                        115 T.C. No. 33



                    UNITED STATES TAX COURT



SHERWIN-WILLIAMS COMPANY EMPLOYEE HEALTH PLAN TRUST, KEY TRUST
            COMPANY OF OHIO, TRUSTEE, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



   Docket No.   21333-97.                 Filed November 9, 2000.



        Trust (T), a tax-exempt voluntary employees’
   beneficiary association described in sec. 501(c)(9),
   I.R.C., set aside for each year at issue a certain
   amount of investment income to provide for the payment
   of reasonable costs of administration directly con-
   nected with providing for the payment of health care
   benefits (amount of investment income at issue).

        Held: In determining for each year at issue the
   unrelated business taxable income (UBTI) of T under
   sec. 512(a)(3)(A), I.R.C., the amount of investment
   income at issue is subject to the limitation prescribed
   by sec. 512(a)(3)(E)(i), I.R.C. Held, further, in
   calculating for each year at issue the limitation
   prescribed by sec. 512(a)(3)(E)(i), I.R.C., the amount
   of assets that T set aside to provide for the payment
   of health care benefits, including reasonable costs of
   administration directly connected with providing for
   the payment of such benefits, is not to be reduced by
                               - 2 -

     the amount of the reserve described in sec.
     419A(c)(2)(A), I.R.C., for post-retirement medical
     benefits. Held, further, because of the limitation
     prescribed by sec. 512(a)(3)(E)(i), I.R.C., in deter-
     mining for each year at issue the UBTI of T under sec.
     512(a)(3)(A), I.R.C., the amount of investment income
     at issue may not be excluded as exempt function income.




     Michael T. Cummins and Robert K. Olson, for petitioner.

     Mark L. Hulse, for respondent.



                              OPINION1


     CHIECHI, Judge:   Respondent determined the following defi-

ciencies in the Federal income tax (tax) of The Sherwin-Williams

Company Employee Health Plan Trust (Trust):

                       Year      Deficiency
                       1991       $489,941
                       1992        339,924

     The issues for decision are:

     (1)   In determining for each year at issue the unrelated

business taxable income (UBTI) of the Trust under section

512(a)(3)(A),2 is the amount of investment income that the Trust




     1
      Unless otherwise indicated, our Opinion pertains to 1991
and 1992, the years at issue.
     2
      All section references are to the Internal Revenue Code
(Code) in effect for the years at issue. All Rule references are
to the Tax Court Rules of Practice and Procedure.
                               - 3 -

set aside3 to provide for the payment of reasonable costs of

administration directly connected with providing for the payment

of health care benefits subject to the limitation prescribed by

section 512(a)(3)(E)(i)?   We hold that it is.

     (2)   In calculating for each year at issue the limitation

prescribed by section 512(a)(3)(E)(i), is the amount of assets

that the Trust set aside to provide for the payment of health

care benefits, including reasonable costs of administration

directly connected with providing for the payment of such bene-

fits, to be reduced by the amount of the reserve described in

section 419A(c)(2)(A) for post-retirement medical benefits

(reserve for post-retirement medical benefits)?    We hold that it

is not.

Background

     This case was submitted fully stipulated.    The facts that

have been stipulated are so found except as stated herein.

     At the time of the filing of the petition, the Trust’s

address was in care of its trustee, Key Trust Company of Ohio,

N.A. (Trustee), in Cleveland, Ohio.

     On December 30, 1987, The Sherwin-Williams Company (Sherwin-

Williams) established the Trust to fund health care benefits for

participants in The Sherwin-Williams health care plan (Sherwin-



     3
      All references herein to an amount set aside are to an
amount set aside within the meaning of sec. 512(a)(3)(B).
                               - 4 -

Williams health care plan participants).   On September 27, 1988,

the Commissioner of Internal Revenue determined that the Trust

was exempt from tax because it qualified as a voluntary employ-

ees’ beneficiary association described in section 501(c)(9).    The

Trust maintained that qualification during the years at issue.

(We shall refer to a tax-exempt voluntary employees’ beneficiary

association described in section 501(c)(9) as a VEBA.)

     The Trust agreement establishing the Trust provided in

pertinent part:

     8.2   Payment of Benefits. * * * Any Trust Fund income
           not used in the year in which it was earned to
           provide life, sickness, accident or other benefits
           described in Section 501(c)(9) of the Code and the
           regulations thereunder or to pay reasonable admin-
           istrative costs associated with the delivery of
           those benefits shall be set aside to provide for
           the payment of the benefits and benefit costs
           described in Section 512(a)(3)(B)(ii) of the Code
           and limited by Section 512(a)(3)(E) of the Code in
           the immediately following year. * * *

     The Trust derived its income from (1) member contributions

from Sherwin-Williams and Sherwin-Williams health care plan

participants and (2) investment income.    The Trust set aside, and

subsequently expended, income to provide for the payment of

health care benefits and reasonable costs of administration

directly connected with providing for the payment of such bene-

fits.   The amounts of income that the Trust set aside to provide

for the payment of reasonable costs of administration directly

connected with providing for the payment of health care benefits
                               - 5 -

equaled $1,580,455 for 1991 and $1,853,529 for 1992.4

     The amounts of assets that the Trust set aside as of the

close of the years at issue to provide for the payment of health

care benefits and reasonable costs of administration directly

connected with providing for the payment of such benefits were

$41,975,366 and $45,637,659, respectively.

