Changes in Sterling Benefit Plans

NEW REGULATIONS AND RULINGS

Over the past several months the IRS and Treasury Departments have published the following rulings and regulations:

1. Notice 2000-15 and Announcement 2000-12. In this Notice and Announcement, IRS put forth its view that arrangements that ignore the deduction limitations of Sections 419 and 419A of the Internal Revenue Code because they purport to comply with IRC section 419A(f)(6) are “potentially abusive tax shelters”. [Note: The effect of being a potentially abusive tax shelter is to require corporate taxpayers to disclose their participation in such transactions.] We did not report this to clients initially because the way the Notice was initially worded (requiring a tax benefit of at least $1 million per year or $2 million total), it did not apply to any of our clients.

2. Notice 2002-51. In this Notice, IRS extended its position announced in Notice 2000-15 to “(t)ransactions that are the same as or substantially similar to transactions” described in Notice 2000-15.

3. Treasury Decision 9000. This expanded the foregoing rulings to all 419A(f)(6) and substantially similar arrangements without regard to a minimum amount of tax benefit. As a result, corporate taxpayers may need to disclose their participation in these listed transactions. This decision also expanded the reporting requirement to participants in such arrangements. As a result of these rulings all employers funding such arrangements and participants participating in such arrangements are now required to report participation in such arrangements to IRS on an attachment to the tax return of the corporation or participating in the arrangement.

4. Proposed Regulations under 419A(f)(6). The IRS also released proposed regulations that have closed the door on variations between employers and products and resulted in every such arrangement not being in compliance. The proposed regulations rehash the requirements of section 419A(f)(6) and add several additional requirements and limitations. The additional requirements and examples demonstrate IRS’s view that the only benefits that comply with the proposed regulations are those that could be provided and tax-deducted without section 419A(f)(6).

5. Notice 2002-45 and Revenue Ruling 2002-41. These rulings have to do with “health reimbursement arrangements” and apply to our VEBAs that contain medical benefits. They require that amounts set aside for health reimbursements may not be used to provide any other benefit.

CHANGES IN THE STERLING BENEFIT PLANS

We are in process of amending current plans and trusts to comply with the requirements imposed by the new rulings and regulations. As a result of the foregoing, we are providing our clients the following choices: (1) Participate in a multiple-employer VEBA that complies with the tax deduction limitations of Sections 419 and 419A of the IRC; (2) Establish a single-employer VEBA; (3) Join a multiple-employer welfare benefit plan that operates similar to a VEBA but is a taxable trust.

The establishment of a single-employer VEBA will entail fees for preparation of plan documents and filing with the IRS to obtain a letter of determination. The Sterling Benefit Plans have always included both benefits that are pre-defined (such as death benefits) by formula and benefits (such as post-retirement medical benefit) that are funded on a “defined contribution” basis, with the maximum benefit equal to the value of the account. In the case of the multiple-employer plans, all investments will now be participant-directed.

TRUSTEE FEES AND SERVICES

The Sterling Benefit Plans have been using the services of Arrowhead Trust Incorporated (“ATI”) as a directed Trustee. We are grateful to ATI for their service. During 2001, ATI raised their annual trustee fee from $750 to $1,000 per employer. Their fees are due annually at the beginning of the year. Any fees not paid within 60 days are deducted from the trust account.

AMENDMENTS TO PLAN DOCUMENTS

Due to the Plan amendments, it will be necessary for each employer to execute a new Group Enrollment Application to adopt the amended and restated plan documents. A sample adoption agreement is included for your review. It will also be necessary for each participant to complete a new Enrollment and Election Form with respect to his or her account.

UNRELATED BUSINESS INCOME TAX

A recent Federal Tax Court Case, Sherwin Williams v. Commissioner, 115 TC 33 (2000), determined that investment income within a VEBA which is used for the purpose of funding post-retirement medical benefits is “Unrelated Business Taxable Income” under section 512 of the Internal Revenue Code and is therefore subject to “Unrelated Business Income Tax” (or “UBIT”). This ruling applies to our VEBAs to the extent that such investment income is for the purpose of providing retiree medical benefits. It does not apply to amounts utilized for current medical benefits or to post-retirement death benefit accumulations. It also does not apply to accumulations in an “employee pay all” VEBA or investment income in a collectively-bargained plan.

TAX-SHELTERED INVESTMENTS

Due to the UBIT issue, we have chosen to provide investments that are either tax-exempt or tax-efficient. Tax-exempt investments include: (1) variable universal life insurance contracts (whether MEC or non-MEC) and (2) municipal bonds and municipal bond funds. Tax-efficient investments consist of certain mutual funds whose policy is to “buy and hold”, thereby avoiding portfolio turnover and deferring the realized gains on investments. Several mutual funds are able to shelter 80% to 90% of their taxable income while still permitting the investor to enjoy the growth of the investments.