Rev. Rul. 56-125

Advice has been requested as to the taxability, to the distributee, of amounts distributed or made available under an employer's funded pension or annuity plan for the benefit of his employees, if the amounts were on account of service rendered by a United States citizen as a bona fide resident of a foreign country, and were distributed or made available in a taxable year of the distributee, beginning after December 31, 1950, and subject to the Internal Revenue Code of 1939 (see section 7851(a)(1)(A) of the 1954 Code), at a time when the citizen-distributee was residing in the United States.

An employer has, for many years, maintained a pension plan covering all his employees. The plan was funded through a group annuity contract with an insurance company. Employees contribute to the plan according to salary brackets and the balance of the cost of the annuities is paid by the employer. The Internal Revenue Service has held the plan meets the requirements of section 165(a)(3), (4), (5), and (6) of the Internal Revenue Code of 1939.

In the instant case, the entire amount of the employee's annuity is based on service rendered in foreign countries during an uninterrupted period of bona fide residence in those countries for 30 years. Upon retirement in 1945, the taxpayer returned and resumed residence in the United States.

Annuities or pensions paid under a nontrusteed plan which meets the requirements of section 165(a)(3), (4), (5), and (6) of the Code are taxable to the annuitant as provided in section 22(b)(2)(B) of the Code. However, due consideration must also be given to sections 116, 117, and 119 of the Code.

Amounts received as an annuity, under an annuity contract, shall be included in gross income in accordance with section 22(b)(2) of the Code. There shall be excluded, however, the excess of the amount received in the taxable year over an amount equal to three percent of the aggregate premiums or consideration paid for such annuity, until the aggregate amount excluded from gross income equals the aggregate premiums or consideration paid for such annuity, after which all amounts received shall be included in gross income.

In addition to the items specified in section 22(b) of the Code, section 116(a)(1) of the Code, as amended by the Revenue Act of 1951, 65 Stat. 452, provides that there shall be excluded from gross income, in the case of an individual citizen of the United States who establishes bona fide residence in a foreign country or countries for an uninterrupted period which includes an entire taxable year, amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) if such amounts constitute earned income, as defined in paragraph (3) of section 116(a) of the Code, attributable to such period.

Treasury Decision 6039, C.B. 1953-2, 162, amended Regulations 111, section 29.116-1(a), and held that for taxable years beginning after December 31, 1950, the exemption from tax provided by section 116(a) of the 1939 Code is applicable to amounts constituting earned income, as defined in section 116(a)(3), from sources without the United States, if not paid by the United States or any agency or instrumentality thereof, and if attributable to an uninterrupted period of bona fide foreign residence which includes an entire taxable year or attributable to that portion of such an uninterrupted period which falls within a taxable year during the course of which the citizen begins or terminates bona fide residence in a foreign country, provided that such period includes at least one taxable year. If attributable to an uninterrupted period in respect to which the citizen qualifies for the exemption from tax thus provided, the amounts shall be excluded from gross income irrespective of when they are received, if received in taxable years beginning after December 31, 1950.

Treasury Decision 6039, supra , also held, in effect, that an amount constituting earned income, as defined in section 116(a)(3) of the 1939 Code, which is derived from sources without the United States, shall not be included in gross income solely because it is received within the United States, since the place of receipt is immaterial in determining whether any items shall be excluded from gross income under the provisions of section 116(a). No amounts received for services performed within the United States shall be excluded from gross income by such section. For the allocation or segregation as between sources within, and sources without, the United States in the case of compensation for labor or personal services, see section 119 of the 1939 Code and regulations thereunder.

Earned income as defined in section 116(a)(3) of the Code means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered. However, see IR-Min. 71, C.B. 1952-2, 170, which states that the portion of any distribution from an annuity or pension plan which represents a return of the employee's own contributions may not be property classed as earned income within the meaning of section 116(a)(3) of the Code, and that to the extent such distributions represent earnings on and accretions to contributions of either the employer or the employee, they constitute income from sources within the United States and accordingly are includible in gross income.

Since, in the instant case, the bona fide residence in a foreign country was continuous and uninterrupted for a period of 30 years, the annuity payments received in taxable years beginning on and after January 1, 1951, may be excluded from gross income in the manner provided in section 22(b)(2)(B) of the Code, to the extent they constitute earned income, within the meaning of section 116(a)(3) of the Code, attributable to such period.

Beginning in 1945, the taxpayer treated the annuity payments in the manner provided in section 22(b)(2)(B) of the Code and thereby, prior to January 1, 1951, recovered tax-free all of his own contributions toward the cost of the annuity as consideration paid for such annuity. However, in determining the amount of the annuity payments received under the employer's annuity plan in any taxable year beginning on or after January 1, 1951, which must be included in gross income pursuant to section 22(b)(2)(B) of the Code, the `consideration paid' for such annuity would be the aggregate of the employee's contribution plus the amounts contributed by the employer which are attributable to services rendered as a bona fide resident of a foregn country or countries. Since the employee's own contributions have already been recovered tax-free, the amount remaining to be recovered tax-free in taxable years beginning after December 31, 1950, will in this case, be limited to the employer's contribution attributable to the services rendered as a bona fide resident of a foreign country or countries.

Accordingly, it is held that for taxable years beginning after December 31, 1950, and subject to the Internal Revenue Code of 1939, annuity payments made to a resident citizen beneficiary, under an employees' funded pension or annuity plan which meets the requirements of section 165(a) of the Code, to the extent they represent the employer's contribution under the plan on account of the employee's services during an uninterrupted period (which includes an entire taxable year) of bona fide residence in a foreign country or countries, may be considered as earned income attributable to such period within the meaning of section 116(a)(1) of the Code and, as such, may be excluded from gross income as `consideration paid' for the annuity under section 22(b)(2)(B). However, that portion of the annuity payments which represents the earnings on or accretions to contributions of either employer or employee is not earned income within the purview of section 116(a) of the Code and therefore not exempt under such section.