     The Trust’s account limit, as defined in section 419A(c),

for its qualified asset account, as defined in section 419A(a),

was $64,615,9365 for 1991 and $84,192,933 for 1992.   The forego-

ing account limits for 1991 and 1992 included $53,313,236 and

$71,602,395, respectively, attributable to a reserve for post-

retirement medical benefits.

     The Trust filed Forms 990, Return of Organization Exempt

From Income Tax (Form 990), and Forms 990-T, Exempt Organization

Business Income Tax Return (Form 990-T), in which it reported as

unrelated business income $1,851,399 and $1,155,793 of investment




     4
      The costs for 1992 ($1,853,529) were paid first from in-
vestment income for that year.
     5
      The parties stipulated that the Trust’s account limit for
1991, as defined in sec. 419A(c), was $65,652,991. However, that
stipulation is contrary to the record in this case. The record
establishes, and we have found, that that account limit was
$64,615,936. We may, and we shall in this instance, disregard a
stipulation between the parties where the stipulation is clearly
contrary to the facts established by the record. See Cal-Maine
Foods, Inc. v. Commissioner, 93 T.C. 181, 195 (1989).
                              - 6 -

income for 1991 and 1992, respectively.6   In its Forms 990-T for

1991 and 1992, the Trust claimed as deductions directly connected

with its unrelated business income (1) “Compensation of officers,

directors, and trustees” in the amounts of $1,456,954 and

$1,618,779, respectively, and (2) “Other deductions” in the

amounts of $156,084 and $287,450, respectively.   Of the foregoing

total deductions claimed in the Trust’s Forms 990-T for 1991 and

1992, $1,580,455 and $1,853,529, respectively, constitute reason-

able costs of administration directly connected with providing

for the payment of health care benefits for which the Trust set

aside income within the meaning of section 512(a)(3)(B).7

     The instructions to Forms 990-T stated in pertinent part:

          Sections 501(c)(7), (9), (17), and (20) organiza-
     tions will not be taxed on income set aside for:

          1. Religious, charitable, scientific, literary, or
     educational purposes, or for the prevention of cruelty
     to children or animals;

          2. The payment of life, sick, accident, or other
     benefits by a section 501(c)(9), (17), or (20) organi-
     zation. The amount allowed as a set-aside may not
     exceed a limit determined using section 419A. See
     sections 419A and 512(a)(3)(E) for details;

          3. Reasonable administration costs directly con-
     nected with 1 and 2 above.



     6
      The Trust reported in Forms 990 additional investment
income of $232,202 and $405,095 for 1991 and 1992, respectively,
which the Trust did not treat as unrelated business income in
those forms or in Forms 990-T for those years.
     7
      See supra note 4.
                               - 7 -

     In the notice of deficiency (notice) issued to the Trust,

respondent determined that, in calculating its UBTI, the Trust

erroneously deducted in Forms 990-T for 1991 and 1992

(1) $1,424,371 and $1,588,555, respectively, as “Compensation of

officers, directors, and trustees” and (2) $156,084 and $264,974,

respectively, as “Other deductions”.   Respondent made those

determinations because the Trust failed to establish that those

disallowed amounts constitute expenses directly related to, and

therefore deductible from, its investment income that it reported

as unrelated business income in Forms 990-T (i.e., $1,851,399 for

1991 and $1,155,793 for 1992).8

Discussion

     On brief, the Trustee abandons the position that the Trust

took in Forms 990-T for 1991 and 1992 that, in calculating its

UBTI, it is entitled to deduct from unrelated business gross

income (1) “Compensation of officers, directors, and trustees” in

the amounts of $1,456,954 and $1,618,779, respectively, and

(2) “Other deductions” in the amounts of $156,084 and $287,450,

respectively.   Instead, the Trustee argues on brief that

$1,580,455 of the Trust’s income for 19919 and $1,853,529 of the


     8
      Respondent made no determinations in the notice regarding
the amounts of unrelated business income that the Trust reported
in Forms 990-T for the years at issue.
     9
      The Trustee makes no argument about the balance of the
investment income (i.e., $270,944) that the Trust reported as
                                                   (continued...)
                               - 8 -

Trust’s income for 199210 constitute exempt function income, as

defined in section 512(a)(3)(B), and that such amounts of income

are excluded from the calculation of its UBTI under section

512(a)(3)(A).   It is respondent’s position that, because of the

limitation prescribed by section 512(a)(3)(E)(i), the amounts of

investment income that the Trust reported as unrelated business

income in Forms 990-T for the years at issue are not excluded

from the calculation of the Trust’s UBTI.11   Petitioner bears the


     9
      (...continued)
unrelated business income in its Form 990-T for 1991. We find
that petitioner has failed to show that such remaining amount of
investment income for 1991 (1) constitutes exempt function
income, as defined in sec. 512(a)(3)(B), or (2) otherwise is not
subject to the tax on UBTI imposed by sec. 511(a).
     10
      On brief, the Trustee acknowledges that for 1992 not only
its investment income but also certain of its other income was
set aside, and subsequently expended, for $1,853,529 of reason-
able costs of administration directly connected with providing
for the payment of health care benefits. The Trustee further
acknowledges that it reported in Form 990-T for 1992 only
$1,155,793 of its investment income for that year as unrelated
business income. Respondent made no determination in the notice
that the Trust’s remaining investment income for 1992 (i.e.,
$405,095), which the Trust did not treat as unrelated business
income in Form 990 and Form 990-T for that year, should be
included in calculating the Trust’s UBTI for that year. We
conclude that the only amount of the Trust’s income for 1992 that
is at issue in this case is $1,155,793 of investment income that
the Trust reported as unrelated business income in Form 990 and
Form 990-T for that year. Our references hereinafter to the
amount at issue for 1992 shall be to the correct amount at issue
for 1992, and not to the amount (i.e., $1,853,529) that the
Trustee claims on brief is at issue for that year.
     11
      Respondent also advances arguments on brief as to why
respondent’s determinations in the notice should be sustained.
However, as noted above, the Trustee no longer contests those
                                                   (continued...)
                              - 9 -

burden of establishing that its position is correct.    See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

