry Richter, chairman and chief executive officer of Corbel & Co., a consulting firm in Jacksonville, Fla., "that you don't have to put as much money in the plan next year. The interest you earned will cover part of the bill for your employees' fringe benefits."

The remaining selling points of a vacation-home VEBA are less tangible. "The company that finds economical ways to provide exceptional vacation benefits," argues Christopher Frey, "will be rewarded by improved employee morale, higher productivity, and more fruitful recruitment programs." Barry Schotz adds, "You will notice less absenteeism right away, and you will notice that employees will be a little more conscientious."

Good as all this sounds, VEBAs aren't right for all companies. Some corporations are too small to make a vacation-home VEBA workable. For example, corporations with fewer than 25 or 30 employees probably won't be able to keep the vacation home full year-round. And renting the facility isn't the answer, because the trust may have to pay taxes on the amount collected. (It would be classified as "unrelated business income.") In addition, small companies have to contend with the IRS. "We've heard," says Larry L. Grudzien, tax supervisor in the Chicago office of the accounting firm, Laventhol & Horwath, "that the IRS is scrutinizing heavily plans with fewer than 10 members."

And there are other drawbacks to consider. You can't use the VEBA home to entertain clients (the facility is for VEBA members only), and, because of the IRS's concern that the vacation home be accessible, the facility should be relatively close to your business's home base. Laventhol & Horwath goes so far as to recommend that your vacation facility be within 250 miles of your business. But consultants say you can increase the likelihood of IRS approval of a more distant location by providing transportation as part of your employees' vacation package.

Another problem is that vacation and recreation benefits that are provided by a VEBA may, in some cases, be taxable to the recipient. That headache may be a minor one, however. Say your corporation's VEBA pays $6,000 for a time-share week at a resort. The time-share week has a useful life of 30 years, making the annual cost of this benefit about $200, an amount that won't make much of a difference on most people's tax returns.

The biggest negative of a vacation-home VEBA, however, is this: Property placed in a VEBA does not belong to the corporation, even though the company paid for it. It is the property of the members of the VEBA. That may not sound so terrible -- and it isn't, until the trust is dissolved. Under the regulations, the assets of a dismantled trust must be distributed to members of the VEBA or used to provide other benefits for them. "But no part of the VEBA's assets," says Frey, "may at any time revert to any contributing employer."

Suppose Benefit Concepts sells its $30,000 condominium. The company paid for the vacation home, but by law it will get nothing at the time of the condominium's sale. Rather, the proceeds would remain in the VEBA, to be divided evenly among the members upon the trust's termination, or the money could be retained by the VEBA and used to pay for other fringe benefits. What is more, if the property has greatly appreciated, the company might forgo substantial capital gains. "You may find that, over the long haul, to keep the facility outside the VEBA is smarter from a capital-gains flexibility point of view," says Schotz. "Don't let the lure of an immediate tax deduction be the overriding reason you put the vacation home in the VEBA."

The key, then, in deciding whether to make use of a VEBA trust for a vacation facility is not to be swayed by any single factor. "It's like the old saying about tax shelters," says Schotz. "A VEBA has got to make more than tax sense. If it doesn't, don't do it."

If you decide to go ahead with a VEBA trust, be prepared for a paperwork avalanche. A VEBA, because it is a tax-exempt entity, must file IRS Form 990 annually, along with a Form 5500 (whether itis a 5500 or a 5500C depends on the number of participants). And, finally, hire a lawyer. He or she will prepare a plan for submission to the IRS. The charge, says Pat Queen, pension sales manager for Corbel & Co., could range from $2,500 to $10,000, depending on the plan's complexity.

Published on: Feb 1, 1984