     Before addressing the issues presented, we set forth the

pertinent statutory provisions implicated by those issues.12

Although section 501(a) exempts a VEBA from tax, section 501(b)

subjects a tax-exempt VEBA to tax to the extent provided in

sections 511 through 515 relating to the tax on UBTI.    Section

511(a) imposes a tax for each taxable year on the UBTI of a VEBA,

as defined in section 512.

     Section 512(a)(1) provides the following general definition

of UBTI:

          (1) General rule.–-Except as otherwise provided in
     this subsection, the term “unrelated business taxable
     income” means the gross income derived by any organiza-
     tion from any unrelated trade or business (as defined
     in section 513) regularly carried on by it, less the
     deductions allowed by this chapter which are directly
     connected with the carrying on of such trade or busi-
     ness, both computed with the modifications provided in
     subsection (b).

     Section 512(a)(3) provides the following special rules in

defining the UBTI of a VEBA described in section 501(c)(9):

          (3) Special rules applicable to organizations
     described in paragraph (7), (9), (17), or (20) of
     section 501(c).--


     11
      (...continued)
determinations.
     12
      Although the statutory provisions set forth below apply
not only to a VEBA but also to certain other organizations, our
discussion generally is limited to the application of those
provisions to a VEBA.
                    - 10 -

     (A) General rule.–-In the case of an organi-
zation described in paragraph (7), (9), (17), or
(20) of section 501(c), the term “unrelated busi-
ness taxable income” means the gross income (ex-
cluding any exempt function income), less the
deductions allowed by this chapter which are di-
rectly connected with the production of the gross
income (excluding exempt function income) * * *.

     (B) Exempt function income.–-For purposes of
subparagraph (A), the term “exempt function in-
come” means the gross income from dues, fees,
charges, or similar amounts paid by members of the
organization as consideration for providing such
members or their dependents or guests goods, fa-
cilities, or services in furtherance of the pur-
poses constituting the basis for the exemption of
the organization to which such income is paid.
Such term also means all income (other than an
amount equal to the gross income derived from any
unrelated trade or business regularly carried on
by such organization computed as if the organiza-
tion were subject to paragraph (1)), which is set
aside—-

          (i) for a purpose specified in section
     170(c)(4), or

          (ii) in the case of an organization
     described in paragraph (9) * * * of section
     501(c), to provide for the payment of life,
     sick, accident, or other benefits,

including reasonable costs of administration di-
rectly connected with a purpose described in
clause (i) or (ii). If during the taxable year,
an amount which is attributable to income so set
aside is used for a purpose other than that de-
scribed in clause (i) or (ii), such amount shall
be included, under subparagraph (A), in unrelated
business taxable income for the taxable year.

    *     *     *     *      *    *     *

     (E) Limitation on amount of setaside in the
case of organizations described in paragraph (9)
* * * of section 501(c).--
                                - 11 -

                       (i) In general.–-In the case of any
                  organization described in paragraph (9) * * *
                  of section 501(c), a set-aside for any pur-
                  pose specified in clause (ii) of subparagraph
                  (B) may be taken into account under subpara-
                  graph (B) only to the extent that such set-
                  aside does not result in an amount of assets
                  set aside for such purpose in excess of the
                  account limit determined under section 419A
                  (without regard to subsection (f)(6) thereof)
                  for the taxable year (not taking into account
                  any reserve described in section
                  419A(c)(2)(A) for post-retirement medical
                  benefits).

     The Trust as a VEBA that is funded by, inter alia, employer

contributions is subject to sections 41913 and 419A.    Section

419A(a) provides:

     SEC. 419A. QUALIFIED ASSET ACCOUNT; LIMITATION ON
     ADDITIONS TO ACCOUNT.

          (a) General Rule.–-For purposes of this subpart
     and section 512, the term “qualified asset account”
     means any account consisting of assets set aside to
     provide for the payment of--

              *       *     *     *      *    *     *

               (2) medical benefits * * *

     Section 419A(c) imposes an account limit on the Trust’s

qualified asset account, as defined in section 419A(a).    Section



     13
      Sec. 419 prescribes rules governing the deductibility of
contributions paid or accrued by an employer to a welfare benefit
fund. The amount of such a deduction allowable under sec. 419 is
determined by reference to, inter alia, any addition to a quali-
fied asset account determined under sec. 419A(b). Sec. 419A(b)
provides that no addition to any qualified asset account may be
taken into account for purposes of sec. 419 to the extent such
addition results in the amount in such account exceeding the
account limit, as defined in sec. 419A(c).
                                 - 12 -

419A(c) provides:

     SEC. 419A. QUALIFIED ASSET ACCOUNT; LIMITATION ON
     ADDITIONS TO ACCOUNT.

     (c) Account Limit.–-For purposes of this section–-

          (1) In general.–-Except as otherwise provided in
     this subsection, the account limit for any qualified
     asset account for any taxable year is the amount rea-
     sonably and actuarially necessary to fund–-

                  (A) claims incurred but unpaid (as of the
             close of such taxable year) for benefits referred
             to in subsection (a), and

                  (B) administrative costs with respect to such
             claims.

          (2) Additional reserve for post-retirement medical
     and life insurance benefits.–-The account limit for any
     taxable year may include a reserve funded over the
     working lives of the covered employees and actuarially
     determined on a level basis (using assumptions that are
     reasonable in the aggregate) as necessary for–-

                  (A) post-retirement medical benefits to be
             provided to covered employees (determined on the
             basis of current medical costs) * * *

     We turn now to the initial dispute between the parties over

whether, in determining for each year at issue the Trust’s UBTI

under section 512(a)(3)(A), the amount of investment income at

issue that the Trust set aside (i.e., $1,580,455 for 1991 and

$1,155,793 for 199214) to provide for the payment of reasonable

costs of administration directly connected with providing for the

payment of health care benefits is subject to the limitation

prescribed by section 512(a)(3)(E)(i).     It is the position of the



     14
          See supra notes 4, 8, and 10.
                             - 13 -

Trustee that that amount of investment income for each year at

issue is not subject to that limitation.   That position rests

upon the contentions of the Trustee that the plain language of

section 512(a)(3)(B) identifies four independent sources or

components of exempt function income and that one of those

sources or components of exempt function income is reasonable

costs of administration directly connected with a purpose de-

scribed in section 512(a)(3)(B)(i) or (ii).   The Trustee posits

that the four sources of exempt function income identified by

section 512(a)(3)(B) are:

     (1) amounts paid by members of the association as
     consideration for goods, facilities, or services;

     (2) amounts set aside for a charitable purpose;

     (3) amounts set aside for the payment of life, sick,
     accident, or other benefits; and

     (4) reasonable costs of administration directly con-
     nected with components 2 and 3.

According to the Trustee, “It is apparent from the plain language

of the statute [section 512(a)(3)(B)] that reasonable costs of

administration are an independent basis of Exempt Function

Income.”

     Proceeding from its premises that reasonable costs of

administration directly connected with a purpose described in

section 512(a)(3)(B)(i) or (ii) are one of the four independent

sources or components of exempt function income under section

512(a)(3)(B), the Trustee argues that the limitation in section
                              - 14 -

512(a)(3)(E)(i) is “plainly restricted to only set-asides for the

payment of benefits described in I.R.C. §512(a)(3)(B)(ii), and

thus, its application does not extend to Exempt Function Income

arising from member contributions, set-asides for charitable

purposes, or administrative costs.”

     Respondent counters that reasonable costs of administration

directly connected with a purpose described in section

512(a)(3)(B)(i) or (ii) do not constitute an independent source

or component of exempt function income under section

512(a)(3)(B).   In support of that position, respondent argues:

          It is clear the statute [section 512(a)(3)(B)] is
     written so that the reasonable cost of administration
     phrase did not have to be written twice, that is once
     after clause (i) and again after clause (ii). This is
     a common drafting technique used throughout the Inter-
     nal Revenue Code. * * *

          Another way of describing exempt function income
     is income set-aside [sic] for a purpose specified in
     section 170(c)(4) including administrative costs di-
     rectly connected with this purpose or, in the case of
     an organization described in paragraph (9), (17), or
     (20) of section 501(c), to provide for the payment of
     life, sick, accident, or other benefits, including
     reasonable costs of administration directly connected
     with this purpose. This is the clear meaning of this
     section [512(a)(3)(B)]. Accordingly, administrative
     costs are a part of the benefit costs which may be set-
     aside [sic] under clauses (i) and (ii) of I.R.C. §
     512(a)(3)(B), not a separate component thereof.

     We first address the premises of the Trustee’s position

under section 512(a)(3)(E)(i), namely, its contentions that the

plain language of section 512(a)(3)(B) identifies four sources or

components of exempt function income and that one of those
                             - 15 -

sources or components of exempt function income is reasonable

costs of administration directly connected with a purpose de-

scribed in section 512(a)(3)(B)(i) or (ii).   While we agree with

the Trustee that the language of section 512(a)(3)(B) is unambig-

uous, we conclude that the plain language of section 512(a)(3)(B)

rejects the Trustee’s contentions.

     Section 512(a)(3)(B) unambiguously defines the term “exempt

function income” to mean gross income from two sources only.

Moreover, section 512(a)(3)(B) plainly does not treat reasonable

costs of administration directly connected with a purpose de-

scribed in section 512(a)(3)(B)(i) or (ii) as income or as a

source or component of income.

     The first source of gross income from which exempt function

income may be derived is specified in the first sentence of

section 512(a)(3)(B) as “gross income from dues, fees, charges,

or similar amounts paid by members of the organization”.   How-

ever, in order to qualify as exempt function income, such gross

income specified in the first sentence of section 512(a)(3)(B)

must be paid by the organization’s members “as consideration for

providing such members or their dependents or guests goods,

facilities, or services in furtherance of the purposes constitut-

ing the basis for the exemption of the organization to which such

income is paid.”

     The second source of gross income from which exempt function
                             - 16 -

income may be derived is specified in the second sentence of

section 512(a)(3)(B) as all other income (except an amount equal

to the gross income derived from any unrelated trade or

business15 regularly carried on by such organization and computed

as if the organization were subject to section 512(a)(1)).   (For

convenience, we shall sometimes refer to the second source of

exempt function income specified in the second sentence of

section 512(a)(3)(B) as non-member income.)   However, in order to

qualify as exempt function income, such non-member income speci-

fied in the second sentence of section 512(a)(3)(B) must be set

aside for a purpose described in section 512(a)(3)(B)(i) or (ii),

including reasonable costs of administration directly connected

with any such purpose.

     The phrase that appears at the end of the second sentence of

section 512(a)(3)(B), i.e., “including reasonable costs of

administration directly connected with a purpose described in

clause (i) or (ii)”, unambiguously pertains to and modifies both

section 512(a)(3)(B)(i) and (ii).   That phrase plainly treats

non-member income (1) set aside to provide for the payment of

reasonable costs of administration directly connected with a

purpose described in section 512(a)(3)(B)(i) as set aside for a


     15
      Sec. 513(a) defines the term “unrelated trade or business”
to mean, in general, any trade or business of the tax-exempt
organization the conduct of which is not substantially related to
the exercise or performance by such organization of its exempt
purposes.
                               - 17 -

purpose described in that section and (2) set aside to provide

for the payment of reasonable costs of administration directly

connected with a purpose described in section 512(a)(3)(B)(ii) as

set aside for a purpose described in that section.16

     To support its position that reasonable costs of administra-

tion directly connected with a purpose described in section

512(a)(3)(B)(i) or (ii) qualify as one of the four independent

sources or components of exempt function income under section

512(a)(3)(B), the Trustee relies not only on the language of

section 512(a)(3)(B), but also on the following statement in Phi

Delta Theta Fraternity v. Commissioner, 887 F.2d 1302, 1307 (6th

Cir. 1989), affg. 90 T.C. 1033 (1988):   “Section 512(a)(3)(B),

however, does allow reasonable costs actually spent in adminis-

tering a tax-exempt activity to be included in ‘exempt function

income.’”    We find the Trustee’s reliance on that statement to be

misplaced.   The United States Court of Appeals for the Sixth


     16
      We need not resort to the legislative history of sec.
512(a)(3)(B) to determine the meaning of the phrase in question
that appears at the end of the second sentence of that section.
That is because the terms of that statutory provision are unam-
biguous, and there are no exceptional circumstances warranting
our turning to that legislative history for guidance. See
Burlington N. R.R. Co. v. Oklahoma Tax Commn., 481 U.S. 454, 461
(1987); Fernandez v. Commissioner, 114 T.C. 324, 329-330 (2000).
Nonetheless, it is noteworthy that, consistent with its plain
language, the legislative history of sec. 512(a)(3)(B) provides
that income will be treated as set aside for benefits specified
in that section where it is set aside and used not only for the
payment of those benefits but also for the payment of reasonable
costs of administration of providing those benefits. See S.
Rept. 91-552 (1969), at 72, 1969-3 C.B. 470.
                                - 18 -

Circuit (Court of Appeals), the Court to which an appeal in the

instant case would normally lie, did not decide in Phi Delta

Theta Fraternity the issues under section 512(a)(3) that are

presented here.17     Moreover, the foregoing statement in Phi

Delta Theta Fraternity on which the Trustee relies in the instant

case is dictum.     Finally, even if the statement in Phi Delta

Theta Fraternity were not dictum, we do not find that that



     17
      The taxpayer in Phi Delta Theta Fraternity v. Commis-
sioner, 887 F.2d 1302 (6th Cir. 1989), affg. 90 T.C. 1033 (1988),
was a national college fraternity (fraternity) that was exempt
from tax as an organization described in sec. 501(c)(7). The
ultimate issue before the Court of Appeals was whether the
investment income of the fraternity qualified as exempt function
income for purposes of sec. 512(a)(3)(A) and (B). In resolving
that issue, the Court considered two questions: (1) Whether
there was a proper set aside by the fraternity within the meaning
of sec. 512(a)(3)(B); and (2) even if there was no proper set
aside within the meaning of that section, whether the fraternity
spent income on exempt purposes, and, if it did, whether that
income therefore qualified as exempt function income. Although
those questions are not presented here, it is noteworthy that in
resolving those matters the Court of Appeals in Phi Delta Theta
Fraternity quoted portions of sec. 512(a)(3)(B) as applicable to
the sec. 501(c)(7) fraternity involved in that case, as follows:

     Such term [exempt function income] also means all
     income * * * which is set aside–-

          (i) for a purpose specified in section 170(c)(4)
     * * * including reasonable costs of administration
     directly connected with a purpose described in clause
     (i) or (ii). * * *

Phi Delta Theta Fraternity v. Commissioner, supra at 1305. Thus,
the Court of Appeals recognized in Phi Delta Theta Fraternity
that the phrase “including reasonable costs of administration
directly connected with a purpose described in clause (i) or
(ii)” does not stand alone, but pertains to and modifies sec.
512(a)(3)(B)(i) as well as sec. 512(a)(3)(B)(ii).
                             - 19 -

statement supports the Trustee’s position here that one of the

four independent sources or components of exempt function income

under section 512(a)(3)(B) is reasonable costs of administration

directly connected with a purpose described in section

512(a)(3)(B)(i) or (ii).

     In further support of its position that reasonable costs of

administration directly connected with a purpose described in

section 512(a)(3)(B)(i) or (ii) qualify as one of the four

independent sources or components of exempt function income under

section 512(a)(3)(B), the Trustee relies on the instructions to

Forms 990-T for the years at issue.   Those instructions provided

in pertinent part:

          Sections 501(c)(7), (9), (17), and (20) organiza-
     tions will not be taxed on income set aside for:

          1. Religious, charitable, scientific, literary, or
     educational purposes, or for the prevention of cruelty
     to children or animals;

          2. The payment of life, sick, accident, or other
     benefits by a section 501(c)(9), (17), or (20) organi-
     zation. The amount allowed as a set-aside may not
     exceed a limit determined using section 419A. See
     sections 419A and 512(a)(3)(E) for details;

          3. Reasonable administration costs directly con-
     nected with 1 and 2 above.

     We acknowledge that the foregoing instructions to Forms 990-

T are not as clearly stated as section 512(a)(3)(B) is.   Nonethe-

less, we find those instructions to be consistent with the plain

language of section 512(a)(3)(B).   We have held that section
                                - 20 -

512(a)(3)(B) plainly treats non-member income set aside for

reasonable costs of administration directly connected (1) with a

purpose described in section 512(a)(B)(3)(i) as set aside for a

purpose described in that section and (2) with a purpose de-

scribed in section 512(a)(3)(B)(ii) as set aside for a purpose

described in that section.

     In any event, we are not bound by the instructions to Forms

990-T for the years at issue.    The authoritative sources of tax

law are statutes, regulations, and judicial decisions, and not

informal instructions published by the Internal Revenue Service.

See Casa de La Jolla Park, Inc. v. Commissioner, 94 T.C. 384, 396

(1990).   We find the Trustee’s reliance on the instructions to

Forms 990-T for the years at issue to be misplaced.

     We hold that section 512(a)(3)(B) treats non-member income

set aside to provide for the payment of reasonable costs of

administration directly connected with a purpose described in

section 512(a)(3)(B)(ii) as non-member income set aside for a

purpose described in section 512(a)(3(B)(ii).

     The Trustee’s contentions that section 512(a)(3)(B) identi-

fies four independent sources or components of exempt function

income and that one of those sources or components is reasonable

costs of administration directly connected with a purpose de-

scribed in section 512(a)(3)(B)(i) or (ii) constitute the pre-

mises on which the Trustee constructs its argument that non-
                                - 21 -

member investment income set aside by the Trust for the payment

of reasonable costs of administration directly connected with a

purpose described in section 512(a)(3)(B)(ii) is not subject to

the limitation prescribed by section 512(a)(3)(E)(i).    We have

rejected those contentions, and therefore those premises are not

valid.     We further reject the Trustee’s argument that the limita-

tion prescribed by section 512(a)(3)(E)(i) does not apply to the

non-member investment income at issue that the Trust set aside to

provide for the payment of reasonable costs of administration

directly connected with a purpose described in section

512(a)(3)(B)(ii).18

     As a VEBA described in section 501(c)(9), a set-aside by the

Trust of non-member income for a purpose described in section

512(a)(3)(B)(ii) is to be taken into account as exempt function

income under section 512(a)(3)(B) only to the extent that such


     18
      It is noteworthy that the Trust agreement establishing the
Trust provided that such costs are subject to the limitation
prescribed by sec. 512(a)(3)(E)(i). That Trust agreement pro-
vided in pertinent part:

     8.2    Payment of Benefits. * * * Any Trust Fund income
            not used in the year in which it was earned to
            provide life, sickness, accident or other benefits
            described in Section 501(c)(9) of the Code and the
            regulations thereunder or to pay reasonable admin-
            istrative costs associated with the delivery of
            those benefits shall be set aside to provide for
            the payment of the benefits and benefit costs
            described in Section 512(a)(3)(B)(ii) of the Code
            and limited by Section 512(a)(3)(E) of the Code in
            the immediately following year. * * * [Emphasis
            added.]
                              - 22 -

set aside does not exceed the limitation prescribed by section

512(a)(3)(E)(i).   See sec. 512(a)(3)(E)(i).   We have held that

the plain language of section 512(a)(3)(B) treats non-member

income set aside to provide for the payment of reasonable costs

of administration directly connected with a purpose described in

section 512(a)(3)(B)(ii) as set aside for a purpose described in

that section.   We further hold that “a set-aside for any purpose

specified in clause (ii) of subparagraph (B)” of section

512(a)(3) to which the limitation prescribed by section

512(a)(3)(E)(i) applies is a set-aside to provide for the payment

of life, sick, accident, or other benefits and reasonable costs

of administration directly connected with providing for the

payment of such benefits.   We also hold that the limitation

prescribed by section 512(a)(3)(E)(i) applies to the amounts of

non-member income at issue that the Trust set aside to provide

for the payment of reasonable costs of administration directly

connected with providing for the payment of health care benefits.

     The Trustee advances an alternative argument in the event

that the Court were to hold, as we have, that the limitation

prescribed by section 512(a)(3)(E)(i) applies to the amounts of

non-member income at issue.   According to the Trustee’s alterna-

tive argument, in calculating for each year at issue the limita-

tion prescribed by section 512(a)(3)(E)(i), the plain language of

that section requires that not only the Trust’s account limit
                             - 23 -

determined under section 419A, but also the amount of assets set

aside by the Trust, be reduced by the amount of the reserve for

post-retirement medical benefits described in section

419A(c)(2)(A).

     The parties agree that (1) the Trust’s respective account

limits, determined under section 419A(c), were $64,615,936 and

$84,192,933 for 1991 and 1992; (2) those account limits for those

years included $53,313,236 and $71,602,395, respectively, attrib-

utable to a reserve for post-retirement medical benefits; (3) the

amounts of assets that the Trust set aside (i.e., the total asset

balances reported by the Trust in Forms 990) for 1991 and 1992

were $41,975,366 and $45,637,659, respectively; and (4) (a) for

1991 $7,342,383 and $34,632,983 of the amount of assets so set

aside were allocable to (i) incurred but unpaid health benefit

claims and reasonable costs directly connected with such claims

and (ii) the reserve for post-retirement medical benefits,

respectively, and (b) for 1992 $6,824,833 and $38,812,826 of the

amount of assets so set aside were allocable to (i) incurred but

unpaid health benefit claims and reasonable costs directly

connected with such claims and (ii) the reserve for post-retire-

ment medical benefits, respectively.   If the limitation pre-

scribed by section 512(a)(3)(E)(i) were to be calculated in the

manner advocated by the Trustee, the amount of assets set aside

by the Trust as of the close of each year at issue would not
                              - 24 -

exceed that limitation.   In that event, the amount of investment

income at issue that the Trust set aside to provide for the

payment of reasonable costs of administration directly connected

with providing for the payment of health care benefits would

constitute exempt function income that is excluded under section

512(a)(3)(A) from the calculation of the Trust’s UBTI.

     It is the position of respondent that, in calculating for

each year at issue the limitation prescribed by section

512(a)(3)(E)(i), only the account limit determined under section

419A, and not the amount of assets set aside by the Trust, must

be reduced by the reserve for post-retirement medical benefits

described in section 419A(c)(2)(A).

     Although we have quoted section 512(a)(3)(E)(i) above, for

convenience we restate it here in addressing the contentions of

the parties with respect to the Trustee’s alternative argument.

Section 512(a)(3)(E)(i) provides:

          (E) Limitation on amount of setaside in the case
     of organizations described in paragraph (9), (17), or
     (20) of section 501(c).--

               (i) In general.–-In the case of any organiza-
          tion described in paragraph (9), (17), or (20) of
          section 501(c), a set-aside for any purpose speci-
          fied in clause (ii) of subparagraph (B) may be
          taken into account under subparagraph (B) only to
          the extent that such set-aside does not result in
          an amount of assets set aside for such purpose in
          excess of the account limit determined under sec-
          tion 419A (without regard to subsection (f)(6)
          thereof) for the taxable year (not taking into
          account any reserve described in section
          419A(c)(2)(A) for post-retirement medical bene-
                               - 25 -

          fits).

     We find the Trustee’s interpretation of section

512(a)(3)(E)(i) (viz., the parenthetical phrase “(not taking into

account any reserve described in section 419A(c)(2)(A) for post-

retirement medical benefits)” modifies both “an amount of assets

set aside” and “the account limit determined under section 419A”

referred to in section 512(a)(3)(E)(i)) to be a strained and

unreasonable interpretation.   We reject that interpretation.   We

conclude that the parenthetical phrase appearing at the end of

section 512(a)(3)(E)(i), as reasonably and properly construed,

modifies only “the account limit determined under section 419(A)”

referred to in section 512(a)(3)(E)(i).   Our construction is

supported by the temporary regulations under section

512(a)(3)(E)(i).

     Section 1.512(a)-5T, Q&A-3(a), Temporary Income Tax Regs.,

51 Fed. Reg. 4332 (Feb. 4, 1986), as amended by 51 Fed. Reg.

11303 (Apr. 2, 1986) (Q&A-3(a)), provides in pertinent part:

          Q-3: What amount of income may a VEBA, SUB or
     GLSO set aside for exempt purposes?

          A-3: (a) Pursuant to section 512(a)(3)(E)(i), the
     amounts set aside in a VEBA, SUB, or GLSO (including a
     VEBA, SUB, or GLSO that is part of a 10 or more em-
     ployer plan, as defined in section 419A(f)(6)(B)) as of
     the close of a taxable year of such VEBA, SUB, or GLSO
     to provide for the payment of life, sick, accident, or
     other benefits may not be taken into account for pur-
     poses of determining “exempt function income” to the
     extent that such amounts exceed the qualified asset
     account limit, determined under sections 419A(c) and
     419A(f)(7), for such taxable year of the VEBA, SUB, or
                              - 26 -

     GLSO. In calculating the qualified asset account limit
     for this purpose, a reserve for post-retirement medical
     benefits under section 419A(c)(2)(A) is not to be taken
     into account. [Emphasis added.]

     Q&A-3(a) plainly provides that, for purposes of determining

the limitation prescribed by section 512(a)(3)(E)(i), a reserve

for post-retirement medical benefits described in section

419A(c)(2)(A) is not to be taken into account in “calculating the

qualified asset account limit”.   Q&A-3(a) does not indicate that,

for those purposes, such a reserve is not to be taken into

account in calculating the amount of assets set aside as of the

close of a taxable year.

     Our interpretation regarding the parenthetical phrase

appearing at the end of section 512(a)(3)(E)(i) also is supported

by the General Explanation of the Revenue Provisions of the

Deficit Reduction Act of 1984 that was prepared by the Staff of

the Joint Committee on Internal Revenue Taxation (General Expla-

nation).   Congress enacted section 512(a)(3)(E)(i) into the Code

as part of the Deficit Reduction Act of 1984.   See Deficit

Reduction Act of 1984, Pub. L. 98-369, sec. 511(b), 98 Stat. 860.

The General Explanation provides in pertinent part with respect

to section 512(a)(3)(E)(i):

          The [Deficit Reduction] Act [of 1984] provides a
     specific annual limit on the amount of income of a tax-
     exempt VEBA * * * that may be considered a permissible
     set aside. Under the Act, the amount of such an orga-
     nization’s income for a year that may be considered set
     aside as exempt function income is generally not to
     increase the total amount that is set aside to an
                             - 27 -

     amount in excess of the account limit for the taxable
     year determined under the deduction limits provided by
     the Act (sec. 419A(c) and (f)). The limit on the set-
     aside is intended to apply to more-than-10-employer
     VEBAs which are exempt from the deduction limitations.
     * * *

          In general, the rules applicable in computing the
     account limit under the deduction rules [section 419],
     such as the special reserve limits for collectively
     bargained plans, also are applicable in determining the
     set-aside allowed for purposes of the unrelated busi-
     ness income tax. However, for purposes of determining
     the limit on the set aside, the account limit is not to
     include any amount with respect to reserves to provide
     post-retirement medical benefits. The limit on the
     amount set aside as exempt function income does not
     include a reserve for post-retirement medical benefits
     because, in view of the advance deductions provided to
     employers for these benefits, it was determined that
     the allowance of such a tax-exempt reserve would pro-
     vide an unnecessary tax incentive with respect to these
     benefits. [Footnote ref. omitted; emphasis added.]

Staff of Joint Comm. on Taxation, General Explanation of the

Revenue Provisions of the Deficit Reduction Act of 1984, at 791

(J. Comm. Print 1984).

     The General Explanation plainly provides that, in determin-

ing the limitation prescribed by section 512(a)(3)(E)(i), a

reserve for post-retirement medical benefits is not to be taken

into account in determining the account limit.   The General

Explanation does not indicate that, in making that determination,

such a reserve is not to be taken into account in calculating the

amount of assets set aside at the close of a taxable year.19


     19
      If we were to accept the Trustee’s alternative position
that for each year at issue not only the account limit, as
                                                   (continued...)
                             - 28 -

     We hold that, in calculating for each year at issue the

limitation prescribed by section 512(a)(3)(E)(i), that section

does not require that the amount of assets that the Trust set

aside as of the close of each such year be reduced by the amount

of the reserve for post-retirement medical benefits.   The parties

agree that for each year at issue the amount of assets that the

Trust set aside to provide for the payment of health care bene-

fits, including reasonable costs of administration directly

connected with providing for the payment of such benefits,

exceeded the account limit, as defined in section 419A(c),

determined without regard to section 419A(f)(6) and without

taking into account the reserve for post-retirement medical

benefits described in section 419A(c)(2)(A).   We hold that, in

determining for each year at issue the UBTI of the Trust under

section 512(a)(3)(A), the amount of investment income at issue

that the Trust set aside to provide for the payment of reasonable

costs of administration directly connected with providing for the

payment of health care benefits may not be excluded as exempt



     19
      (...continued)
defined in sec. 419A(c), but also the amount of assets set aside
by the Trust are to be determined without regard to the reserve
for post-retirement medical benefits, we would undermine the
reason set forth in the General Explanation why Congress decided
to require the account limit to exclude any amount with respect
to such a reserve in determining the limitation prescribed by
sec. 512(a)(3)(E)(i). See Staff of Joint Comm. on Taxation,
General Explanation of the Revenue Provisions of the Deficit
Reduction Act of 1984, at 791 (J. Comm. Print 1984).
                              - 29 -

function income.

     We have considered all of the contentions and arguments of

the Trustee that are not discussed herein, and we find them to be

without merit and/or irrelevant.20

     To reflect the foregoing,



                                      Decision will be entered for

                                 respondent.




     20
      We shall briefly address one of those arguments. The
Trustee argues that the Trust’s investment income at issue is not
subject to the unrelated business income tax because the invest-
ment income of a VEBA described in sec. 501(c)(9) “is not taxable
if spent in furtherance of its exempt purpose.” In support of
that argument, the Trustee relies on certain legislative history
of the Tax Reform Act of 1969 which enacted sec. 512(a)(3)(A) and
(B) into the Code. The Trustee’s reliance on that legislative
history is misplaced. When Congress enacted sec. 512(a)(3)(A)
and (B) in 1969, it placed no specific limitation on the amount
of income that may be set aside by a VEBA. See Tax Reform Act of
1969, Pub. L. 91-172, sec. 121(b), 83 Stat. 537. However, in
1984 Congress decided to impose a limitation on the amount of
income that may be set aside when it enacted sec. 512(a)(3)(E)(i)
into the Code. See Deficit Reduction Act of 1984, Pub. L. 98-
369, sec. 511(b), 98 Stat. 860; H. Conf. Rept. 98-861, at 1161-
1163 (1984), 1984-3 C.B. (Vol. 2) 415-417; see also Staff of
Joint Comm. on Taxation, General Explanation of the Revenue
Provisions of the Deficit Reduction Act of 1984, at 790-791 (J.
Comm. Print 1984).
